Faced with the prospect of finite oil reserves and a crippling domestic gas shortage, state-owned Malaysian O&G company PETRONAS has gone into overdrive, as it seeks to sustain oil production and secure a long-term supply of gas. Last year, it announced a number of high-profile projects, including the development of marginal oil fields at an estimated cost of five billion ringgits ($1.7 billion), enhanced oil recovery for 46 billion ringgits, and the North Malay Basin project worth 15 billion ringgits. But the focus is not just upstream: PETRONAS has been increasing downstream activities as well with the five billion ringgit Pengerang Independent Deepwater Petroleum Terminal, for instance. It is also conducting a feasibility study on its 60 billion ringgit Refinery and Petrochemical Industrial Development (RAPID ) project in southern Johore. All in all, the energy giant has allocated up to 72 percent of its capital expenditure on domestic projects in the past two years; up from 55 percent previously.
All of this points to an O&G revival in Malaysia starting from 2012, say industry watchers, who note that the rising tide is expected to lift domestic energy players, aside from allowing for involvement by foreign entities. This, says Andrew Nimmo, partner at Watson Farley Williams Asia Practice (WFWAP) in Singapore, will allow local companies to move up the value chain. “You only need to look at the growth and success of the likes of Bumi Armada, MIS C, MM HE, Petronas, GPS and SapuraCrest outside Malaysia,” he says. “There are also up-and-coming local players like M3nergy that are among those to watch.” He adds that the firm has worked on numerous projects for Malaysian entities looking to apply their know-how and growth outside Malaysia. “These have included projects in Nigeria, Vietnam, Indonesia, Australia and India,” he says.
As it beefs up its exploration and production activities, PETRONAS has begun awarding an increasing number of new production sharing contracts; 11 were awarded in 2011, in contrast to just four PSCs in the previous year. In January, it awarded PSCs for two EOR projects in offshore Sarawak and Sabah in East Malaysia to Shell Malaysia and PETRONAS ’ subsidiary, PETRONAS Carigali, respectively. Under the new EOR PSCs, Shell Malaysia and PETRONAS Carigali will further develop nine oil fields in the Baram Delta, and four oil fields in the North Sabah development area using EOR and other related technologies. “[These projects] certainly seem to be a step in the right direction,” says Tan Hon Yik, deputy managing partner at Naqiz & Partners. “I expect to see a lot more tie-ups in the joint ventures and alliances in the near future.”
Challenges amid opportunities
Malaysia’s crude oil and condensate reserves stood at about 5.86 billion barrels of oil equivalent, or about 26 more years of oil, as of January 2011. Currently, it has 106 marginal oil fields (producing 30 million barrels of oil equivalent or less), along with a combined 580 million barrels of oil reserves. PETRONAS plans to develop a quarter of these fields. In fact, some 22 additional marginal oilfields have also been identified for development. At the end of 2010, the government took the first step towards sustainable oil production by offering tax incentives to companies, thereby enhancing the commercial viability of abandoned marginal fields.
Gerawat Gala, managing partner at Zaid Ibrahim & Co in Malaysia, says that while the EOR and RAPID projects are technically feasible, the success of these projects will also be dependent on the contractual and commercial terms offered by PETRONAS to the companies that have the technical capability, financial capacity and human resources to undertake such projects successfully. “PETRONAS and Shell have recently signed an agreement for EOR projects in Sarawak waters for the next 20 years. I am very sure both parties are committed to making the EOR project a success in terms of increased and sustained production of oil and gas in the areas covered,” he says. “The challenge will be for PETRONAS and the multinational companies with the EOR technology to allow for meaningful participation of local Malaysian industry players.”
WFWAP partner Goh Mei Lin adds that economics will play a crucial role. “Given the upstream offshore nature of many of these projects, and the need to utilise high value capex equipment such as floating production storage and offloading units (FPSOs), mobile offshore production units (MOPUs), floating storage and offloading unit (FSO) rigs, and potentially floating liquefied natural gas (FLNG ) and floating storage and regasification unit (FSRU) assets, the most important issue will be the long term barrel price, with anything over $60 to $70 making the return on capex economic,” she says. Tan adds: “They need to be careful about costs.”
Increasing foreign investment
According to Gala, there will be an inevitable increase in the amount of foreign investment into Malaysia’s O&G industry. “As the owners and practitioners of the technologies for EOR and deepwater projects are the multinationals, and due to the increasing focus on EOR and deepwater projects as the main source of future oil and gas production, there will certainly be an increase,” he says. Gala notes that production from most fields in shallower and near-water areas has been depleting over the years – the average recovery factor is only half the 46 percent average in the orth Sea – and, therefore, EOR has become absolutely necessary to prolong the field’s productive life. “The cost of exploring and producing from deep waters is beyond the capacity of Malaysian companies as the risks involved are huge,” he adds. EOR implementation is also currently expensive, with the cost of deploying chemical EOR currently being $13 per barrel. However, PETRONAS ’ initiative is expected to be supported by new tax incentives for marginal field development, as well as rising global oil prices.
WFWAP partner Damian Adams says that the trend of foreign investment into Malaysia’s O&G industry is already happening. “We have worked on a number of joint ventures for FPSO, MPO and offshore support vessel assets (OSV) for the likes of MIS C, SapuraCrest and Bumi Armada where foreign investors have been the joint venture parties,” he says. “We are also seeing the growing presence of foreign players, such as Petrofac, Transocean, Shell and Hess using Kuala Lumpur as a regional base.”
Gala says that for foreign investors, the bureaucracy and attracting local talent might be twomajor issues. “The immediate obstacles facing foreign investors will be their readiness or willingness to comply with PETRONAS ’ licensing requirements, and the necessity to employ and train local expertise,” he says. “Most Malaysians with the requisite skills and experience may prefer to work outside Malaysia due to the attractive remuneration as international staff.” Additionally, he says that foreign investors may be required to share resources or facilities to optimise costs by, for example, sharing drilling rigs, barges, and pipelines to evacuate their production. Currently, foreign players are required to tie up with local listed partners, which in turn need to hold at least 30 percent equity ownership in the joint venture. But Adams does not feel it will greatly impact foreign investment in the sector. “Restrictions on direct foreign investment may delay, but will not prevent exploration and production in the end,” he says. “While there will be some potential issues with maintenance of 30 percent control for listed companies, I do not see many issues that would prevent foreign investment.”
Law firm s size up potential
One of the things that investors need to keep in mind is that the whole of the oil and gas industry in Malaysia is covered by the Petroleum Development Act (PDA ), a very comprehensive piece of legislation. Gala says that one notable drawback of the act is that it makes PETRONAS the ultimate owner of all facilities built by the PSCs or investors. “While PETRONAS can negotiate with various PSCs to share facilities with other PSCs to ensure optimum utilization of facilities and, therefore, reduce project development costs through economies of scale, an agreement among PSCs is difficult to achieve,” he says. “There may be a need to amend the PDA to allow PSCs to own or part own facilities with PETRONAS , so that they can also benefit from tariff charges for utilisation of their facilities.”
Marcus Gordon, partner at WFWAP, says that among legal services, what will be most in demand is “dispute resolution in relation to the delays and cost overruns associated with construction of FPSOs, FSOs, FSRUs, tender rigs and pipelayer barges/vessels in the Malaysian and Singapore yards.” He adds: “Another area in which we expect increased activity is in consolidation – the merger of SapuraCrest and Kencana Petroleum being the most obvious recent example. As the sector develops, we expect the number of players to reduce and get larger by way of acquisition of assets and/or competitors.” Finally, he expects finance practices to be in demand from local and international banks in addition to ECAs, all of which are providing project finance to Malaysian oil and gas developers and contractors. Tan of Naqiz says that much of the work his firm does in this area relates to joint ventures in exploration, terminals and also offshore services, apart from advising on matters under the PDA .
However, Gala does not think there will be a significant increase in business for law firms. “Most industry players are more comfortable getting services from their large in-house legal department because they believe in-house legal resources know their business better, and are less costly,” he says. “They do refer to outside legal firms for specific advice and services for certain agreements, such as gas sales agreements, technical service agreements, facilities sharing agreements, as well as review of operational contracts.”
Looking ahead, he believes that law firms should employ some lawyers with oil and gas experience. Alternatively, they should consider making experienced lawyers available for short assignments with PSCs and oil and gas contractors as in-house counsels to give them a better understanding of the business. “There will be increasing demand for legal services, but legal firms must ensure that they have counsels who have exposure and experience handling oil and gas projects in order to get the confidence of the PSCs and the contractors on the competency of such counsel to handle oil and gas work,” he says.
According to Tan, demand for offshore and additional support services is expected to increase in the near term. WFWAP’s Nimmo says that successful firms need to be able to advise on commercial contracts such as EPCI/conversion/ construction contracts, charters/leases, O&M and drilling contracts, as well as specialised agreements. In addition, he says law firms should expect work in the upstream offshore sector to only increase in the future, as the phenomenon of depleting and remote wells and the need for deepwater assets will require more investment. However, he cautions firms that are currently eyeing the space from outside. “It is all about specialisation,” he says, “and given the limited number of specialists in the region, I would expect it to be very difficult for those that don't currently play in this space to become serious players, as the investment cost to enter is potentially very high and discounting into the market which is already price-sensitive, is a zero-end game.
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