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Petronas president Hassan Merican gave a grossly distorted view to the public when he claimed that three quarters of its profits were distributed to the government and that Petronas return to capital was double those of international oil majors. In an interview with The Edge (July 3) in conjunction with the announcement of Petronas record profits for financial year ending March 31, 2006, Hassan said:

'Petronas is already distributing 76.5% or RM 41.7 billion of its profits (at company level) before tax, royalty and export duty back to the government. What is left is the 23.5% for us to reinvest, expand and grow the business further. That is a lot of distribution of the profit. It s a very high percentage.'

The catch is this so-called distribution of RM41.7 billion includes RM9.3 billion of royalty and export duty and RM13.4 billion of tax (profit before tax of RM 45.2 billion minus net profit of RM31.8 billion). Subtracting these items, the government gets RM19 billion as dividend which is equivalent to 60% of the company's net profit of RM31.8 billion.

And how much is that RM19 billion dividend compared to the net profits of the Petronas group? It is 44%, since the group's net profit is RM 43.6 billion.

So wouldn't it be more honest for Hassan to just say that Petronas is distributing 44% of its net profit to the government instead of playing and harping on the figure of 76.5%?

He also said. 'Petronas boasts a return on average capital employed of 40%, which is far superior to the 20% to 30% return achieved by international oil majors'.

Petronas' return ratios are fallacious. The reason is that its RM70.2 billion group profit before tax is overwhelmingly made up of what are in effect royalty collections from the crude petroleum producers under Production Sharing Contracts (PSC).

Under Malaysian laws, all petroleum producers have to sign up a PSC with Petronas whereby the producers (known as the PSC contractors) will have to carry out all exploration, development and production works at their own risks and costs, in exchange of a share of the oil and gas so produced.

Thus, without having to incur any expense except overhead costs, Petronas, as collection agent of the government, collects its share of crude petroleum production and sells the same to the downstream industries. The proceeds from these sales are reported as revenues from Petronas' domestic productions and reflected as profits in Petronas' financial report.

To appreciate how huge this source of cost-free revenue - subsequently accounted as profits - is, let us do some simple computation.

For the financial year ending March 2006, Malaysia produced an average of 700,000 barrels of crude oil and 957,000 barrels of oil equivalent (boe) of natural gas per day. Of these, Petronas shares under PSCs are 530,000 barrels and 634,000 boe per day respectively.

For the whole financial year, Malaysia's total production of crude oil and natural gas is 605 million boe. Of this total, Petronas' share under PSCs is 425 million boe, or 70%. The weighted average price of Malaysian crude oil is US$61.60. That for Malaysian natural gas is not stated in the financial report.

However, for the purpose of making an approximate estimation of the market value of Petronas' share of 425 million boe, we conservatively assume an average price of US$50 per boe for both oil and gas, and a currency conversation rate of US$1 = RM3.75. The total value of 425 million boe is then calculated as RM3.75 x 50 x 425 million = RM79.7 billion.

That is to say, if Petronas sits down and does nothing other than taking delivery of its share of the crude oil and natural gas produced by the PSC contractors, it should have collected some RM80 billion worth of crude petroleum.

Deducting the royalty and export duty payment of RM9.3 billion and the subsidies of RM14.3 billion to the power producers and a relatively small amount of management and administrative expenses, it should have amassed a pre-tax profit of some RM55 billion on the company level.

(Incidentally, this estimation has thrown up a short fall of RM10 billion in Petronas' pretax profit of RM45.2 million at company level for which Petronas must now explain.)

Now, how would Petronas' group pre-tax profit look like if Petronas is deprived of the privilege of collecting what in reality are petroleum royalties from the PSC contractors (which is the case with other oil majors)?

Wouldn't the group's pre-tax profit plunge from RM70.2 billion to some RM15 billion? And wouldn't that cause Petronas' return on capital as well as other ratios such as return on revenue and return on assets to plunge drastically?

It is clear that by lumping petroleum royalties as revenue, Petronas has grotesquely exaggerated its profit, rendering all its performance ratios meaningless while hiding from the public view the government's true petroleum income from the PSCs.

It is therefore imperative that Petronas reports the value of its share of production under PSCs separately, and discount these as revenues in the computation of its operational profits. It is only when Petronas reverts to such honest accounting that its true competitiveness can be gauged.

More importantly, the government must now seriously consider making Petronas convey the entire proceeds from its share of PSC production directly to the Treasury, now that Petronas can stand on its own feet.

This measure will open up a major source of funds to the government for utilisation in improving the quality of life of the entire people. Petronas could then be compensated with a management fee of say 3% - 5% for its service as collecting agent of the government.

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