For the first time local oil and gas players have a chance to play a major role in the production and development of marginal oil fields. However there are risks involved. Will the local companies step up to the challenge?
THE recent US$800mil risk-service contract (RSC) awarded by Petroliam Nasional Bhd (Petronas) to a consortium formed by two local parties and a foreign player for the development and production of the Berantai marginal oil field, located 150km offshore Terengganu, has drawn enormous interest for more than one reason.
Firstly, it marks the adoption of a new contract, RSC, for development and production of local marginal oilfields (as oppose to the production-sharing contract used for exploration and production works).
As the bidding for many more local marginal oilfields are to be carried out, local oil and gas service providers stand to reap benefits either by way of being a bidder or as a beneficiary of sub-contracts.
But this also gives rise to questions on how local contractors are chosen, why Petronas has not chosen to undertake development of these fields through its own unit, and will local oil and gas service providers learn quickly enough to go it alone in marginal oil field development in the coming years?
The art of the field
National oil company Petronas president and chief executive officer Datuk Shamsul Azhar Abbas says Malaysia has 106 marginal oil fields containing 580 million barrels of oil, with Petronas having firm plans to develop 25% of the total marginal oil fields to replenish its oil reserves and generate new revenue.
A marginal oil field is defined as a field that can produce 30 million barrels of oil equivalent (BOE) or less.
“For the remaining 75% of marginal oil fields, we don't have plans yet as they require further assessment. We have been working with the Government to come up with another method as the PSC (arrangement) does not encourage the development of marginal oil fields,” Shamsul told a media briefing held late last month.
Shamsul says that two more marginal field contracts will be awarded by April.
The first RSC was awarded to a consortium formed by Kencana Petroleum Bhd, SapuraCrest Petroleum Bhd and Petrofac Energy Developments Sdn Bhd (PED) in January to develop and produce petroleum resources in Berantai over a nine-year period starting from Jan 31 this year.
The joint operating agreement will be 50% owned and led by PED, part of the London-listed Petrofac Ltd group of companies, while Kencana's wholly-owned Kencana Energy Sdn Bhd and SapuraCrest's wholly-owned Sapura Energy Ventures Sdn Bhd would each hold a 25% interest.
Bids for marginal oil fields are called roughly every quarter, with the bid for the Berantai oil field having taken place last October and the next bidding expected to take place in March. As Petronas will cluster four to five marginal oil fields to make it more attractive in drawing bidders, the 26-odd marginal fields earmarked for development will likely be awarded in the next one to two years, says an industry source.
While the estimated cost of development for the Berantai marginal field is pegged at US$800mil, an industry player projects that development cost for the other marginal fields could vary between US$500mil and US$1bil, with the RSCs tenure ranging from three to nine years accordingly.
Although there is certainty that these marginal fields will have petroleum resources, there is no certainty how much can eventually be exploited from these fields.
“For any field under the ground, you are using probability from high up utilising the seismic (method). The chances of misjudgement are high for marginal oil fields, which are smaller in nature compared with bigger (developed) oil fields,” says Dialog Group Bhd executive chairman Ngau Boon Keat. Dialog is an engineering company in the oil, gas, petrochemical and chemical industries and is widely speculated by research houses as one of the front-runners for the RSC job to be awarded down the road.
The seismic method is used for exploration of oil and gas, involving field acquisition, data processing and geologic interpretation.
Kencana Petroleum chief executive officer Datuk Mokhzani Mahathir says each marginal field is unique as its geology and geophysics would vary, thus the business model for each field may differ.
Simply put, if a field is estimated to produce say, 30 million barrels, then development cost would be derived based on that. However, if the field eventually only produces 15 million barrels, the higher development cost will have to be absorbed by the contractor. Therein lies the risk.
“A marginal field needs to be studied very carefully before anybody submits a bid. It is not as simple as people think it is,” says Mokhzani.
However, sceptics point out that the risks faced by the consortium partners are limited and that the players are more likely to recoup their investments, hence make a guaranteed profit as the discovery of petroleum resources is a sure bet in marginal fields, which are essentially discovered fields. Noteworthy is that Petronas will own all the oil and gas extracted and produced from these marginal fields.
There is a concern that the fee structure of the RSC may result in less net income for the national oil company as opposed to if Petronas were to develop these marginal oil fields on its own or together with a niche foreign player.
The foreign player, in the consortium, will act as the main contractor to develop and operate the marginal oil fields. Given that the foreign player will not want to see its margin squeezed through the presence of a local partner (which it is required to tie up with under the RSC), there is concern that Petronas may end up paying out more than it really needs to under these contracts.
These concerns have arisen in the absence of furher details on the RSC. Petronas declined to response to queries by StarBizWeek, specifically on the RSCs, as they are deemed confidential.
But this much, Petronas has made known. The project cost will be forked out by the contractors based on their equity portion and that contractors will receive payment only upon first production, which involves a reasonable return with limited upside.
The contractors also have to meet key performance indicators such as the development cost, production rate and time-frame that have been agreed upon by both Petronas and the consortium, with incentives or penalties triggered depending on the consortium's performance.
In defence
The local players are quick to defend their role in the consortium, stressing that they have been chosen solely on the merits of their technical and financial capabilities.
“These are very credible and serious players getting together to provide a service to the client (Petronas). There are (also) other companies in Malaysia which can chip in to do different things. The client will have to vet these companies based on their criteria, which are extremely high, such as technical expertise, competencies, the track record of having delivered projects on time within cost and the balance sheet to take on such big projects,” says Mokhzani.
Sapura Group president and chief executive officer Datuk Shahril Shamsuddin says that one way of ensuring the local partners carry their weight in the consortium is the investment that will be pumped in according to their equity portions.
“To ensure that the locals can execute the job, Petronas has asked us to put in our own money so that if we make a mistake, we'll get burnt. US$200mil is like half of our cash reserve, so the motivation to do things right is very high!” says Shahril.
Both Mokhzani and Shahril emphasise that Petrofac chose them as its partners due to their respective long-standing working relationships.
“This is a fast-track project, so they need someone with competencies and in our case it was in laying the pipes to do subsea infrastructure installation to manufacturing subsea equipment. They wanted to look for a partner that will not drop the ball it is about risk mitigation as well as sharing of risk,” says Shahril.
While the foreign player is at liberty to choose its local partner, the buck does not stop there. According to an industry source, Petronas would also need to sign off on the local partners selected by the foreign companies.
“There are some people who just want to be agents ... they want to get the job and then outsource the work. But Petronas will not allow these agents to be bidders. The bidders will have to be real oil and gas service providers that are listed,” the source adds.
Although there may be some 15 local companies involved in the oil service presently, only half may have the financial muscle to pull off the financing involved as a partner in marginal oil field development.
Thus, it can be expected that the remaining local companies to be awarded the RSCs will continue to draw much attention and scrutiny from the public.
A sweet deal
If an average marginal oil field produces 30 million BOE and is sold at an average crude oil price of US$80 per barrel minus the development cost of US$800mil, Petronas would make US$1.6bil without taking into account the “reasonable return” paid to the consortium partners.
An industry source says that potential return on marginal oil field development for the contractors can be as high as 15%, in line with returns seen for upstream works.
For illustration, a 15% return on the Berantai field development works out to be US$120mil (RM360mil). This means that local players Kencana and SapuraCrest could see gross profits of up to RM90mil respectively based on their equity portion, which breaks down further to RM10mil yearly per company over the contract period.
OSK Research Sdn Bhd says it expects potential revenue and earnings for Kencana to comprise a combination of fabrication of oil and gas structures as well as some installation revenue.
“We understand that the net fabrication margin for this project is about 15%. Going forward, margins are expected to improve, especially when the company starts to manage the oilfield in 2012, by which time margins could well exceed 50%,” its report on Kencana last month said.
However, both Kencana's Mokhzani and Sapura's Shahril remain mum when asked on their expected returns from the Berantai project.
Industry observers have also wondered why Petronas has not formed its own unit for the development and production of marginal oil fields, especially since it is the custodian of the country's oil and gas reserves.
While it is a question best left answered by Petronas, chiefs of the local oil and gas companies offer a few possibilities.
Shahril says that it makes more sense for Petronas to deploy larger investments and its human capital for larger exploration and production projects that bring in higher returns.
“Take two companies Company A with RM10bil assets invests RM300mil to make annual returns of RM1bil while Company B with RM100bil assets invests RM3bil to make RM10bil annually. Company B, which has a larger asset base, would represent Petronas,” he explains.
Ngau says that Petronas would typically focus its manpower to develop larger fields as opposed to operating marginal oil fields.
Another corporate head agrees, saying that Petronas has to focus its limited manpower, especially with many of its engineers being sought after by Middle Eastern oil and gas companies.
“Many Petronas engineers were offered salaries that were four to eight times higher by the Arabs, several years ago. So the manpower now has to be used for bigger projects,” he adds.
Big boys don't try
Petronas' Shamsul had mentioned that oil majors, such as Shell and ExxonMobil, are not keen to develop marginal fields as they are considered “sub-economic”. While marginal fields may be part of their local PSCs, some of these foreign majors have chosen to relinquish them, passing them back to Petronas largely owing to lack of interest.
Shamsul adds that a key motivation in getting the foreign players to tie up with the locals is to allow the latter to broaden their technical expertise and knowledge.
Acknowledging that local oil and gas service providers cannot become exploration and production players, Shamsul says that local service providers could become development and production players.
“The local guys can't do it themselves, so we need to bring in the teachers and upgrade the capability of local players,” says Shamsul.
There are many foreign oil companies in the world which focus largely on marginal oilfields. They include London-based Petrofac, US-based Newfield Exploration Co, UK-based Salamander Energy Plc, Abu Dhabi's Mubadala Oil & Gas, Australia's Roc Oil Co Ltd, French-founded Perenco Group and Swedish Lundin Petroleum AB.
If these projects take off as planned, it will have a multiplier effect on the economy such as job creation while retaining the wealth within the economy (as opposed to awarding all of it to foreign players who are likely to expatriate their profits to their respective home base).
In addition, it could also increase the possibility of local companies, one day, venturing into the development of marginal oil fields overseas.
While industry players hope to acquire the relevant skills to become the main contractor of marginal oil fields in the next five to seven years, Shahril is gunning for his company to do it within three to four years.
“We need to learn to complete our value chain now. What happens to the local oil and gas industry when all the oil here runs out? So we've gotta start developing our capabilities now to get the jobs out there in future,” he says.
All of that, of course, will depend on whether the plan to award local players a stab at developing marginal oil fields in the country and its aim to allow them to tap the skills and know-how of foreign oil companies to better compete for jobs abroad, will work out as planned. Until then, the process will be closely scrutinised by market watchers.
