Sputtering on gas

Sabah Energy Corporation reinvents itself in an industry riddled with pitfalls

By Sebastian Lee

Gas from Sabah’s offshore wells has always been contentious since it was discovered 40 years ago. Ironically, it hasn’t helped the state’s quest for heavy industries. And there are no straight answers to Sabah’s gas dilemma. Petronas, Malaysia’s state-owned oil company, says Sabah’s gas reserve is too small to sustain big industries for at least 20 years. At the same time, there aren’t enough industries to take up whatever little gas that is available. But things are looking up. New gas fields have now allowed Petronas to set up Sabah’s latest petrochemical complex which is expected to drive the resource-rich Borneo island state’s long overdue industrialisation.

Petronas hasn’t said how much the new gas will add to Sabah’s known reserve of 11 trillion standard cubic feet of gas (tscf) in scattered fields. It is the smallest compared to Sarawak’s 45 tscf and the Peninsula’s 39 tscf. The Kikeh field, about 120km (75 miles) northwest of Labuan, is said to have 75 billion cubic feet of gas while the Kebabangan is estimated to have 2 trillion cubic feet. There are others. The new discoveries have buoyed state and industry officials who are nevertheless mindful of Sabah’s misadventure in heavy industries.

Thirty years ago, uncertainly over gas power scuttled an ambitious billion-dollar aluminium smelter on tiny Labuan island off Sabah’s west coast. Since then Sabah has never recovered from a 10-year financial disaster from 1982 to 1992 sparked by massive losses and debts of its three gas-fed heavy industries: a 79mw power station, a 600,000-tonne sponge iron factory and a 660,000-tonne methanol plant in Labuan. They replaced the aluminium smelter but were sold to the federal government 10 years later when it rescued Sabah from its financial troubles.

In the early 1970s, petroleum engineers and state officials watched ruefully as gas was burnt off in extracting oil from Sabah’s first wells of Erb West and Samarang. A 3-billion ringgit ($1 billion) gas utilisation project was hatched to put the gas to good use. Petronas and Shell gave the Sabah government a 20-year supply of natural gas for a small annual payment of 1m ringgit. An initial daily 60m standard cubic feet of gas (mmscfd) was meant to fire a 350mw power plant to supply electricity to industries.

The Sabah Energy Corporation and Sabah Gas Industries, two state-owned companies formed to start heavy industries in 1982, soon wallowed in a sea of debts. SGI is no more. But SEC, like the legendary phoenix, has risen from its ashes as it reinvents itself in an industry riddled with pitfalls.

It is too early to tell. But SEC looks set to take centre stage in Sabah’s oil and gas industry that is giving it new impetus. It is an associate of a consortium that is building the 4.7-billion-ringgit Sabah ammonia and urea (samur) plant in Sipitang, about 115km south of Kota Kinabalu. Najib Razak, the prime minister, launched it on February 16, describing it as a world class project that will put Sabah on the road to industrialisation as the plant will spawn many supporting industries.

SEC’s role is to register and shortlist Sabah contractors for about 600m-ringgit worth of civil works of the plant which is owned by Petronas Chemicals Fertiliser Sabah Sendirian Berhad, a subsidiary of Petronas Chemicals Group. However it has no say in the awards which rest with Petronas.

Harun Ismail, 52, SEC’s chief executive officer, is upbeat. He sees opportunities for his company to spin industries from oil and gas. He is well aware that natural gas gave birth to his company. Its main task has been to find other uses for Sabah’s oil and gas.

SEC built the 200-km undersea pipeline, then hailed as the world’s longest, to bring gas from the Erb West and Samarang fields onto Labuan to fire SGI’s industries. But they were doomed from the start. Cheap scraps competed with more expensive sponge iron. An oil glut in the early 1980s saw the mothballing of more than 40 oil tankers on the Malaysian side of Brunei Bay off Labuan. They were heading for scrap yards, dampening the price of sponge iron even more. Methanol prices slumped as surplus oil pushed its price below $10 a barrel in 1986, two years after the industries started.

The power plant, though greatly scaled down to about a fifth of the drawing board’s 350mw, could not find more customers beyond the handful that gave it birth: a ceramic tile factory, a shipyard, an oil-rig fabrication yard, a few small factories and warehouses besides the sponge iron and methanol plants. The 91-square-kilometre (35-sq-mile) Labuan island, about a tenth of Singapore, then had a population of 30,000. (Now it has about 86,000 people.)

Debts soared as the industries chalked up losses, compounded by the sudden and sharp appreciation of the Japanese yen which ballooned offshore loans that the Sabah government had borrowed for the projects. Some loans were for SEC to build pipelines, a jetty, houses and other facilities for the industries. By 1992, the Sabah government was unable to repay its yen loans that had doubled to more than 2 billion ringgit. So the federal government, as its guarantor, bailed it out.

The methanol plant was sold to Petronas, the sponge iron factory to the Lion Group and the power station to the Sabah Electricity Board, now known as Sabah Electricity Sendirian Berhad (SESB). SGI closed.

Known as a restructuring of the Sabah gas utilisation project, the bailout freed SEC of debts and gave it ownership of the 64 hectares (154 acres) of land on which the three plants were built; and so it could earn rentals from them. SEC has been blessed with a big land bank from the start, not just in Labuan, but in Kota Kinabalu where it has branched out into property development.

The federal rescue was a blessing for SEC. Although it did not receive any cash, and the Sabah government was too poor to give it any, millions of ringgit from land leases have allowed it to go into other businesses that have since been giving it handsome profits.

Harun is proud that his company has paid the Sabah government almost 79m ringgit in dividends since 1993. His 11 subsidiary and associated companies turned in group revenue of 229m ringgit and chalked up a pre-tax profit of 74.5m ringgit last year. The SEC on its own had a pre-tax profit of about 43m ringgit on a turnover of 65m ringgit. Harun tells Insight Sabah that he plans to pay the government a dividend of 6.3m ringgit this year.

Under a new agreement, Petronas took over SEC’s pipelines and gas supply to the Labuan plants in 1992. But it gave SEC the sole right to distribute gas to smaller customers. Each of them should not use more than 2m standard cubic feet of gas a day. But Harun says this has put his company at a disadvantage. Gas is a high volume business and SEC does not have enough customers to make it viable.

Selling gas, as it has turned out, is bad business. SEC has been losing about 400,000 ringgit a year on its sales that have averaged about 1.5m ringgit. Gas sales formed 11% of SEC’s total revenue of 14m ringgit in 2010. The rest came from rentals at about 12.5m ringgit.

For the last 20 years since its rescue, SEC has only 11 gas customers, including one in Labuan: the Sabah Flour and Feed Mill. The 10 are at the Kota Kinabalu Industrial Park, in Menggatal, about 25km (16 miles) north of Kota Kinabalu city centre. Together they use about 160,000 standard cubic feet of gas a day.

The biggest users of gas are the power stations and the Labuan methanol plant, all supplied directly by Petronas. The gas guzzler is the methanol plant which uses about 150 mmscfd. The sponge iron factory needs about 30 mmscfd and the power plant which has since been expanded to 112mw takes 20 mmscfd. The three gas-fired power plants at KKIP producing about 500mw of electricity among them hardly use 100 mmscfd. Depending on who you are talking to, there is an excess of 50 mmscfd of gas at KKIP which gets it from Petronas’ Gayang gas terminal nearby. Gayang has a capacity of 150 mmscfd.

Industry officials say there is nothing to stop Petronas from supplying more gas to KKIP by increasing the flow rate of its pipelines. But there are no industries big enough to use much of its gas. After 18 years, KKIP has slightly more than 200 mostly small and medium factories which do not use gas or have to turn to costlier fuel for their manufacturing because delivering relatively small amount of gas through pipelines to them would be even more expensive. Officials say it costs about 1m ringgit to lay a kilometre of pipeline.

Hassan Marican, former Petronas’ chief executive officer, said there were no takers for the first gas which landed at Gayang before 1995. Ranhill Powertron, which SEC has a 40% stake, is the first independent power producer (IPP) that uses gas and steam to produce 190mw of electricity at KKIP. It takes about one-fifth or 32 mmscdf of Gayang’s gas.

All electricity produced by the four IPPs at KKIP is fed to the west coast power grid of the SESB which supplies about 1% of its 800mw of electricity to industries. About 82% of it goes to residential consumers while commercial users take about 16% and street lighting uses up the rest.

So, says an official, Petronas and Sabah industrial planners have been facing a dilemma: There are not enough industries to make gas supply worthwhile. At the same time, investors won’t set up factories in Sabah if they can’t be assured of a good ready and steady supply of cheap gas.

Natural gas prices are kept artificially low through high government subsidies in order to keep manufacturing costs and consumer prices low. The government subsidizes up to 80% of the market price. Gas subsidies had cost Petronas 131 billion ringgit between 1997 and 2010. Much of the gas is used in power generation and manufacturing. Compounding the problem is that Malaysia has to import slightly more than a third of its natural gas. It is losing about 12% a year of its 85 trillion standard cubic feet of gas to industries. This reserve will disappear in 32 years according to official estimates.

Thus it is understandable that Petronas wants to keep as much of the gas for itself to be used for its downstream petrochemical industries such as its liquefied natural gas, fertiliser and methanol plants that will earn it handsome revenue.

Supplying gas for Sabah energy use is even more unpalatable for Petronas. It sells gas at 6.40 ringgit per mmbtu to SESB and at an average price of 9.35 ringgit per mmbtu to SEC. Its cost in delivering gas in Sabah is much higher than on the Peninsula because of the state’s smaller gas reserve. Including exploratory and development costs, industry sources conservatively estimate it at about 35 ringgit per mmbtu. Current market price of natural gas is about 60 ringgit per mmbtu, they say.

Yet there are pitfalls for Petronas or anyone else using the gas to set up petrochemical industries. An earlier study conducted by Petronas and the Yayasan Sabah, a Sabah government socio-economic foundation, had found a world-scale urea plant in Sabah to be unsustainable because of its high capital cost. Petronas has not said what has since changed. The Sipitang plant will be Malaysia’s biggest, producing 1.2m tonnes of urea and 740,000 tonnes of ammonia. It will almost double Petronas’ urea production to 2.6m tonnes a year and may make the country the biggest fertiliser producer in Asia Pacific, according to Wan Zulkiflee Wan Ariffin, PCG chairman. Two other plants are in Bintulu, Sarawak (750,000-tonne), and Gurun, Kedah (683,000-tonne).

Total investment has reached more than 50 billion ringgit including oil fields development and the building of the 2.4-billion ringgit Sabah Oil and Gas Terminal (SOGT) at Kimanis, about 60km south of Kota Kinabalu. Oil tankers will call at Kimanis to ship crude from SOGT which will store 300,000 barrels of oil a day from offshore wells.

The first gas is to land at Kimanis next year. But industry officials say only 750 mmscfd of the planned 1,250 mmscfd will be piped onshore. The reason again is that there are not enough industries to take up the gas. Of the 750 mmscfd, 100 mmscfd will fire a 1.5-billion ringgit 300mw power station, 150 mmscfd will go to samur which will come on stream only in 2015. And 250 mmscfd will make its way to Bintulu through a 5.5-billion ringgit 500-km undersea pipeline from Kimanis. The balance of 250 mmscfd of gas will be waiting for takers.

The irony is not lost on those in the industry. Petronas talks of “base loads”, meaning there must be industries big enough to put gas to profitable use. Sabah does not have them. Thus Bintulu, home to the world’s largest LNG plant, is seen as a fallback for Sabah. Besides the LNG and fertiliser plants, Bintulu also has the world’s first plant that converts natural gas into high quality synthetic oil and other petroleum products. They will be able to use all of Sabah’s gas.

There are no gas fields off Sabah’s east coast. And LNG will have to be shipped to Lahad Datu which houses the palm oil industrial cluster (POIC) for a 1.6-billion ringgit 300mw power plant. Petronas is building a 1-billion ringgit “regasification” terminal there which will turn LNG back to its natural state to fire the power station to produce its first electricity in 2015.

Gas indeed excites SEC which has been trying to live up to its name of an energy company. In a way, its investment in Powertron I and II at KKIP and Serudong Power in Tawau, three independent power producers, is seen as a saving grace. They turned in total pre-tax profit of slightly more than 39m ringgit in 2010. Only the newest of the three, Powertron II, chalked up a loss of 7.1m ringgit because it has yet to break even since it was commissioned two years ago. SEC owns 20% of Powertron II and 31% of Serudong which runs on diesel fuel to generate 36mw of electricity. Sale of electricity has become the third most important income for SEC as a group. It earned it about 23m ringgit in 2010.

Despite the 2 mmscfd cap, SEC actually has an unlimited supply of gas from Petronas or as much as the oil company can bring onshore. And it is eager to turn gas retailing into a profitable business. At an average retail price of 30 ringgit per mmbtu, SEC sells gas at about three times higher than it buys from Petronas. But what has set back SEC is the high distribution cost which is four times the gas cost, even after discounting expenditure on laying pipelines.

Harun sees a solution in compressing natural gas into containers that are then transported by trucks to customers. Costly lengthy pipelines are eliminated. Known as the virtual pipeline system developed by Argentina’s Gallileo, it only needs two stations: one known as a mother station that connects to a gas pipeline to receive natural gas that is then compressed in portable boxes. At the customers’ premises, the boxes are connected to a daughter station where gas is distributed to users through short pipelines.

What is left is for SEC to convince industries that compressed natural gas or CNG would save them about half of their diesel or medium fuel cost. Next is to find enough customers for CNG. Harun says he needs only one customer to use 500,000 standard cubic feet of gas a day to start his project which will cost SEC about 20m ringgit.

If SEC succeeds in selling CNG to industrial users, it might then try to expand the business by selling it to residential customers. CNG would then be competing with the cheaper liquefied petroleum gas (LPG) or cooking gas which is also heavily subsidised by the government.

Harun would like to see SEC as a smaller brother of Gas Malaysia which sells 300 mmscfd of gas on the peninsula. Still gas retailing is daunting. A day will soon come when the Malaysian government will stop subsidising gas. It will then be a whole new ball game for Petronas and SEC.

For now SEC’s losses from gas sales are insignificant. By a twist of fate, and with business acumen and ingenuity, it has become one of the most profitable government-linked companies (GLCs). SEC derives much of its income from its investments in companies that provide ancillary services to the oil and gas industry. The Asian Supply Base Sendirian Berhad, which has been providing oil and gas logistic services since 1984, has remained a cash cow of SEC which owns all of it. Last year, ASB turned in a pre-tax profit of 41.8m ringgit on revenue of 175.9m ringgit.

Harun has set his sight on making even more money for SEC. A shipyard on a 25-hectare (60-acre) site at Sepanggar to carry out ship repairs is awaiting government approval. It is developing a 1.5-hectare piece of land at Likas Bay into condominiums, a posh hotel, offices and shops. The 850m-ringgit 1Likas is a joint-venture with Gandingan Erajuta, a local company.

SEC will have a 13-storey tower called the Menara SEC. Harun says his company may occupy half of the building, letting out the rest which should add to its rental income. Starwood Hotels and Resorts will have its fourth Four Points by Sheraton hotel at a 120m-ringgit 28-storey building. It will have 234 rooms.

All said, gas or none of it, SEC can look forward to more happy days. – Insight Sabah