20 pct royalty on O&G is quite affordable Part I

Borneo states’ sole right to impose royalty

“ROYALTY means share of the products of proceeds from the oil and gas produced and reserved to the owner of land for permitting another [Petronas] to use the property:” MCculloh v Almach (OKA 1941).

It is very different from the historical subservient usufruct, namely where the federal government and Petronas would only have a limited legal usufructuary right, if lawfully given by the owner for a specific time period akin to shorter than life estate or by operation of the law in enjoying the profits from a property or leases that belong to the owner with no right of alienation but servitude under the Roman Law or a limited in rem right under the Civil Law.

But it is very different in the case here on the Sarawak’s dominion of its O&G with the exclusive right to issue O&G licenses and impose royalties or local sales tax for the time being as the alternative and on the oil by-products per se.

Nevertheless, royalty like a rose is still a royalty by other names for the federal government and Sarawak, such as cash payments of 10% for winning the O&G of Sarawak under Section 4 of the PDA 1974, because of the additional and unofficial (oral) 5% royalty as an additional development fund given to Sarawak, as assured by Tun Razak on behalf of the federal government in consideration of aborting the declaratory judgment in the Privy Council on the PDA 1974 by Tun Rahman Yacob, the third Chief Minister of Sarawak, on behalf of the Sarawak government under the Assurance in Article VIII of the MA1963.

Therefore, the coastal state of Sarawak has the dominion of its oil and gas (O&G), namely the sole entrenched legal ownership, sole economic right and constitutional rights under the four-tiers entrenched provisions of Item 2(c) of the State List Ninth Schedule, a part of the 7 Articles of the federal constitution (“7FCs”) and 7 protective municipal laws of Sarawak (“7PMs”) to exclusively issue profit sharing contracts (“PSCs”) on its land under its entrenched Item 2(a) with the proprietary and property rights of its O&G stretching from onshore to 350 nautical miles in its continental shelf under Section 76 of the United Nations Convention on the Laws of Seas (“UNCLOS”) 1982.

Under the constitutional entrenched Item 2(d) and Article 95D of the Federal Constitution (“FC”), the federal government is prohibited to compulsorily acquire Sarawak’s O&G with reasonable compensation under Article 13 of the FC which is applicable only to the various states of Malaya and Federal Territories.

Consequently, Sarawak, not the federal government, has the sole constitutional right to issue PSCs and impose royalty.

Fixed royalty which is paid based on the sale price of O&G before the recovery of costs and taxes to the dominion of Sarawak on its O&G, but not to the federal government, is very different from the net net profit after all the costs, deductions, allowances, amortizations, R/C index, threshold volume, depreciation, abandoned costs, taxes, past losses, if any, and others depending on how trim and efficient in managing the costs and profits aiming at margin of profits, but not on gross turnovers, as in large corporations.

So, Sarawak with its dominion has the sole constitutional and legal right to impose royalty on its O&G under the 7 PMs and 7FCs specifically accepted by the federal government under item 3 of the Part V of the Tenth Schedule of the FC and others.

However, the federal government has only imperium, namely political rights and sovereignty only in the context of jurisdiction between sovereign nations and administrative control over and duty to safeguard Sarawak’s O&G, but no dominions on the O&G of the Borneo Territories nor any right to impose royalty nor right to issue PSCs under the entrenched provisions of Item (c) and other items of the Ninth Schedule and the federal constitution (“FC”).

Taxes and share profit of O&G for federal is around 75% to 80% now

The royalty is paid by way of 10% cash payment or “royalty” under a different name by Petronas to the federal government and 5% official royalty to the Borneo Territories with varied internal arrangement.

Officially it is 5% for Sarawak every six months directly from Petronas, unofficially another 5% additional unofficial royalty mentioned above, totalling 10% before recovery cost and taxes, as and when the state would request for it.

In the contractor company’s 15% (net 11%) Petronas has 15% to 20% with no management/ working interest with carried interest (free) and some direct investments in the older PSCs but more direct investments from 40% to 60% with controlling working interest in the new PSCs.

Based on US $100 bbl on oil for easier calculation (with certain assumptions), the profit centres, taxes and share profit on Sarawak’s O&G for the federal government excluding Petronas’s taxable profit are shown approximately as follows: (1) The taxes/impositions would be petroleum income tax (PITA) 38% (10% net with deductions), (2) 10% export tax (4% net with deductions), (3) Supplementary tax (excess profit tax with deductions) (4% net) based on US $ 50 bbl, (4) Cess research 0.5% (0.15% net) imposed on the contractor company only, (5) 3.85% State Equity Cash Flow (under federal’s control) totalling 22% revenue for the federal government.

Minus the standard 10% royalty before recovery costs and taxes as cash payments, there is still a balance of about 53% share profit on O&G of pure revenue or gravy for the federal government totalling 75% with the share profit O&G including the 22% taxes with the State Equity Cash Flow now with certain variations due to the different O&G fields and fluctuating prices of O&G daily.

But still there is another 5% balance cash payment left with the federal government after minus the unofficial 5% royalty.

So out of the 53% pure share profit of Sarawak’s O&G 10% royalty can be used to pay half of the 20% affordable royalty approved unanimously by the Sarawak Council Negeri including the honourable YBs from DAP and PKR Sarawak representing Sarawak’s interest.

Absorbing that cost still makes gas competitive.

The other 10% royalty comes from the existing official payment of 5% by Petronas under the 2page Sarawak Oil Agreement and another assured 5% unofficial and oral additional royalty mentioned above.

In brief, the federal government after paying 10% additional royalty still has pure revenue of 43% (53%-10%) of the share profit of O&G and 22% tax inclusive of the State Equity Cash Flow under its control, totalling 65% plus 5% balance of cash payment as royalty, apart from Petronas own profit centres with dividends for taking care a part of the national financial rescue packages to plug the Rm 1 trillion financial hole.

There is no federal sale tax nor any tax on the 53% pure revenue unless Petros takes over the licensing of PSC.

Of course, Sarawak also will impose state sales tax on that 53% or 43% on the share profit of O&G under Item 7 of Part V 10th Schedule, including downstream, distillates,LNG, fertilizers and petrochemical products and CNG in future which Petros and Petronas should set up another one in the state, if feasible.

Chinese companies would be keen for the market shares. Bintulu will do well for future CNG’s hub like Singapore.

Contractor companies on 15% IRR

The contractors’ companies are subject to variable R/C Index, depreciations, deductions, abandoned costs, tax, capital allowances THV (threshold volume) at different level and changes of percentage of shareholdings ratio.

Therefore on shallow waters, 20% royalty poses no problem even if the oil price is at US$40 bbl or at US $4/MCF for gas.

For deep waters, the contractor has special cost recovery with their EEA costs, CAPEX and OPEX allocated about 15% for its IRR.

RSC is in the back burner after termination of Balai Cluster and BERANTI due to poor recovery and price.

However, the hitherto 75% to 80% plus for the federal share profit and Petronas’s profit on O&G over the last 40 years compared to the official 5% and 5% unofficial royalty for Sarawak and 5% for Sabah would be quite disproportionate and inequitable based on net loss not net gain to Sarawak respectively with only a partial payment of that unofficial 5% royalty being made sporadically in the past.

A reconciliation statement would not be out of order.

The balance due to Sarawak could be used to offset agreed acquisitions of the assets of Petronas, if agreed by the federal government.

20% royalty is quite affordable even oil at US $40 bbl Based on contractor companies’ estimates, the net federal government’s share profit of O&G as pure revenue excluding the taxes imposed on the contractor companies’ portion with Petronas investments and carried interest in the PSCs but including the existing 10% (5%+5%) royalty for Sarawak as assured by Tun Razak, plus another 10% royalty out of share profit on Sarawak’s O&G totalling 20% for the Sarawak government, excluding the 4 taxes and Petronas taxable profits, would be even affordable at different prices, approximately as follows : (i) At US $40 per bbl : 44% share profit of oil with 10% additional royalty (totalling 20%), it still would leave behind 34% share profit on oil as pure revenue; (ii) At US $60 per bbl : about 49% of the share profit on oil less the 10% additional royalty totalling 20% royalty would still leave behind 39% share profit; (iii) At US $10/ MCF - the estimated share profit on gas would be around 40% after less 10% additional royalty totalling 20%, and it would still leave behind 30% share profit on gas (boe); (iv) At US 6/MCF - The share profit would be about 35%, after deducting 10% royalty with total 20% royalty similarly it would leave behind 25% still; (v) At US $4/MCF the share profit would be about 30%.

After deducting 10% out of the 20% royalty (10%+10%) in total, it would leave behind 20% still.

In addition, there is the 5% balance of 10% cash payment in the federal government.

Only revenue of RM204,908 filed by Petronas in SSM

For the profit of Petronas from Sarawak’s operation including perhaps the O&G, the downstream LNG and others, the petrol kiosks and others as reported, if accurate, though strangely was not reflected in the audited financial account of Petronas, as a public company filed with SSM (20076-K) which showed only a revenue of Rm204,908 against the report of Rm45.4 billion profit in 2017 (net?).

So 20% royalty for payment is quite affordable, but would be very inequitable and unjustifiable on the net net profit formula, as dominion of its O&G.

Sarawak has several production platforms for payment of the 20% (10%+10%) royalty with the critical and transparent sums and parts, share profits of O&G details from the Data Room of Petronas including the detailed audited accounts of the sales in real times to reflect different market prices fluctuating daily which ought fairly be made available to verify this quite affordable 20% royalty at all times.

Council Negeri has the constitutional and legal right to have those details to answer on 20% royalty for meaningful debates and discussions, under the Rule of Law and administrative governance recently proclaimed by the federal government.

Let our farsighted Prime Minister be the right person, in the right time and in the right place of the Borneo Territories to do the right thing to fulfil the visions, aspirations and dreams of the founders of the Borneo Territories under MA 1963.