On managing and allocating subsidies

Malaysian consumers have many unanswered questions about fuel subsidies. It’s time to explain how pump prices are set, experts tell SANTHA OORJITHAM.

“MALAYSIA is exporting crude oil. If the oil price goes up, don’t our exports earn more and can’t that subsidise pump prices?” asks a college professor in Kuala Lumpur.

Saudi Arabia is lowering oil prices, claimed DAP’s Teratai state assemblywoman Jenice Lee after a protest earlier this month. “How come we are not able to do it?”

Many don’t understand how the Automatic Pricing Mechanism for petrol works and why petrol and diesel prices rose 41 per cent earlier this month.

While economists agree that the pump price had to be raised, they note that the public was not adequately prepared for the hike – even though petrol prices have risen steadily since 2000 and subsidies have been adjusted yearly since they were introduced in 2004 for petrol and 2000 for diesel (see chart).
Yes, we export crude petroleum, says the president and chief executive officer of Petronas, Tan Sri Hassan Marican. In 2007, Malaysia extracted about 600,000 barrels per day, of which 339,000 barrels per day were refined here. The remainder was exported unprocessed, making us a net exporter of crude.

On the other hand, notes Minister for Domestic Trade and Consumer Affairs Datuk Shahrir Samad, Malaysia is a net importer of refined petrol.

We produced 110,000 barrels of refined petrol per day last year but the demand was 190,000 barrels per day.

The balance had to be imported – 29 million barrels for the whole year.

A booklet about subsidies produced by the Economic Planning Unit last February explained that Malaysia exports its higher quality “sweet” (low-sulphur) crude oil and imports cheaper “sour” (high-sulphur) crude to make a profit.

“For now, we have a net balance,” says Hassan.

But based on present demand growth of six per cent per year, he estimates Malaysia’s demand will exceed local production in 2011 – making us a net importer although we will still have oil reserves for another 22 years and gas reserves for 39 years.

Moreover, subsidised fuel doesn’t encourage consumers to conserve.

“Oil revenue is going up but there is a limit to subsidies,” warns CIMB Investment Bank’s head of economics Lee Heng Guie. “If there isn’t, people will waste.”

Asks Malaysian Institute of Economic Research (MIER) executive director Datuk Dr Mohamed Ariff: “Should our oil wealth be used to subsidise present consumption or to generate future capacity through investment?”

At RM43 billion last year, Shahrir notes, fuel subsidies consumed about a quarter of the RM164 billion operating and development expenditure.

DAP’s Lee, however, says she heard the claim that oil reserves would only last for another 22 years a decade ago.

“The more we sell, the more we earn,” she argues. “And with the stronger ringgit, when we import, the cost should be lower.”

She notes that in its election manifesto, DAP had promised a bonus of up to RM6,000 per family for households earning less than RM6,000 per year, which secretary-general Lim Guan Eng said would come from Petronas profits.

“We should enjoy the benefits from the land,” says the DAP MP. “Where is the money going? We are not satisfied with the answers.”

Petronas made RM86.8 billion in pre-tax profit last year. Of this, it paid RM52.3 billion to the government in royalty, dividends, corporate income tax, petroleum products income tax and export duty. That formed about 32 per cent of the government’s total RM142 billion revenue.

As Petronas’ profits go up, its contributions to the government increase, notes Hassan. That revenue goes into the government’s consolidated fund, part of which is used to subsidise oil prices.

Petronas itself also subsidises the price of gas sold to both the power and non-power sector. According to the EPU booklet, that came to RM18 billion last year.

On the retail side, Petronas sells about 31 per cent of petrol and diesel to motorists. If it subsidised pump prices, which some Malaysians are suggesting, the president points out that would amount to subsidising foreign oil companies such as Shell, Exxon Mobil, BHPetrol and Caltex which retail in Malaysia.

Those who ask why subsidies are being reduced now may not be aware that they only started in 2004 for petrol — with a four-sen subsidy.

Until then, the government had been collecting duty, which it gave up in 2004. Now, notes Hassan, the government is “both forgoing duty and paying out a subsidy???.

He explains that the pump price includes the actual cost of petrol or diesel, the operating costs (including transportation and marketing), margins for dealers and the retail oil companies — balanced out with either a subsidy or duty.

By 2005, the product cost alone had overtaken the pump price. The National Economic Action Council began to study price controls and subsidies in general, recalls Datuk Zainal Aznam Yusof, one of its members.

“We had already made recommendations, but they were shelved,??? says the economist, who is also a member of the Anti-Inflation Council chaired by the prime minister, which held its first meeting this month.

“The pressure was not there in 2005. But now oil prices have gone through the ceiling.???

The government could bear subsidies of up to 20 sen per litre, estimates MIER’s Ariff, “but 30 sen per litre appears to be the tipping point.???

(The subsidy last year was 19 sen per litre and before the recent reduction, it had gone up to 55 sen per litre this year.)

Inflation was the main focus of the new government after the March 8 general election, says Shahrir.

“We couldn’t go on subsidising petrol because we would be required to subsidise food. It was a question of how to manage our subsidy policy and how to allocate subsidies.???

By the end of May, he says, “we realised it would take a lot of time to implement a more comprehensive system based, perhaps, on MyKad???.

“There was now a greater deal of urgency with the petrol price increasing.

“The subsidy bill was over RM2 billion per month. It was just too frightening.???

That’s why the reduction of subsidies — and the rebates at the point of renewing road tax — were announced on June 4 as an interim measure.

“It is not perfect,??? the minister admits. “Certain problems could arise.???

He adds that government policy is to steer Malaysians to conserve petrol and have more fuel-efficient cars.

“We have to make road tax for cars using diesel the same as petrol, since diesel is 30 per cent more efficient.

“We will move towards encouraging better grade diesel, incentives for hybrid cars and use of NGV.???

Commenting on comparisons with other oil producers, Shahrir says: “Saudi Arabia is the world’s largest producer, with 10 million barrels per day. We are not even in the top 20. Its reserves are 70 times bigger.

“And in the Middle East, extraction costs are US$6 (RM19) per barrel. Ours are 10 times more because it is deep-water, offshore field extraction.

“We have to put this in a way that the layman can understand,??? urges Hassan.

As an example, he points out that in a local coffeeshop, customers pay RM1.20 for a cup of coffee.

“A cup of petrol before the price increase cost 60 sen,??? he says. “Today, it costs RM1.???

“There appears to be no single leader on the issue,??? notes Datuk Astaman Abdul Aziz, formerly Titiwangsa MP and a member of the Parliamentary Committee on Energy.

“The government must explain how the money saved is diverted — preferably to the Welfare Department for unemployment benefits, to public transport and personal income tax reduction.???

Stresses CIMB’s Lee: “There should be a more coordinated unit to disseminate information correctly to the public.

“This should include daily updates on the world oil price and how the local pump price is decided.???

To avoid confusion, he says: “There should only be one spokesman. It could be Datuk Shahrir.???