Conservative estimates suggest that in the wake of oil prices crashing in late 2014, the Malaysian oil and gas services and equipment (OGSE) sector contracted by at least 11%. Analysis of overall financials for the OGSE sector by the Malaysian Petroleum Resource Corp, an agency under the Prime Minister’s Department, reveal that revenue for 2015 fell by 11%, while profits contracted by a severe 52.3%. Including companies such as MISC, Sapura Energy, Dialog, Scomi, Bumi Armada, the numbers for 2016 are not available yet, but a glance over the financial reports released for the bigger players indicate that while sector revenue will probably be down for the year, profits maybe be up, after aggressive cost-cutting that included a tide of retrenchments.
So what is in store in 2017 and beyond?
If we go by the health of Petroliam Nasional Berhad, better known as Petronas, the word seems to be “cautiously optimistic”. The guardian and bellwether of Malaysia’s Oil & Gas sector, Petronas is one of the few major integrated state oil companies that is holding up fairly well during the current on-going oil crises. Petrobras is engulfed in debt, as is PDVSA, while Pertamina appears to be struggling with corruption and clarity of its long term investment direction while select Russian entities battle being used as political tools. Full year 2016 revenue for Petronas fell by 17.3% from lower sales coupled with weak crude prices but profit was up by a whopping 28% to RM16.95 billion (US$3.82 billion), just slightly behind Shell’s own profit for 2016. For 2017, Petronas projects better times ahead, promising no more staff redundancies and bolstering defences by pegging its 2017 capex expenditure at US$45/b, while it prepares to focus on natural gas - both at home in Sarawak and Sabah, and abroad in its Canadian LNG export project, and the recent go-ahead given to its massive US$27 billion RAPID refinery and petrochemicals project.
However if oil prices fall any further or just lingers within the US$50-55/b range, the so called recovery being experienced now, may just stagnate or not be strong enough to re-boot the industry to its previous glorious days and create the jobs badly needed for Malaysia. The threat of market oversupply is still there as US shale oil continues to grow unabatedly. The reality is low oil prices for (much) longer. The future prosperity of Petronas would depend on how much it can increase its productivity and lower production costs. Petronas has moved very decisively and embarked on intensifying its internal cost competitiveness through better collaboration amongst other upstream operators in Malaysia through the CORAL 2.0 project, and is beginning to see lower cost scenarios for its well engineering programs already. On the new technology front, Petronas is collaborating with MIT Innovation Sdn Bhd (MIT) to promote a smart and efficient technology that significantly lowers drilling costs. All moves in the right direction.
The weak link to Petronas’s current cost strategy and competitiveness globally could however be its very own local supply chain. As Petronas tries to prosper in the current climate, the industry that supports it needs to be similarly positioned to do the same - efficient and cost competitive. With the exception of a few large players like MISC, Sapura Energy and Dialog that have the width and breadth to survive challenging conditions like in 2015 and 2016, further down the supply chain, the smaller players many of whom are just agents or third-party equipment representatives do not necessarily own technology, are extremely vulnerable to volatility. (Debt is a particularly pressing concern in this end of spectrum especially in the offshore segment, with players like UMW Oil & Gas, Dayang Entreprise and Perisai Petroleum Teknologi facing recent problems in renegotiating their debt incurred during the good times. Those who can’t keep afloat will be targets for acquisition or forced mergers, like the recent merger between UMW Oil and Gas, Icon Offshore and Orkim.) In a recent business seminar, Malaysia Petroleum Resources Corp (MPRC) senior vice-president Syed Azlan Syed Ibrahim said that “although we foresee 2017 will not be far off than 2016, I do not think it will be worse. This is the opportunity for players to make the hard decision to restructure or reform. That time is now. They (local oil & gas supply chain companies) need to do it now so that when the market goes back up they will be ready” Calls for consolidation amongst local companies, especially in the upstream segment will help strengthen the industry, allowing for greater combination of resources for increased technological innovation and value creation that is urgently needed for Petronas to be competitive locally and overseas. Less reliance on foreign US dollar denominated technology or service providers will help Petronas achieve its low cost operations goal.
As Petronas announces fewer projects in 2017 compared to pre-2014 levels, local service player will need to compete and work outside Malaysia for revenue and business growth. It will be useful here for the local oil industry to emulate the success in the Norway. As we have seen and witnessed the growth of Statoil, Norway's national oil company, as a global player in the oil industry, it is backed-up with a group of highly matured and capable technology and services providers. The grouping is now known as Norwegian Energy Partners or NORWEP in short. NORWEP looks beyond the shores of Norway for new business, and compete for projects globally. It independently (without Statoil’s direct assistance) builds relations with other governments and strategically partners with other state controlled oil companies. To date, it has achieved a respectable track record in developing new technologies in enhanced oil recovery methods as well as strong health & safety in its operations.
Looking into the future of energy, the argument for diversification into how energy will be generated, distributed and utilised also seems compelling. Shell is convinced that the next phase of fossil fuel energy will belong to gas. Petronas is well positioned in the gas business, as it continues to be within the top 3 exporters of LNG globally with strong gas reserves and infrastructure locally as well as internationally, especially in Canada. However the argument for energy diversification goes further from fossil fuels. During the 2017 CERAWeek, the fossil fuel big annual conference, most speakers proclaim a long and prosperous future for their industry. But companies and countries that rely on oil and gas income are recognizing that renewable forms of electricity are gaining traction as prices come down and their popularity rises. Oil executives are adapting their portfolios to add cleaner fuels and moderating their rhetoric on climate change. "A low-carbon future will reshape the energy space. Some see this as a threat to our industry, but we should rather look for and act on the opportunities it offers," said Eldar Sætre, CEO of Norway's Statoil. "We have to respond more forcefully to the challenge of climate change." The oil and gas industry has clearly recognized that its monopoly on transportation fuels is weakening for the first time since automobiles replaced horse-drawn carriages. To be fair, Petronas has embarked on feasibility projects in renewable energy space with the commissioning of a Solar Independent Power Plant (IPP) project in Gebeng in Kuantan. The Solar IPP project came on-stream in 2013 has a capacity of 10 megawatt peak (MWp). However this venture seems to be dwarfed by recent announcements especially from the gulf operators. Saudi Aramco is planning to produce 10 gigawatts of power from renewable energy sources including solar, wind and nuclear by 2023 and transform Aramco into a diversified energy company. The kingdom also plans to develop a renewable energy research and manufacturing industry as part of an economic transformation plan announced by Deputy Crown Prince Mohammed bin Salman. Shell, Europe’s largest oil company, has also recently established a separate division, called New Energies, to invest in renewable and low-carbon power. The new division brings together its existing hydrogen, biofuels and electrical activities. Should Petronas make bigger investment in-roads into the renewable energy sector now rather than later? Shell is projecting that it will not make any money from renewable investments at least for another 10 years. Getting ahead in the game will certainly help any new player. Noting of course that there are other players in Malaysia in the renewable energy scene, for example Tenaga Nasional Berhad or TNB is growing its portfolio in solar energy aggressively.
In conclusion, Petronas seems to be generally on the right path in evolving its energy mix and growth strategy in the energy sector. Being a state controlled company, it will require undivided political support to transform its local supply chain and embark on a commercially driven low cost structure. If the large dividends that Petronas pays annually to Government are to continue, it should be an incentive for the Government for more action to reform the industry’s supply and support base.
Petronas being a large and complex business, reforms typically take time. However due to the prolonged nature of the low oil price climate, the pace of change impacting the industry seems to be moving faster compared to previous downturns. As the oil business is global and fairly transparent in terms of revenue and cost structure, Petronas is unfortunately unable to dictate it’s not own timeline in reforming itself and the industry that supports it. “Faster the better..lah” seems to come to mind. Easier said than done.
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Unplanned crude oil production outages for the Organization of the Petroleum Exporting Countries (OPEC) averaged 2.5 million barrels per day (b/d) in the first half of 2019, the highest six-month average since the end of 2015. EIA estimates that in June, Iran alone accounted for more than 60% (1.7 million b/d) of all OPEC unplanned outages.
EIA differentiates among declines in production resulting from unplanned production outages, permanent losses of production capacity, and voluntary production cutbacks for OPEC members. Only the first of those categories is included in the historical unplanned production outage estimates that EIA publishes in its monthly Short-Term Energy Outlook (STEO).
Unplanned production outages include, but are not limited to, sanctions, armed conflicts, political disputes, labor actions, natural disasters, and unplanned maintenance. Unplanned outages can be short-lived or last for a number of years, but as long as the production capacity is not lost, EIA tracks these disruptions as outages rather than lost capacity.
Loss of production capacity includes natural capacity declines and declines resulting from irreparable damage that are unlikely to return within one year. This lost capacity cannot contribute to global supply without significant investment and lead time.
Voluntary cutbacks are associated with OPEC production agreements and only apply to OPEC members. Voluntary cutbacks count toward the country’s spare capacity but are not counted as unplanned production outages.
EIA defines spare crude oil production capacity—which only applies to OPEC members adhering to OPEC production agreements—as potential oil production that could be brought online within 30 days and sustained for at least 90 days, consistent with sound business practices. EIA does not include unplanned crude oil production outages in its assessment of spare production capacity.
As an example, EIA considers Iranian production declines that result from U.S. sanctions to be unplanned production outages, making Iran a significant contributor to the total OPEC unplanned crude oil production outages. During the fourth quarter of 2015, before the Joint Comprehensive Plan of Action became effective in January 2016, EIA estimated that an average 800,000 b/d of Iranian production was disrupted. In the first quarter of 2019, the first full quarter since U.S. sanctions on Iran were re-imposed in November 2018, Iranian disruptions averaged 1.2 million b/d.
Another long-term contributor to EIA’s estimate of OPEC unplanned crude oil production outages is the Partitioned Neutral Zone (PNZ) between Kuwait and Saudi Arabia. Production halted there in 2014 because of a political dispute between the two countries. EIA attributes half of the PNZ’s estimated 500,000 b/d production capacity to each country.
In the July 2019 STEO, EIA only considered about 100,000 b/d of Venezuela’s 130,000 b/d production decline from January to February as an unplanned crude oil production outage. After a series of ongoing nationwide power outages in Venezuela that began on March 7 and cut electricity to the country's oil-producing areas, EIA estimates that PdVSA, Venezuela’s national oil company, could not restart the disrupted production because of deteriorating infrastructure, and the previously disrupted 100,000 b/d became lost capacity.
The UK has just designated the Persian Gulf as a level 3 risk for its ships – the highest level possible threat for British vessel traffic – as the confrontation between Iran with the US and its allies escalated. The strategically-important bit of water - and in particular the narrow Strait of Hormuz – is boiling over, and it seems as if full-blown military confrontation is inevitable.
The risk assessment comes as the British warship HMS Montrose had to escort the BP oil tanker British Heritage out of the Persian Gulf into the Indian Ocean from being blocked by Iranian vessels. The risk is particularly acute as Iran is spoiling for a fight after the Royal Marines seized the Iranian crude supertanker Grace-1 in Gibraltar on suspicions that it was violating sanctions by sending crude to war-torn Syria. Tensions over the Gibraltar seizure kept the British Heritage tanker in ‘safe’ Saudi Arabian waters for almost a week after making a U-turn from the Basrah oil terminal in Iraq on fears of Iranian reprisals, until the HMW Montrose came to its rescue. Iran’s Revolutionary Guard Corps have warned of further ‘reciprocation’ even as it denied the British Heritage incident ever occurred.
This is just the latest in a series of events around Iran that is rattling the oil world. Since the waivers on exports of Iranian crude by the USA expired in early May, there were four sabotage attacks on oil tankers in the region and two additional attacks in June, all near the major bunkering hub of Fujairah. Increased US military presence resulted in Iran downing an American drone, which almost led to a full-blown conflict were it not for a last-minute U-turn by President Donald Trump. Reports suggest that Iran’s Revolutionary Guard Corps have moved military equipment to its southern coast surrounding the narrow Strait of Hormuz, which is 39km at its narrowest. Up to a third of all seaborne petroleum trade passes through this chokepoint and while Iran would most likely overrun by US-led forces eventually if war breaks out, it could cause a major amount of damage in a little amount of time.
The risk has already driven up oil prices. While a risk premium has already been applied to current oil prices, some analysts are suggesting that further major spikes in crude oil prices could be incoming if Iran manages to close the Strait of Hormuz for an extended period of time. While international crude oil stocks will buffer any short-term impediment, if the Strait is closed for more than two weeks, crude oil prices could jump above US$100/b. If the Strait is closed for an extended period of time – and if the world has run down on its spare crude capacity – then prices could jump as high as US$325/b, according to a study conducted by the King Abdullah Petroleum Studies and Research Centre in Riyadh. This hasn’t happened yet, but the impact is already being felt beyond crude prices: insurance premiums for ships sailing to and fro the Persian Gulf rose tenfold in June, while the insurance-advice group Joint War Committee has designated the waters as a ‘Listed Area’, the highest risk classification on the scale. VLCC rates for trips in the Persian Gulf have also slipped, with traders cagey about sending ships into the potential conflict zone.
This will continue, as there is no end-game in sight for the Iranian issue. With the USA vague on what its eventual goals are and Iran in an aggressive mood at perceived injustice, the situation could explode in war or stay on steady heat for a longer while. Either way, this will have a major impact on the global crude markets. The boiling point has not been reached yet, but the waters of the Strait of Hormuz are certainly simmering.
The Strait of Hormuz:
Headline crude prices for the week beginning 8 July 2019 – Brent: US$64/b; WTI: US$57/b
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