Petronas’ cash squeeze should end Canadian LNG project

By Khairul Khalid

Why is Petronas pressing on with its controversial RM123 billion Canadian LNG project when it has admitted to having cash flow difficulties that could last indefinitely?

It looks like that the oil crisis is biting Malaysia’s energy giant Petronas harder than it thought it would.

Last week, during its financial results announcement for second quarter of financial year 2015 (2Q15), chief executive officer (CEO) Wan Zulkiflee Wan Ariffin admitted that the company is having cash flow problems that will force Petronas to dip into its RM126 billion cash reserves.

Could it be the final straw that breaks the camel’s back for Petronas’ controversial US$30 billion (RM123 billion) liquefied natural gas (LNG) venture in Canada?

“I do not expect our cash flow from operations this year to meet our capital expenditure and dividend commitments. We will have to draw on our cash reserves,” said Wan Zulkiflee.

The numbers are indeed very alarming and things are not expected to improve anytime soon.

Petronas’ profit after tax for 2Q15 is down 47% year-on-year. Cash flow from operating activities in 2Q15 fell 33%. Since Brent crude oil prices started sliding in the middle of last year from highs of over US$100 per barrel to just under the US$50 mark last week, the price rebound that many had hoped for has not happened just yet.

Do these extraordinary economic circumstances mean that Petronas would at least reconsider its billion-dollar investments in Canada?

Not according to CEO Wan Zulkiflee. He said that Petronas will go ahead with the RM123 billion project regardless, citing the fact that it is a long-term play that could last 20 to 25 years.

Falling LNG volume and prices were blamed for its falling profits in 2Q15. How certain is Petronas that things will eventually swing back in its favour? At the moment, top management seems less than confident.

“There is chronic oversupply. We do not foresee a reprieve from low oil prices in the near future,” said Wan Zulkiflee.

Pacific NorthWest (PNW) LNG, the Canadian joint-venture company that is majority owned by Petronas, has given the green light for this massive project to go ahead, pending an environmental assessment approval by the British Columbia government between September and December this year.

Petronas had started the Canadian project when prospects were rosier. In 2012, Petronas purchased Canadian based oil and gas (O&G) company Progress Energy for US$5 billion, giving it shale gas assets in northeastern British Columbia.

The project is estimated to eventually cost Petronas US$30 billion over its entire duration of 25 years.

But Petronas’ entry into the then much-coveted Canadian LNG market seems ill-advised from the start. Although the Progress Energy purchase provided Petronas a footing into the Canadian market, an LNG terminal that is a pivotal component for the entire project was less than secure. Without the terminal, Petronas’ potential returns in its Canadian venture would be diminished in value.

The bulk of the terminal is being built on aboriginal land and is critical to the long-term commercial viability of the project by facilitating exports of LNG to lucrative markets in Asia, but its construction has been hampered by domestic opposition and environmental concerns.

Petronas had to play hard ball to extract better tax rates and other incentives from the British Columbia government to make the project viable before oil price crashed.

After it obtained hard-won concessions from British Columbia government late last year, Petronas encountered resistance from a band of natives called the First Nation in British Columbia, claiming that the terminal would pose grave dangers to marine habitat in the area.

Last May, a community of the opposing Canadian aboriginals, the Lax Kw’alaams, rejected Petronas’ compensation offer of C$1 billion (RM2.9 billion) to construct the LNG terminal on their land in Lelu Island.

Petronas said that the project will still go ahead, regardless of the aboriginals’ consent, while the natives themselves have steadfastly claimed otherwise.

It is unclear if the natives’ objection could lead to legal action and ultimately derail Petronas’ project, but according to Petronas officials, they are still “in constant negotiations” with the them.

Most importantly, now that LNG prices have also dropped in tandem with oil prices, many analysts are seriously questioning the viability of Canadian ventures, not just Petronas’, but others as well.

In other words, would Canadian LNG projects still make financial sense under current economic conditions?

There are 20 proposed LNG projects inclusive of Petronas’ PNW and deep uncertainties over depressed O&G markets have thrown them into doubt. The LNG market is currently oversupplied and the situation may sustain for several years.

According to a study by London-based Carbon Tracker Initiative, given prevailing market conditions, Petronas’ PNW project will not be needed in the 2015 to 2035 period.

Even previous Petronas CEO Shamsul Azhar Abbas, under whose watch the Canadian venture began, admitted last year that the project was increasingly difficult to monetise.

“The reality of the global LNG market is that we are facing potential overhang and decreasing demand that creates downward pressure on LNG prices. The current project economics appeared marginal.

Without material cost reduction efforts across the project, the company will have a tough time reaching a positive final investment decision,” said Shamsul rather ominously in October last year. Maybe the outgoing CEO had already seen the writing on the wall for the Canadian venture.

Petronas is now caught between a slippery, oily rock and a hard place – partly of its own doing, partly due to the brute force of unpredictable market forces.

Sure, as Petronas CEO Wan Zulkiflee put it, the Canadian LNG project is a long-term play scheduled to run 25 years, or maybe even more. If Petronas pulls out now to cut its losses, it could be construed as a tacit admission of its missteps in Canada. On the other hand, if oil and LNG prices miraculously recover in the long term, Petronas could look foolish and miss out on a potential LNG bonanza.

Or it may not. Prices may plunge further and Petronas could be dragged further into a Canadian mire. Some analysts are predicting oil could conceivably go below the US$40 threshold.

Get this: while a slight increase in Brent crude prices in 2Q15 cushioned the impact from falling LNG volumes and prices in that quarter; in the third quarter, to-date prices have declined further, according to Bloomberg data. In other words, the cash squeeze is likely going to get worse.

Regardless, given the current economic climate, with huge outflows of foreign funds in recent months and the drastic fall of the ringgit, Petronas’ main priority now should be domestic investments, not risky overseas gambits that may backfire, like its Canadian venture.

More than ever, it is in the best national interest for Petronas to focus on its domestic investments and scale down on gambles overseas, 

As Wan Zulkiflee himself admitted, Petronas will no longer have the luxury of depending on its vast cash reserves from now on.

It will have to be more prudent in its capital investment and if that means cutting back on a once promising project – such as the Canadian LNG venture – it should be brave enough to pull the plug now rather than risk taxpayers’ money with further bloodbath in the oil markets.

The golden age of record oil prices seems to be over. Yes, Petronas is Malaysia’s only Fortune 500 company and did not achieve this by shying away from major risk taking.

But under the current climate of prolonged volatility, ambition desperately needs to be tempered with realism. The reality for Petronas – and other energy companies – is not as pretty as what it was just 12 months ago. And things could get even uglier.

GRRRRR!!!