The three minute clip was pulled out after the company reviewed the mixed feedback on the video, which had drawn more than 130,000 views.
The video featured young Malaysian ethnic Indians performing the "Dappan Koothu", an energetic form of Tamil folk dance performed to loud music on any occasion not necessarily funeral.
It is very popular in South Indian Tamil movies featuring rural areas.
"In all of our festive campaigns, it has always been Petronas' intention to help promote and inculcate the common underlying values from the diverse heritage, tradition and cultures that bring all Malaysians together," Petronas said in a statement.
Petronas removed the video, which was part of its overall campaign themed "Be the Light A Celebration of Culture and Tradition," last evening.
Diwali, a festival of lights commemorating the triumph of good over evil, is a public holiday in the multi-religious, multi-ethnic Muslim majority country where ethnic Indians form eight per cent of the population.
In response, Malaysia Hindu Sangam president RS Mohan Shan thanked Petronas for respecting the Hindu culture and sentiments of Malaysian Indians, he said.
The Malaysian Indian Congress, the largest ethnic Indian political party and a component of the ruling Barisan party, had earlier asked Petronas to remove its Diwali advertisement, saying it did not reflect the Indian culture.
MIC secretary-general S Murugesan said that the advertisement may send the wrong message to Indians youths in the country, especially the Hindus.
The advertisement, which runs for over three minutes, shows youth named Raj doing the Dappan Koothu dance and getting unlikely people to join his dance routine.
Petronas defines the Dappan Koothu dance as an energetic dance routine which is prominent in Tamil cinema.
An NGO Angkatan Warga Aman Malaysia had threatened to launch a nationwide protest if Petronas refused to remove the advertisement.
The NGOs secretary-general, S Bharathidasan, said that the video was an insult to Malaysian Hindus as it did not have any message related to Diwali.
"Dancing on the street is not Malaysian Indian culture. The dance routine is an imitation from Tamil movies. Stereotyping Indians like this is bad and should be stopped," he said.