Malaysia's Pandora's Box State
What the Pas victory in Trengganu means for Malaysian business and the stock market
By a#sIF SHAMEEN

December 7, 1999
Web posted at 8:25 p.m. Hong Kong time, 7:25 a.m. EDT

Malaysia's elections are over. Dr. Mahathir Mohamad, who celebrates his 74th birthday this week, gets to keep the post he has held for 18 years for another five. Why then is the stock market in Kuala Lumpur so jittery? During every election there is a pre-election rally in anticipation of a big government victory. There is almost always an even bigger post-election rally, celebrating the government's return to power. This year, despite the highly significant two-thirds-of-Parliament win by Mahathir's Barisan Nasional coalition, there was no rally. Indeed, since the results were announced the market has only gone one way -- south.

To find the reason, you need only to look at Trengganu, the east coast state on the Malaysian peninsula that fell to the opposition Parti Islam SeMalaysia (Pas). The government's spinmeisters are playing down the loss, saying the state had been briefly controlled by the opposition before. But that was before Trengganu became a huge exporter of oil and gas, before it became the site for a huge petrochemical complex and Malaysia's largest steel plant.

Fundamentalist Pas also controls neighboring Kelantan state, as it had before the recent polls. Kelantan continues to vote for the opposition because it is poor -- in fact, it is the poorest state in the country. Kelantan's fortunes would never move the stock market. But Trengganu is different. It is one of the richest of resource-rich states in the Malaysian federation. (Yes, Malaysia is a federation of states -- more like U.S. than a monolith country like France or Japan.)

Trengganu's offshore area contains about 64% of Malaysia's proven oil reserves, estimated at 3.9 billion barrels, and 40% of its proven gas reserves, estimated at 86.9 trillion cubic feet. The state produces about 300,000 barrels of oil a day, earning a 5% royalty on every barrel. Last year, that amounted to $180 million in oil royalties. Add in revenues from gas and from the petrochemical industry, and you have a state that is quite well off -- even before it starts to collect a single penny of taxes or tolls. Last year, when oil prices were between $10 and $12 a barrel, Trengganu's total revenues from oil and gas were about $250 million. Now oil is $27 a barrel, and gas and petrochemical prices normally rise in tandem with oil. So if oil prices remain where they are, Trengganu's government could be fetching $700 million in royalties alone. a#suming the royalties stay at 5% of total oil production.

Under a 1974 agreement with the Malaysian federal government, states get just 5% royalties. Trengganu's new Pas government says that's ridiculous. Its leaders have been telling foreign journalists that they want their state to get a fair share of the resources. That would be about 20%. Provincial or state governments around the world get anything from 10% to 20%, they say. Why should Trengganu get just 5%? A four-fold increase in revenues at today's prices would mean the Trennganu government could collect $ 2.8 billion in royalties. That's before the taps are turned on full blast. (Although Malaysia isn't a member of OPEC, it has curtailed its own oil production in sympathy with OPEC's recent slowdown.) If Iraq supplies remain suspended and there is cold winter in Europe and North America, swing producers like Malaysia have the luxury of turning their output up just a little to get extra money without actually flooding the market with a lot of oil.

In Kuala Lumpur, government officials are pooh-poohing the propects for a battle over oil royalties, saying Pas's mullahs don't understand business or contract law. Not quite. At least two Pas candidates in the recent general elections were ex-CEOs of medium-sized listed companies in Kuala Lumpur, with U.S. degrees -- MBAs to boot. Indeed, Pas leaders tell me they have employed lawyers over the years to look at things like Trengganu's oil contract. They say that the contract was signed under duress by a previous state government without consulting the people. Pas, which won over 60% of the popular votes, now has a two-thirds majority in the Trengganu state a#sembly. If it held a referendum tomorrow on the oil-royalties issue even Mahathir's supporters would vote for it. Trengganu, say PAS leaders, isn't asking for autonomy or secession, but just for its fair share of oil and gas revenues.

Another issue: contracts for oil and gas support services. Because oil is extracted by the national oil company, Petronas, supplier contracts for everything from offshore logistics to building rigs are farmed out mainly to people with connections. PAS says these people are cronies of UMNO leaders and wants the contracts to be awarded to local Trengganu people through open-tender process instead.

Then there is the tourist industry. Trengganu's famed hotels and beach resorts are owned mainly by non-Trengganu people -- many of them businessmen with close links to UMNO. Pas is not keen on renewing licenses of several resort operators, and at least two listed companies that own hotels or resorts have seen their shares beaten down. Pas has already banned gambling, alcohol and betting centers. That's bad for Malaysian lottery companies, whose stocks have also been plummeting.

But it's still Trengganu's potential oil and gas demands that could open a pandora's box. If Trengganu gets a 20% royalty or even 10%, other Malaysian states, like Sabah and Sarawak which also have oil and gas, will start demanding more -- making Malaysia's budget deficit worse and delaying the country's recovery process.

A week ago, most pundits said a convincing victory by Mahathir at the polls would do away with political risk in Malaysia and spur the Kuala Lumpur stock market to new heights. It has actually made matters worse. As the Trengganu saga unfolds, domestic and foreign investors may take to the trenches.