This article first appeared in The Edge Malaysia Weekly on August 30, 2021 - September 5, 2021

IN a 1½-hour-long interview, Petroliam Nasional Bhd (Petronas) president and group CEO Tengku Muhammad Taufik was his usual affable self — sharp, witty, candid and, most importantly, clear on his direction for the company.

Despite his light-hearted banter, it is obvious that Petronas — which is Malaysia’s only Fortune 500 company — is going through a difficult period, as the operating runway for it to position itself for a low-carbon future and in a business world that places emphasis on environmental, social and governance (ESG) issues is getting shorter.

Never has Petronas been so tested, and vulnerable to the many challenges — from policy uncertainties at home and abroad, to supply-demand risks in a fragile economy, and the increasingly delicate balancing act of meeting its obligations as a national oil company (NOC). Here are excerpts of the interview:

The Covid-19 pandemic has badly affected the bottom line of oil majors and national oil companies like Petronas. Is the worst over for Petronas?

By and large, I would hope that last year would have spelt the bottom. I cannot say that suddenly it is going to turn around and Petronas is leveraging on a super cycle that gives you three times the top line. I don’t think it’s going to happen that way.

When we draw the conclusion (at least for crude oil), the recovery is going to be fragile. Opec (Organization of the Petroleum Exporting Countries) is still going to play an important role in stabilising the market. We expect this management to continue well into late-2021 to mid-2022.

In stark contrast, you are seeing liquefied natural gas (LNG) spot prices coming to even the mid-teens, and that is a really, really good departure, given that we have a gas-heavy portfolio.

The refining and petroleum products — the real frontline products — are showing a hit.

I have to be quite categorical in stating this to you — I don’t have a propensity to say that things are not looking good unless they are backed by data. When you drill down by product lines, it’s not all great.

All the oil and gas (O&G) majors recorded improvements [this year] with both profit and cash flow from operations surging upwards. But all of them continue to take very cautious steps. You won’t see the kind of uptick with capital commitments, particularly after their behaviour in spending more into hydrocarbons is being put under very close scrutiny by their shareholders and lenders (notably during this ESG scenario).

What is your priority then? And in the ESG and renewable energy (RE) scene, will it be hydrogen, solar or wind?

At the end of the day, what we must make sure is that the 1.7 million barrels per day of O&G equivalent (production) is uninterrupted. New energy is going to help us desensitise, make us less volatile, and also offer a pathway of getting electrification in our operations, as much as it helps us get RE certificates.

But, equally, the impetus is also to do things that are low carbon. For solar, we are taking measured partnerships in certain markets. If you’re looking at two of the natural adjacencies, it is carbon capture and hydrogen.

We have pushed to solarise and electrify more and more of our facilities. We also worked on carbon capture and storage projects, and we are partnering with an engineering house called Xodus. We have established partnerships with Adnoc and Masdar — both Abu Dhabi companies — to pursue unconventional resources, technologies, bunkering as well as green hydrogen.

There is one other space. If you want to reduce the shocks in the system, you need to move into specialities. In PCG (Petronas Chemicals Group Bhd), they are already moving into things like surfactants, food additives and agriculture supplements.

And if you go further downstream, you must go into areas where the margins are good; we need to make sure it’s more cost-effective.

You will eventually hear Petronas embarking on more circular economy ventures — for example, capturing used plastics and using them as feedstock. We are already putting in the seeds so that they become our new cash generators.

All of these pieces are a lot more weathered from the volatility of commodities.

Those choices will also have to be made; potentially the vehicle is PCG itself. We have not come to that juncture to decide definitively one way or another. There are four if we think about it — CCUS (carbon capture, utilisation and sequestration), hydrogen, specialties and the traditional RE.

For the traditional RE, I would imagine partnerships. If I dump all my money for lower returns, long gestation periods, it’s also going to dent our ability to generate and pay out [dividends] because there’s a lot of capital committed. But it’s not to say that it does not have its merit. It does generate credit; it helps electrify our own businesses.

While we’re doing that, within the traditional portfolio, we’ve got to get emissions down, we’ve got Malacca (refinery) producing Euro5 diesel now and, god willing, once Pengerang is up and running, that’s the standard that we’ll generate out of there.

With COP26 (UN Climate Change Conference), where countries put in commitments, I’m keen to see where Malaysia (the government) places its pegs in the ground, so to speak. If not, we won’t know how to position ourselves.

We know where our destination markets are going. A lot of cities in China are going net zero, Japan is embracing full net zero. We’re even hearing Thailand and Indonesia being a lot more aggressive and ambitious.

The high gas mix in our portfolio (about 70%) can truly be a blessing now.

For crude oil, we’ve been hearing so much about it at a Benjamin (US$100) a barrel — but you seem pessimistic.

It is quite contrarian, but here’s the thing, you are even hearing the trend for carbon-neutral cargoes of oil being pursued by certain buyers. While our markets at home may not have market pricing and sustainable energy generation high on the radar, the rest of the world is moving.

Petronas has to respond to this accelerated energy transition. We are even talking about aviation fuel being moved to be lower carbon and sustainable. You’re seeing India shifting its food policy to allow some of its sugar to be redirected as ethanol.

What it does signal is that countries are taking policy shifts. It’s only a matter of time.

And while we understand that in Asia, 660 million to 670 million people are moving into the middle class, they are all still going to be energy-hungry. [But] a lot of them are going for cleaner solutions too.

With more and more of that happening, we need to make sure that we bring our gas to [production]. And we have a natural advantage; we still have a healthy horizon of gas supply in the LNG complex in Bintulu, and we are going to be able to monetise out of Canada as well, and that does help serve the Far East markets.

We still see natural gas having an incline — much less steep than before, maybe 2% — but oil, if you look at three or four consultant estimates, anywhere between the middle of this decade to 2030, there’s going to be a drop-off.

In this respect, how do you view your current oil assets?

With regard to the exploration assets that we have, and the liquid-prone places, be it in Latin America or unconventional oil like in Argentina, we need to get them to cash and self-funding ASAP. That must be our immediate focus. They pay for their own explorations and developments.

But in so far as locking in markets to off-take them, that is also going to be critical. There’s going to be a gradual drop-off, so there’s still going to be consumption.

But we need to counter [declining demand] by having new revenue streams. At the end of the day, as an NOC, you want to have some flexibility around your ability to generate shareholder returns.

On the ESG route — the Europeans, the Shells and the BPs are moving at a faster rate compared with the Americans. Where is Petronas in the picture?

If you plot at one end of the spectrum, compelled by legislation, consumer demand and partners, to have a clearer, concrete pathway, naturally the Europeans are going to be the fastest.

You got the Americans who turned around and said ‘we’ll manage it, we’ll avert doing anything that pollutes’ and keep it as a longer-term target.

Then, (US President Joe) Biden came in [to power] and one of the first acts was to stop a pipeline (the 1,897km Keystone XL oil and gas pipeline from Alberta, Canada to Nebraska).

That really sends a signal, and more and more, the IOCs (international oil companies) within the American sphere are compelled to show that they are taking clear strategic commitments to go towards more ESG compliance.

NOCs, in contrast, have an obligation to still monetise. You have to remember the likes of ExxonMobil and Shell don’t own sovereign resources. In the case of Petronas, we have an NOC obligation; the path we take must be decarbonised. But as we undertake and develop more, we need to find ways to either mitigate, and perhaps even move towards carbon negative — that’s the challenge if you’re going down a longer path to become net zero by 2050.

The building blocks are there. One of the beliefs is that if you were to go down the ESG path — at least this is the hypothesis that we hold on to — CCUS will need to be part of the solution. That is something we are taking very large steps into.

We are already able to do methane reforming, into blue hydrogen, and if you are gas heavy, hydrogen seems to be the natural evolution. And by virtue of hydrogen being a technical challenge to transport, liquefying it is now an alternative — transporting it in the form of ammonia.

The typical buyers [of hydrogen] are buyers of LNG. In this case, we have customers that we know, that are contending with the policy shifts, and seek hydrogen as an end-state energy solution.

Is there a ballpark figure on how much you’re looking to spend on all this?

You have to make sure you partner up with the right technology partner, make sure the market is ready to receive, and all the parts of the equation that make it a viable and valuable business for us need to be in place first.

I am not about to spend Malaysians’ money on something that does not eke out returns.

Will this also include acquisitions?

It is inevitable. At some point, there will be acquisitions.

With the ESG push and energy transition, does it mean that it will be more expensive for Petronas to continue its O&G operations?

Even without ESG, given where oil prices were last year — US$40 to US$45 per barrel — the challenge that I threw down to the management team was to make sure your blended cash breakeven goes way below US$40 per barrel, or else you won’t get returns.

The discipline is that if it doesn’t make it at US$40, you shouldn’t be looking at these investments.

Yes, the outlook changes from year to year. Because as oil prices improve, maybe the long-term average for this year, people are looking at north of US$50 per barrel instead of US$40, US$45, but in so far as making that cost efficiency, there’s going to be another challenge now with regard to scrutiny — if you produce, are you emitting?

On that basis, we’ve got certain facilities — Bokor (oil fields in shallow areas of Baram Delta offshore Sarawak) has gone to zero-flaring mode where it does not emit. We also look for more straightforward energy efficiency.

Does it mean there’s a likelihood of Petronas showing weaker earnings during this transition?

We are looking very carefully, because there are many modes to do this. You can go one big outlay and take a huge capital bet. That’s not wrong; some of the European IOCs in order to help boost their ESG credentials as well as reduce emissions are making huge forays into renewables.

But they will have to manage their shareholders and say, this is not going to yield the kind of 20%++ PBT margins, it is going to be utility-type returns over the long term, returns in the region of 6% to 8%.

We have to manage the transform element — there is going to be some gestation period, some capital lock-up, [I have to] manage the expectations of my shareholders.

Don’t forget, even though we are a progressive energy and solutions provider, the staple of Petronas will still be on the back of our hydrocarbon core (O&G). By 2040, if the demand and energy mix is still going to be made up sizeably by natural gas, and with 70% of our portfolio being gas, we are still well-positioned to eke out the returns from that segment.

At the end of it, we cannot go to extremes and have a knee-jerk reaction. Every country in the world has got a policy shift response, has got a rate of demand, traction for cleaner energy … They are going to have to run it as a business at the end of the day, right?

So, you still have to respond to the needs between now and 2040. And for the time being, we still see natural gas being part of that equation.

The challenge I put to the entire group is best summarised in three numbers: 50, 30, 0 — 50% improved cash flow by 2025, 30% of new sources from non-traditional revenue by 2030, and getting to net zero carbon by 2050 … That’s the mantra.

Was the government — the sole shareholder of Petronas — understanding when you explained things to them?

When I came back into service at Petronas, when speaking to Tun [Dr Mahathir Mohamad] at the time, he understood that there was going to be a need to address the reinvestment. When I took on the role of CEO and spoke to Tan Sri Muhyiddin Yassin, he said, “you need to find something to shelter the returns, or else”... he knew.

It’s going to be the case of constant re-education … We need to have that understanding that Petronas will need to have a shelf life beyond its 50th-year anniversary [in 2024], which is not that far away. We need to get to be 100 potentially.

Can you share what’s the progress on the reshaping of your portfolio?

High grading our portfolio is a constant effort. There are some where we know beyond this current period or certain concessions, we have to make a call depending on where the price outlook is.

But where there have been mature ­[assets] that now become a bit of an ESG risk to hold on, those have been put into the market already. That needs to be sanctioned by the board by this fourth quarter.

Some believe that because I am offloading, it can help buttress dividends. That is hardly the case; in fact, in many cases, [it is] an aversion from having to spend on decommissioning.

We look at the entire portfolio regularly. If the time frame is right, if I can redirect my money to other parts of the portfolio, particularly bringing my gas to bear and my LNG portfolio to a faster fruition, I will redirect.

A lot of it (divestments) will involve oil assets?

Those clearly are the candidates. While we believe natural gas will be [part of] the future, there are some oil assets that if they can be produced at low enough prices and are self-funding, we can churn them back, and if there is a short pathway to get into a payback, I will hold on to them. And that depends on the market. Traders need to find a home for the products but where we can, we will continue to monetise and squeeze the assets first.

In this scenario — where gas looks like it will have a better future — where do you place your Canadian gas assets?

We have a JV, North Montney JV. It was originally intended to feed the Pacific Northwest, which didn’t come into FID (final investment decision). But the 53 tcf (trillion cubic feet) of assets [can be used elsewhere]. Even if we target slightly over 1.2 bcf (billion cubic feet) per day for the LNG Canada project — another gas project which Petronas partnered with Shell, Petro China, Mitsubishi and Korean Gas — we have the ability to ramp up to Phase 2 of that project so that the unit cost goes down again. LNG Canada is an avenue that we will have to commit together with Shell.

The problem that we have right now is of course the policy in Canada, whether it will allow that many LNG exports without having too many restrictions — they are a very ‘woke’ government, very conscious about making sure emissions are low, so we have to put forth a solid business case.

But it is the highest-quality asset in British Columbia, Canada. I don’t want to lie … Canada has its own set of challenges. What we can focus on is operational excellence, getting our molecules out cleanly and cheaply, and the cost to serve — either exported as LNG or ammonia or for domestic gas — that still has to be our priority.

Is it safe to say you are still banking on the Canada projects?

The intention was to make sure that Petronas has a ready funnel of new heartlands. Canada was identified as a potential heartland given the logistical advantages of being able to ship into the Far East.

Equally, also, there was a prospect that if there were clear policy shifts in the Americas, it could be a target for LNG exportation. At that point in time, and the hypothesis still holds true, we believed that at a certain price level, given the outlook for natural gas, we would be able to eke out the returns.

Some say that one of the challenges when it comes to local exploration, particularly on gas, is the fact that some of the gas is still sold locally at a discounted price.

This is where the whole fiscal framework needs to work correctly. We are in partnerships in many places. We have ConocoPhillips, Murphy Oil [as partners].

Once gas is evacuated, they will expect in their investment models that they are taxed in a certain way, and they will get a price that is comparable to the market. A complete departure or suppressing the prices artificially does not help.

Notwithstanding that, Petronas recognises that in certain states, you have to spur certain local industries. There are mechanisms around this, but to make this overbearing to the point where investors don’t get incentivised to spend more, means all the many tcfs of gas that we should be able to monetise get left in the ground.

Remember, gentlemen, the runway is getting shorter and shorter. While returns are not going to be assured, and not only do we have a shorter runway, what’s left in the ground everywhere in the world is not going to be easier to extract.

You have higher contaminants, you have more offshore construction — all of these solutions when you consider them together need to be weighed to make sure we have a vibrant O&G industry for the decades to come.

We have to manage a very fine balance. In this context, the kind of decision and clarity that we make [as a nation] helps Petronas make those investment decisions as well.

At this moment, what is not clear?

Tax … If we are attuned to have a windfall mentality and see us, for a lack of a better phrase, as a core bedrock of the revenue stream, we won’t be able to plough back the future revenue. There will be a period where I need to invest, where the returns will come only later.

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