Petronas may incur a write-off for pulling back from the ambitious gas pipeline project in Canada. But it had no other options, as the environment is not right for the project.
WHEN Datuk Wan Zulkiflee Wan Ariffin took over as president and chief executive of Petroliam Nasional Bhd (Petronas) two years ago, the biggest challenge he faced was to balance the cashflow of the national oil and gas company with its capital expenditure (capex).
In particular, he had to see through Petronas’ capital commitments of some RM176bil for two projects to be carried out right until 2019 – the Refinery and Petrochemical Integrated Development (Rapid) in Pengerang, Johor, and a gas pipeline cutting across Canada.
The RM60bil Rapid, which will become the largest oil and gas (O&G) hub in Asia, creating jobs and other spinoffs, has been seen as a project that the national oil company cannot afford to drop.
For one, the Rapid project has always had more certainty in the form of committed investments from other partners, approvals from authorities and seemingly minor execution risks.
The ambitious Canadian gas pipeline project, on the other hand, which would likely have been the single biggest investment by a Malaysian entity out of the country, has been fraught with challenges from day one.
The project faced a melange of issues ranging from aboriginal rights to environmental and legal challenges, not to mention the changing dynamics of the gas supply industry.
In fact, the approval given for the gas pipeline in September last year by the Canadian government came with 190 additional conditions, mainly environmental-related issues, which had to be adhered to by Petronas. This could have potentially escalated costs, say industry players.
Wan Zulkiflee took over from Tan Sri Shamsul Azhar Abbas in April 2015 when the O&G industry was spiralling down. But even then, it was a known fact that Rapid was going to go ahead. Today, Rapid is about 62% complete as of end-March and is expected to begin operations by 2019.
The fate of the C$36bil (RM124bil) Pacific NorthWest liquefied natural gas (LNG) gas pipeline in Canada, meanwhile, was largely dependent on the dynamics of the O&G prices.
Three years later, the reality is that sentiment in the O&G sector has not improved. Prices are still where they were in 2015.
So, when Petronas announced that it was not going ahead with the project in an annoucement last Wednesday, it did not come as a shock. It has been reported that Petronas would take a hit of up to US$800mil (RM3.4bil) for costs incurred in undertaking works related to the project so far.
“But the short-term pain is nothing compared to the long-term gain of not going ahead with the project,” says an executive of an O&G company.
Had Petronas gone ahead with the project, analysts have alluded that it would not have had enough cashflow to fund its capex and dividend payouts.
Moody’s Investors Service in a report last month noted that the national oil company’s cashflow from operations would not be sufficient to fund its capex and dividends.
At the time the report was issued, it had taken into consideration the possibility of Petronas undertaking the Canadian LNG pipeline project.
Not totally giving up
But it is noteworthy that Petronas isn’t totally giving up on its LNG ambitions in Canada that it had ventured into in 2012.
Petronas is simply realigning its strategy in that area and may team up with other oil major to build the gas pipeline in the future.
There are at least 18 proposals to build gas pipelines with terminals to export the gas in Canada, and it was a certainty that many would have failed under the current low gas price environment.
The view among industry executives is that Petronas may team up with other oil majors to build a gas pipeline cutting across that country.
In fact, Petronas itself has stated that it was still committed to its investments in Canada, held through Progress Energy Canada Ltd.
“Progress Energy will be re-aligning its strategic approach to developing its world-class natural gas assets in North Montney with its (North Montney) joint-venture (JV) partners,” Petronas says in an e-mail response to StarBizWeek.
Petronas also says that there is no need for it to write down its investment in Canada, as the assets are already producing.
“The North Montney assets are already producing and supplying natural gas (via a pipeline) to the Canadian domestic market. Its production has increased from about 200 million standard cubic feet per day (mmscfd) in 2012 to about 540 mmscfd in 2017,” it says.
It adds that it will retain its stake in Progress Energy and will also continue to explore ways to monetise its gas assets.
“From Petronas’ perspective, we see in the next 10 to 15 years, O&G will continue to be relevant in the energy market, where LNG will continue to be a preferred source of cleaner energy. Renewables will progressively continue to have their place, and we see it as a future potential for us,” says the national oil corporation.
Petronas first bought into Progress Energy for C$5.5bil in December 2012 during the tenure of Shamsul.
The Calgary-based Progress Energy is the largest holder of contiguous land in the North Montney area, which has rich resources of natural gas.
The acquisition by Petronas was made when oil prices were around US$100 a barrel. It had raised the issue of whether it was ill-timed and if the investment was worth all that money.
Progress Energy was then a listed company in Canada, and Petronas had offered its shareholders a price of C$22 per share, which was at a hefty 90% premium over Progress Energy’s share price at that time.
Subsequently, it sold equity in Progress and the LNG project to four partners – Japan Petroleum Exploration Co Ltd (10%), Petroleum Brunei (3%), Indian Oil Corp Ltd (10%) and China Petrochemical Corp (15%). Petronas is the majority owner of the Canadian project with a 62% stake.
That move not only lowered Petronas’ cost of acquisition and future capex costs, but also ensured that the bulk of its future production from the project had ready secured buyers, as these consortium partners had agreed to offtake their respective pro-rata shares of the LNG output from the project.
Notably, the Petronas-led gas pipeline was widely viewed by Canadian industry analysts as the most promising among 20 proposals to export gas from the country’s West Coast to energy-thirsty customers in Asia.
The Petronas gas pipeline would have supplied up to 19.2 million tonnes of LNG a year, or about 8% of last year’s global trade.
It would have enabled Petronas to sell and transport Progress Energy’s shale gas assets from British Columbia to lucrative Asian markets.
When the national oil company conceived the project, LNG was in sharp demand after Japan shut its nuclear plants following the 2011 Fukushima meltdown and needed alternative power supplies. At that time, spot LNG prices in Asia rose to near US$20 per million British thermal units.
Low LNG prices making it not viable
However, basic economics no longer make the project viable.
Had Petronas proceeded with the Canadian project, more capex would have been needed and the return on investment would have been longer simply because the price of gas has declined significantly.
By scrapping the project, it can free up funds that can be channelled to higher-priority projects such as Rapid. Although Petronas only bought into Progress Energy some five years ago, technological advancements have changed the energy landscape over that short period of time. Technology has brought down the cost of producing both O&G.
Also, by the time Petronas secured the green light for the project in September last year, a lot had changed in the global LNG market
For one, LNG-AS prices had fallen more then 70% over the last two years to trade at US$8.52 as of end-May.
LNG has been historically sold in other parts of the world through long-term contracts tied to the price of oil. While natural gas does not mirror oil prices exactly, there is a general correlation, sometimes with a time lag. Another reason that may have played a factor in Petronas’ decision was that United States LNG exports had climbed to a record last year.
The country is expected to become the world’s third-largest exporter of LNG in 2018.
With budget cuts and cost reductions being undertaken by Petronas, the national oil company is now in a better position.
Moody’s notes that Petronas is expected to start reaping the benefits of its cash conservation efforts fully from 2017 onwards.
The national oil company will also benefit from a reduction in oilfield services rates and drilling costs, as it is able to renew and renegotiate its current contracts at lower rates.
Petronas’ 2016 capex dropped 22% year-on-year (y-o-y) to RM50bil, of which 80% was spent domestically.
In the first quarter to March 31, Petronas saw its operating cashflow grow 51% y-o-y to RM18bil.
As at end-March 2017, Petronas remained in a net cash position at RM59bil.
The rating agency notes that Petronas has announced measures to limit the increase in its net borrowings and protect its credit profile.
“As such, Petronas reduced its dividend payment to the Malaysian government in the course of 2016 – to RM16bil in 2016 from RM26bil in 2015. The company’s proposed dividend for 2017 amounts to RM13bil. However, as oil prices recover, we would expect the dividends for future years to increase,” the rating agency says.
Petronas’ net profit surged by more than 100% y-o-y in its first quarter ended March 31.
Moody’s expects the medium-term crude oil price band to range between US$40 and US$60 per barrel.
So, Wan Zulkiflee’s decision to pull back from the Canadian LNG project is a wise one, considering the murky outlook of the industry.
However, he has to decide on the long-term plan for Progress Energy, which is now supplying gas to the US market.
A factor that could well sway Petronas’ move to get back into the Canadian gas pipeline project is that LNG prices in Asia are higher compared to the US. So, watch this space.