In our previous post, we provided an overview on the relevant laws and guidelines applicable to the Malaysian Oil & Gas Industry. We also highlighted the licensing regime in place for the purpose of carrying out business in the Industry. Essentially license granted by PETRONAS shall be in the form of a Production Sharing Contract (PSC) or a Risk Sharing Contract.
This article focuses some of the key requirements and considerations that investors and service providers (especially foreign entities) should take note in carrying out an oil & gas business in Malaysia.
Provision of Goods and Services
Companies that aim to provide goods and services in the upstream oil industry in Malaysia are subject to significant local or bumiputera equity requirements. These requirements are enumerated in the Standardised Work and Equipment Categories (SWEC) for Product and Services and are enforced through the licensing system established by PETRONAS.
These equity requirements differ from category to category. For instance, companies looking to provide goods and services in the categories of ‘Chemicals’ or ‘Engineering, Construction and Projects’ (amongst others) may need to have a minimum of 31% bumiputera equity participation whilst certain sub-categories of “Logistics and Warehousing” demand a full 100% bumiputera participation. To view the full SWEC list please click here.
As a result, foreign companies often choose to supply goods and services through either agency agreements with locally licensed companies authorized by Petronas or by establishing joint ventures with local companies or individuals.
Exploration and production Activities
When it comes to upstream exploration and production activities, there are no specific legal requirements or restrictions on the involvement of foreign companies. To engage in these activities, foreign companies need to obtain a license from PETRONAS, which typically takes the form of a Production Sharing Contract (PSC). The key PSC provisions that investors and service providers should take note are discussed below:
Participating Interests of PETRONAS in PSCs
PETRONAS has a policy wherein its wholly owned subsidiary, Carigali, which handles exploration and production activities, is involved as one of the contracting parties in each PSC. The level of Carigali's participation interest in each PSC may vary, but it typically holds no less than a 15% interest. Due to the high-risk nature of these ventures, including the possibility of not discovering commercially viable hydrocarbons despite substantial investments, it is common to have multiple contracting parties in a PSC. However, there is usually one designated "Operator" who assumes primary responsibility and operates on behalf of all other participating contractors. Although Carigali may act as the operator in some cases, it is not the general practice.
Duration of PSCs
The duration of a PSC can vary and typically includes specific timeframes for exploration, development, and production stages. The production period for PSCs is typically set at 20 years, and it may be extended upon application for further extensions as needed.
Title of Assets used for Exploration and Production Activities
PETRONAS generally holds the ownership rights to the equipment and assets acquired by contractors participating in PSCs for oil exploration and petroleum operations. However, the contractors retain the right to utilize these assets throughout the duration of the applicable PSC. The costs associated with these items can be recovered through the allocation of barrels of cost oil or gas equivalent.
A common provision found in PSCs states that PETRONAS has the authority to request PSC contractors to engage in reservoir unitization. This occurs when PETRONAS determines that the strata within a PSC contract area forms a single geological structure or reservoir with another PSC contract area.
Regarding cross-border reservoirs, PETRONAS will consult with contractors of the respective PSC areas and represent the PSC contract areas in international unitization agreements. PSC contractors are obligated to adhere to the terms agreed upon by Petronas in these international unitization agreements.
Allocation of Liabilities
The allocation of liabilities for each party is specified in the Joint Operating Agreement (JOA), PSC, or Risk Service Contract (RSC). Under the PSC, the contractors have the responsibility to secure all necessary financing and assume the risks associated with exploration, development, and production activities in exchange for a portion of the total production.
Additionally, the PSC contractors are obligated to seek authorization before incurring expenses beyond a certain threshold and obtain other approvals from Petronas at various stages of operations. Failure to comply with these requirements may result in the termination of their rights to carry out the operations.
Furthermore, as per the Petroleum Regulations, any person who fails to comply with the conditions of the Petronas license may be charged with an offense. Upon conviction, the individual can be subjected to a maximum fine of RM 50,000, imprisonment for up to two years, or both. In the case of a continuous offense, an additional fine of RM 1,000 per day or part of a day can be imposed for each day following the initial conviction.
Provision of Parental Guarantees
When a subsidiary is involved as a party to a PSC or RSC, it is typically necessary to provide parental guarantees. These guarantees ensure that all obligations and commitments of the subsidiary are covered. It is not mandatory for the parental guarantee to come from the ultimate parent company, but it should encompass all the subsidiary's commitments. Bank guarantees and security deposits are typically not utilized to cover all commitments but may be required for specific work obligations or to secure certain operations.
Transfer of Interests or Changes in Shareholding/Control
In general, PSCs include a provision that mandates contractors to seek prior approval from PETRONAS before transferring or assigning their participating interests to any related party. Additionally, the contracts stipulate that consent from other contractors is necessary when transferring or assigning participating interests to a third party (excluding related parties). However, it is specified that such consent should not be unreasonably withheld.
There are no specific laws or regulations that explicitly outline the procedures for obtaining approval for a change of control/shareholding. However, in most cases, the PSC will include a clause addressing such changes. This clause typically stipulates that the contractor must obtain written consent from PETRONAS before executing any change in control/shareholding. The estimated timeframe for obtaining approval from PETRONAS is typically around six weeks to two months.
Recovery of Costs
The PSCs established between contractors and PETRONAS contain clauses that regulate the payment of royalty, limits on cost oil, and the distribution of profits derived from petroleum production. Cost oil refers to the portion of production allocated to contractors, enabling them to recover the expenses incurred during operations under the PSC. It is important to note that there is a maximum limit, or "ceiling," on cost recovery determined by PETRONAS. The ceiling has been set at up to 50% since the 1976 PSC and was revised to 70% in subsequent versions of the contracts.
A PSC may also contain provisions that reduce the production entitlement of PSC contractors once they reach specific cost-recovery milestones specified in the contract. In accordance with the Petronas Procedures and Guidelines for Upstream Activities (PPGUA), which must be adhered to by parties involved in PSCs with PETRONAS in Malaysia, there are generally three categories of costs that are not recoverable (referred to as "NR costs"):
a) Governance and common issues
b) Costs pending approval from Petronas
c) Operational and business risks.
The specific details regarding these non-recoverable costs (NR costs) are typically outlined in the terms of the PSCs.
The O&G industry in Malaysia is heavily regulated and requires adherence to a laundry list of laws and guidelines. We have the expertise to guide you through the legal landscape in terms of business entity formation, licensing application and preparation/review of key agreements. If you're interested to know further on how we may assist you, please do not hesitate to reach out to us for a complementary chat.