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Hey Petronas, Royalties are *not* the same as Profits


For the last few months, there has been an escalating dispute in Malaysia between Petronas and Sarawak regarding the rights to Oil & Gas. I wrote a quick summary a while ago for those outside of Malaysia. And also made a quick update shortly after the recent federal elections which saw a change of government.

Today, local Malaysia media stated:

KUCHING: Prime Minister Tun Dr Mahathir Mohamad defines oil and gas royalty as a percentage of the profit made by Petronas paid to the states from where the natural resources were extracted.
He gave this explanation during a press conference in Kuala Lumpur after chairing a Parti Pribumi Bersatu Malaysia Supreme Council meeting yesterday.
Dr Mahathir in the Parliamentary sitting on Thursday said the PH government would fulfil its promise to give 20 per cent oil royalty to the oil-producing states including Sarawak.
However, he seemed to clarify his earlier statement later when speaking to reporters outside the Parliament house by saying that the 20 per cent payment will be based on profit instead of production.
Yesterday, responding to a question from a reporter at the press conference on the two different statements he made on payment of oil and gas royalty he said, “Royalty is from profit, if you make 100 million, 20 million will be the royalty. It is based on the profit made by Petronas in that area. What we collect in Terengganu we will not pay to Sarawak or Sabah.”
Earlier, Minister of Tourism, Arts, Culture, Youth and Sports Datuk Abdul Karim Rahman Hamzah in response to Dr Mahathir’s statements on Thursday said the payment of 20 per cent oil royalty promised by the Pakatan Harapan (PH) federal government to Sarawak should be based on the value of the production instead of profits.
Abdul Karim pointed out that there is a huge difference between 20 per cent of production value and profits.
He said if payments were based on profit, Sarawak is likely to receive lower sum than the current five per cent in royalty after taking into account the production costs.
“What Prime Minister Tun Dr Mahathir Mohamad said is
not clear as he at one time mentioned 20 per cent oil royalty and on another occasion he said 20 per cent of the profits.
“There is a big difference in this matter and if royalties are paid based on profits, world oil prices and high production costs, the 20 per cent profit can be lower than the current five per cent royalty,” he said.

This contradictory wordplay of Royalties and Profits strikes me as disingenuous.

Profits and Royalties are not the same, they are very much different.

Let's review the PH Manifesto which was part of the promises before the election:

FACTBOX-Malaysia's new government promises reforms

May 22 (Reuters) - Ministers in Malaysia's new government began their first day at work on Tuesday, having promised a slew of economic and financial reforms in the lead up to a stunning election win over an alliance that had led the country for the six decades since independence.
Prime Minister Mahathir Mohamad's government has vowed to fulfill some of those promises in its first 100 days.
Here are the key points from the manifesto: ...
- Increase petroleum royalties to East Malaysian states Sabah and Sarawak, and other petroleum producing states, to 20 percent.  
- Examine the rights of Sabah and Sarawak over their national resources and oil and gas reserves.

Take note of the very clearly stated, unambiguous election promise:

" Increase petroleum royalties to East Malaysian states Sabah and Sarawak, and other petroleum producing states, to 20 percent."

Let's have a look at the differences between Royalties and Profits, and so people don't get too upset, I'll use the definitions of Royalies and Profits in the context of Ice Cream, rather than the highly emotionally charged topic of Oil & Gas.

Why Are Royalties Based on Net Sales & Not Profits?

... Sales vs. Profits
A product's net sales is simply the money a company takes in from selling it, minus the value of such things as returns, volume discounts and discounts for damaged or substandard merchandise. The profit on a product, on the other hand, is what's left over when you subtract the company's cost of making or acquiring the product. For example, say an ice cream parlor sells ice cream cones for $5, and it takes $4 worth of raw materials, direct labor and other costs to produce each one. Sales revenue for the ice cream cone is $5, while the profit is $1.

With me so far? OK, let's continue.

Royalties Are Costs
One key reason many inventors insist that royalties be based on net sales rather than profits is that the royalty itself is a basic production cost. Say an ice cream parlor is licensing your system to make ice cream. Just as the place can't make extra smooth and creamy ice cream without milk and sugar, it can't make it without paying your royalties.The ice cream parlor wouldn't tell its milk supplier that it'll pay its bill only if it makes a profit. It shouldn't do the same to you. So if it sells a scoop of ice cream using your system, you should get a cut of the sales revenue, not of the profits. The parlor's profits are reduced by other costs -- costs that don't concern you.

Starting to see the distinction between Royalties and Profits? Continuing on...

Profit-Based Royalties
Companies will nevertheless try to get inventors to accept royalties based on profits rather than sales, and companies dealing from a position of strength may get them to agree. This arrangement benefits the company licensing the invention, not the inventor. Accounting figures can easily be manipulated to show minimal profit that's subject to royalties. That place selling ice cream cones for $5 might explain that it's really selling the ice cream for $3.75 and the cone for $1.25. It might also say that the $4 cost breaks down to $3.75 for the ice cream and 25 cents for the cone. The ice cream is making no profit so, sorry, no royalty.

Get it?

There is a huge difference between the 20% Royalties that were promised in the Election Manifesto, and the obfuscating wordplay of clarifying that Royalties will be based on profits.

Moving on...

Malaysians in general seem to be under the mistaken idea that Petronas belongs to Malaysian people.

By law, Petronas is controlled directly and only by the Prime Minister.

Here is Section 3 of Act 144 - Petroleum Development Act 1974


The Corporation
3. (1) Notwithstanding section 22 of the Companies Act 1965, relating to the names of companies, the Corporation shall be styled as the Petroleum Nasional Berhad or in short form PETRONAS.
(2) The Corporation shall be subject to the control and direction of the Prime Minister who may from time to time issue such direction as he may deem fit.
(3) Notwithstanding the provisions of the Companies Act 1965 or any other written law to the contrary, the direction so issued shall be binding on the Corporation.

The Prime Minister can easily clear up this royalty mess, in my opinion.

So... how about the government returning to the promises in its election manifesto:

- Increase petroleum royalties to East Malaysian states Sabah and Sarawak, and other petroleum producing states, to 20 percent.  

- Examine the rights of Sabah and Sarawak over their national resources and oil and gas reserves.

On LinkedIn, I have commented ad nauseum that Petronas and Sarawak should sit down and amicably discuss a win - win agreement regarding oil & gas rights.

2 years ago, as the moderator on Oilpro, I had a face to face, one on one interview with Dr. Mahathir about Petronas (he was previously the Petronas Advisor, along with being the former Prime Minister of Malaysia). I asked Dr. Mahathir some tough questions, and he didn't flinch, and he replied at length.

So, now that Dr. Mahathir is one again the Prime Minister, and since Petronas is controlled directly and only by one person - Malaysia's Prime Minister, I leave it to the Prime Minister to sort out this 20% royalty issue.

Before readers and lurkers come to incorrect conclusions about who I am and why I am writing this, please allow me to clarify, for those who don't know me.

I'm a Permanent Resident of Malaysia, and have been married to a Malaysian Citizen for a couple decades. I lived 3 years in Sarawak, working in Sarawak Oil & Gas. I'll eventually retire here in Malaysia. I've been working in Malaysia and International Oil & Gas for many years.

I strongly support the current government, and am generally very happy with the changes being implemented by the new government in Malaysia.

In my spare time, I'm currently a moderator on Oil Price, and here is my general advice for the Oil Price forum members, which is also applicable here:

*** Important !  I do not expect others to agree with my opinions. I tend to have rather unusual opinions about international Oil & Gas.  I do hope that readers will fearlessly voice their own views about international oil & gas.
As a former moderator on the Oilpro forum, (and now a moderator here on the Oil Price Community forum) I encourage dissent, andencourage Freedom of Speech, andencourage others to freely voice their views and convictions about oil & gas. 
A diversity of global views is what makes the world a special place.  Conformity is just a slow, painful death of not speaking your mind.  So SPEAK UP.  Please don't be a jerk about about it, though.  If you want others to consider your views, please be willing to consider the views of others.

So, back over to local Malaysia to voice up their own opinions about the 20% royalty that was promised to the oil producing states in Malaysia. Don't just b*tch and moan, dosomething, say something, become active in events that affect you. Voice up your opinion to your local elected government representative.

I've previously offered to assist in moderating this Petronas / Sarawak dispute, since I have years of experience in international oil & gas and years of experience on international oil & gas forums, making sure others play nice. If either Petronas or Sarawak or the other oil producing states wish to message me about this, kindly note that I always respond to questions about international oil & gas. Yesterday on LinkedIn, I had a cordial, public exchange with the former General Legal Counsel for Petronas about this issue. No reason this royalty issue can't be resolved amicably, as a win-win solution.

Just my opinion; as always, you are free to disagree.

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