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Federal Government, Kelantan State Clash over Malaysian Oil Royalties

Published: 18 November 2009
Tensions between the Malaysian federal government and the Kelantan state government have risen in recent weeks over the state's entitlement to oil royalties from offshore fields.

IHS Global Insight Perspective



The Kelantan state government claims that Petronas made an agreement to make royalty payments to Kelantan of 5% of revenues generated from the production of petroleum in both onshore and offshore areas, although the federal government states that because offshore fields are located more than three nautical miles offshore, the state's right to royalties does not apply.


The federal government's resistance to paying royalties to Kelantan could also be motivated by its yawning budget deficit. This has increased its reliance on taxes, dividends, and royalties from Petronas to support the state budget.


The government has promised to make unspecified "goodwill payments" to Kelantan, perhaps to counter accusations that it is withholding funds to pressure the electorate to vote back in the ruling coalition, although with opposition politicians promising to take the matter to court and propose their own legislation on royalty distribution, the tensions over the issue look set to continue.

Royalty Row

Tensions between the federal government and the Kelantan state government have resurfaced in recent weeks over the state's entitlement to oil royalties from fields in the joint development area (JDA), which Malaysian NOC Petronas Carigali is developing together with Ameralda Hess and PTT Exploration & Production (PTTEP). The Kelantan government argues that in return for ownership, rights, powers, liberties, and privileges Petronas would make cash payments twice a year to Kelantan of 5% of revenues generated from the production of petroleum in both onshore and offshore areas. The state government claims that their legal arguments are supported by the 1975 Petroleum Development Act (PDA). Former Petronas chairman Tengku Razaleigh Hamzah has showed his support for the Kelantan government, saying that he signed a vesting deed arrangement on behalf of Petronas that entitles the state government to the revenues in question. However, Datuk Seri Nazri Aziz, who works in the Prime Minister's Department has maintained that Kelantan state is not eligible for oil royalties because offshore oil production facilities are located around 150 kilometres offshore, exceeding the three-nautical-mile limit that the federal government recognises as the boundary for royalty rights over offshore production. Beyond this limit it is up to the authorities to decide whether they give the money to state governments or not. To support the federal government's legal claim Nazri has pointed to Section 4(2) of the Emergency Ordinance 1969, which states that Malaysia's territorial waters stretch to the three-nautical-mile limit.

The issue of royalties was first raised by Datuk Husam Musa in 2001 while he was the MP for Kubang Kerian, although the issue has periodically resurfaced and has become more pertinent since the launch of gas production from the Cakerawala field in Block A-18 in the JDA in January 2005 (see Malaysia: 23 July 2009: Kelantan State Claims Royalties from Malaysia-Thailand JDA). Kelantan is keen to claim royalties from the JDA given the area’s favourable gas reserve and production potential, which will also come from Block B-17 and Block C-19 in which at least 12 discoveries have been made. Opposition MPs have claimed that Malaysia's federal government has paid out royalties to other states such as Sabah and Terengganu that have offshore oil production facilities located around 210 kilometres and 220 kilometres offshore respectively, which has raised doubts over the consistency of the government's argument over entitlement based on nautical miles from the coastline. The state government's claim has also been strengthened by the federal government's own statistics department, which lists Kelantan as one of four oil and gas producing states in the country.

Indeed, there are some grounds to suggest that the federal government's resistance to Kelantan's royalty claims may be motivated by other factors aside from strictly legal arguments. Following the global economic slowdown, which prompted the government to bolster spending to stimulate the economy, Malaysia's government has been left with a yawning budget deficit. In this context the government has come to rely increasingly on dividends, taxes, and royalties from Petronas to maintain contributions to the state budget. These contributions are expected to hit 67.8 billion ringgit (US$20.12 billion) in 2009, one of the highest levels in recent years (see Malaysia: 23 October 2009: Opposition Calls for Cap on Petronas' Contribution to Malaysia's Government). The government could be reluctant to divert royalties from Petronas operations in the JDA to Kelantan, particularly given that unlike older fields located offshore peninsular Malaysia, revenue from the JDA is likely to increase in future years as new production comes onstream. Many MPs in Kelantan believe that political considerations could also be influencing the government's decision. Kelantan state is dominated by the political opposition party, the Islamic Opposition Party, and the central government has already been accused of withholding funds for development projects as a means of pressuring voters into voting ruling coalition Barisan National back into the state government. The dispute over oil royalties is likely to be viewed in this context by opposition politicians, suggesting it could also lead to broader tension between political parties.

Outlook and Implications

The federal government has been adopting a carrot and stick approach to its dealings with Kelantan state. On the one hand Nazri has stated that the federal government is prepared to go to court if the Kelantan government were to dispute the oil royalty case while on the other the government has reiterated its commitment to the wellbeing of the people in Kelantan and promised "goodwill payments", possibly to counter accusations that it is withholding royalties to undermine the Islamic Opposition Party. However, the concession of these payments has done little to resolve tensions with Kelantan as MPs have questioned why the state cannot receive royalties in a similar way to Terengganu state, which has been receiving royalties under Section 144 of the National Petroleum Act. Indeed, the amounts that the government will give to Kelantan in the form of goodwill payments are rather vague and the state government may worry that they will be short-changed. The payments also appear to lack a firm legal basis and so could be stopped and started at the government's discretion.

The furore over the royalty issue has prompted Anwar Ibrahim, leader of Malaysia's opposition coalition Keadilan to consider drafting a bill that would ensure that income from oil extracted from Kelantan, Trengganu, Sabah, and Sarawak would be equally distributed to the states. He has also pledged to improve the transparency of regulations dealing with the issue, which could have political benefits for him in Kelantan. However, such a bill would likely be opposed by the federal government, particularly as it would raise the political profile of Anwar Ibrahim at the government's expense. Looking ahead, the row over oil royalties is likely to continue and could conceivably enter the courts as production from the JDA increases and thus the stakes over royalty payments increase. However, the federal government needs to make sure that its need for money to plug the budget deficit and boost the economy does not result in a further decline in political relations both with the state government and population of Kelantan.
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