December 4, 2016 9:00 pm JST
Company in focus

Petronas caught in dilemma between oil flatline, Malaysian politics

Shakeup on horizon for Malaysian state-owned giant after revenue hit

CK TAN, Nikkei staff writer

KUALA LUMPUR -- Late in the afternoon of Nov. 29, work came to a sudden halt in the offices of Petroliam Nasional Berhad.

Led by Wan Zulkiflee Wan Ariffin, the state oil company's president and group CEO, hundreds of group employees walked from company headquarters inside Kuala Lumpur's iconic Petronas Twin Towers to a nearby convention center in order to greet Nico Rosberg of the Mercedes AMG Petronas team, the winner of this year's Formula One championship. Fresh from the final race of the season, held in Abu Dhabi the previous day, he had been flown directly to Malaysia's capital.

"Formula One works for our brand, it works for our products and it works for our people," a jubilant Zulkiflee said of his company's involvement in the prestigious auto race.

But on Nov. 20, just days before the chief executive's euphoric speech, the Malaysian government announced it would not renew the Malaysian Grand Prix when its agreement to host the race expires in 2018, citing the 300 million ringgit ($68 million) annual operating cost. Petronas has been the title sponsor since the first race was held in 1999 at the Sepang International Circuit, at that time the Formula One's only Asian race besides Japan. Although details behind the decision have been sparse, it is believed the Grand Prix's toll on Petronas' coffers was a major factor.

Commodity crash

Malaysia's looming withdrawal from the Formula One schedule is indicative of the broader headwinds faced by Petronas -- the only firm in Southeast Asia featured on the Forbes Fortune 500 list -- and the country as a whole. Group earnings have been battered by the commodity price rout that began in the second half of 2014. Crude oil prices on Dated Brent, the group's main benchmark, plunged to a $52 average barrel price in 2015, down 47% from a $99 average the year before.

In the first nine months of 2016, group year-on-year net profit tumbled 58% to 7.5 billion ringgit, with an across the board drop in average realized prices for all products. Combined revenue at its four listed units -- Petronas Dagangan, Petronas Chemicals Group, Petronas Gas and MISC, which account for around a quarter the group total -- fell in tandem.

After a Nov. 30 OPEC meeting resolved to cut production, share prices for the four listed subsidiaries rose marginally at the end of trading on Dec. 1. The same day, however, Malaysian equities research firm Kenanga downgraded Petronas Chemicals and Petronas Gas stocks, noting that positive short-term prospects were already reflected in current share prices.

OPEC's decision sent the Brent benchmark up by 8% to pass $50 per barrel, but according to Jeffrey Halley, a senior market analyst at foreign exchange company OANDA, oil prices will likely struggle to sustain a $55 to $60 range going forward as the United States considers propping up shale gas production.

Petronas has already braced for a grim outlook, with a spending plan for 2016 formulated based on a conservative $30 per barrel. The group plans to reduce capital expenditure by 50 billion ringgit over the next four years, after spending an average of 58 billion ringgit annually since 2012.

So far, it has deferred constructing its second floating liquefied natural gas vessel after the recent successful commission of its first. It remains to be seen whether it will press ahead with a proposed $27 billion LNG gas plant in Canada for exports to Asia by April, when reports say a decision on the project is due. The group had made its foray in shale gas properties by acquiring Canada's Progress Energy Resources in 2012, a decision that one industry player said was "not farsighted enough" in the wake of the oil crash.

With a price recovery out of the question in the short term, BMI Research said it would be hard for Petronas to justify large-scale investment in costly plays, including frontier exploration and major greenfield developments for the group's upstream business.

Golden goose

Established by the Petroleum Development Act in 1974, the year after an oil embargo in the Middle East sparked a global economic crisis, Petronas' original charter was to manage domestic oil and gas assets -- until that time operated by Shell and other foreign companies. As an integrated oil and gas company with both upstream and downstream operations, Petronas acts as a regulator that determines the development of the industry in Malaysia.

The group scaled ever greater heights under former Prime Minister Mahathir Mohamad, who paved way for overseas explorations that began with Vietnam in 1991. Today, with operations in over 30 countries, it is capable of producing 2.29 million barrels of oil equivalent per day. Petronas logged sales of 329.1 billion ringgit during its recent peak in 2014, accounting for nearly a third of Malaysia's gross domestic product, while dividends and taxes from Petronas comprised 41% of government revenues in 2009.

The group has itself played a key role in infrastructure, notably the construction of Kuala Lumpur's landmark Twin Towers and development of the surrounding areas. It also bailed out the loss-making national carmaker Proton Holdings during the Mahathir government. Mahathir himself became an advisor to the group after his 2003 retirement until he was sacked by Prime Minister Najib Razak in April, after his outspoken criticism of government over the 1MDB corruption scandal.

The impact of low oil prices on the Malaysian economy has already been felt, with lower exports and weakening investment in the third quarter of the year. Earnings from Petronas and the oil and gas sector fell to 15% of total government revenues in 2016. Last year Malaysia introduced a goods and services tax to broaden its revenue base, a move which has dampened domestic consumption.

The burden on Petronas to deliver, meanwhile, remains as great as ever. Calling Petronas the "goose that lays the golden eggs for the nation," Najib said in September that the group could play a greater role and the government would ensure that it succeeded, according to state news agency Bernama.

Zulkiflee, appointed to head Petronas in April 2015, is desperate to take necessary measures to keep the businesses rolling and pump in money to state and government coffers.

A chemical engineer by training, Zulkiflee took the helm at a time when tumbling oil prices had already plunged the industry into turmoil. Amid the crisis, he saw an opportunity to take a scalpel to the 42-year-old group.

"We need to have a quantum change in the cultural beliefs of the whole group to be a high-performance company," Zulkiflee was quoted by a local daily as saying during a visit to London in September.

The call for a cultural change -- which is slated to include the introduction of a younger workforce to core management roles and a whistle-blowing policy to curb inefficiencies -- is part of six focus areas of an internal transformation unveiled by Zulkiflee in February to weather industry uncertainties. The first three areas of cash generation, cost efficiency and project execution are short-term measures to deal with plunging oil prices. To address long-term sustainability concerns, he flagged reforms to workplace culture, deployment of new technology and talent development initiatives.

As a wholly state-owned company, Petronas has long been seen as a haven of security and career prospects among Malaysians, who account for some 80% of its 50,000-strong workforce. But the myth of lifetime employment was dispelled for some 1,000 underperforming Petronas staff earlier this year, sacked under the group's first ever redundancy program.

Further layoffs were on the horizon as part of Zulkiflee's mission to transform Petronas into "a merit-based high-performing organization," he told a press conference in August, without elaborating on the size and scope of future cutbacks.

But as a state-owned enterprise whose employees are traditionally strong supporters of the ruling party, Petronas may not have much room to reduce headcount ahead of a looming general election.

The present government does not need to call a vote until the second quarter of 2018, but there are already signs that Prime Minister Najib may bring the poll forward a year in order to take advantage of a fractious opposition. After weathering the 1MDB scandal, Najib's United Malays National Organization -- the largest party in Malaysia's ruling coalition -- is likely to postpone any reform that risks alienating its political base.

"Once we have resolved the UMNO's internal issues, we should be ready to face the general election," said Najib recently at the party's annual convention.

Caught between the need for reform and political imperatives, investors are for now left to watch Petronas' next move on its Formula One partnership to divine Zulkiflee's commitment to change.

On Nov. 29, the Petronas chief did not touch on the fate of the existing partnership with Mercedes or the imminent end of the Malaysian Grand Prix fixture, only crediting the investment for raising the group's profile. The current partnership with Mercedes was renewed in May 2014 after the initial five-year contract, at an estimated $42 million annual cost. 

"Petronas is still a young company. Not many people know that we have been involved in F1 for the past 21 years. But it is the recent era that has been a really great story for us," he said, in the wake of the Mercedes team's championship victory.

Perhaps so, but it is in the coming era that the group's future is at stake.

-- Company in focus

-- CEO in the news

Asia300

PETRONAS Chemicals Group Bhd.

Malaysia

Market(Ticker): KLS(5183)
Sector:
Industry:
Process Industries
Chemicals: Specialty
Market cap(USD): 13,335M
Shares: 8,000M

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