Subsidy Rationalisation: A Question of Priority and Affordability?

The recent announcement by Dato’ Seri Idris Jala of a new “price adjustment” for petrol, diesel, LPG and sugar was expectedly met with mixed reactions – depending whom you speak to. Although the public relations branding of the subsidy rationalisation exercise seems to be working (judging from the public response so far), the announcement broke a few promises made earlier by the administration.

At the beginning of the year, PEMANDU came very strongly with its commitment to reform the energy sector, in particular the massive RM19 billion subsidy borne by PETRONAS each year to keep the natural gas price to TNB and independent power plants artificially low. There was an understanding that PEMANDU would put a high priority for the rationalisation of this subsidy while it pushes for gradual removal of fuel subsidies.

Dato’ Seri Ismail Sabri Yaakob (Domestic Trade, Cooperative and Consumerism Minister) also famously said that there would not be any new price hike on fuel and essential goods after the first series of price hikes in July 2010.

Both commitments were broken, hence the mixed reactions.

I took a particular interest in the question of subsidy rationalisation since 2007 given my professional background in the oil and gas industry. Continuous dependent on artificially low prices of energy is a bad thing for the economy, especially when our oil resources are depleting and the subsidy is extended to everyone. It distorts the real cost (and therefore the value) of fuels and worse, it promotes wasteful consumption habits.

But the issue should also be viewed from a wider perspective. There is also the moral issue of extending state assistance to the group most burdened with escalating cost of living, more so when the bulk of the nation’s income is derived from its hydrocarbon riches. If governing is about ensuring social and economic justice in a society, then we cannot divorce the philosophical issue of a just distribution of the nation’s wealth to the needy, notwithstanding the urgent need to reduce budgetary deficits.

It is in this respect that I defer from the conventional views that subsidy must be removed at all cost. Fuel subsidy is a luxury to those who can afford a certain lifestyle, but a necessity to the households whose disposable income is too small for them to make any spending adjustment.

40% of our households (roughly amounting to about 8 million people) earn on average RM1,500 per month. The bulk of this wage will go to pay for basic household expenditures such as housing (rent, mortgage), food, school expenses, energy (electricity, fuel) and clothing. It is estimated that 80% of household income for such families will go to these expenses, leaving little room for them to manouvre each time the government announces new price hikes on essential goods.

To these families, a 5 sen hike in fuel, a 20 sen hike in sugar and LPG will make a big difference to them as their disposable income will be affected immediately. For them, there is a moral justification that some form of assistance needs to be extended to lessen their burden.

Therefore, I always suggest that we should discuss the issue of subsidy rationalisation from the primary question of affordability. Can the nation afford allocating a sum each year to provide subsidies on essential goods meant for the lower income groups most affected by any price hikes? How much does it cost to do this? How much does the cost for this compare to the total income generated from our hydrocarbon resources?

Previously, it was quite difficult to put the numbers together due to the unavailability of information especially the amount of subsidy for each litre of fuel borne by the government. The credit must be given to PEMANDU which had had no qualm to share with the public that the government bears a subsidy of 40 sen per litre of petrol when crude oil price is in between the USD70 to USD80 per barrel range. This allows for an economic model to be built, assuming that refining cost and refinery margin do not change much over a fixed period of time.

Based on the latest public data provided by the International Energy Agency (IEA), 61% of oil products (from crude and refineries) in Malaysia were consumed for transportation purposes in 2008. Industry usage makes up the second highest consumption at 23%.

For transportation, a total consumption of fuel (by private and industry users) translates to an equivalent of 9.8 billion litre of petrol and 5.3 billion litre of diesel annually (both figures are estimates, taking into account different conversion and estimation methods used). This adds up to an estimated amount of RM7.5 billion of total subsidy for transport fuel borne by government each year.

Going back to the question of necessity and afforability, out of the 15 billion litres of fuels (petrol and diesel) consumed for transportation purposes each year, a significant portion of this is consumed by the private sector and the industry. Since an official figure is not available yet, even a hypothetical estimate of 50% split between individual and private/industry consumption will alter the picture quite radically. I dare say that only RM3.8 billion to RM4.5 billion of the fuel subsidy actually goes to individual citizens for their private use. This does not discount the fact that a great many in our society will not qualify for fuel subsidy, if fuel subsidy is extended only to the needy groups.

So in the end, it boils down to the most basic question which I have repeated in the past: can we afford a fuel subsidy of RM3 billion a year (assuming crude oil price in the region of USD70 to USD80 per barrel), if we were to gradually remove the fuel subsidy for the industry and private sectors (having been convinced that it will have a minimal impact on the inflation)?

Once we stack this magical number against all the other figures, I will leave the conclusion to the readers. RM3 billion against RM19 billion in gas subsidy to the power sector (while some of the IPPs continue to reap huge profits) is a small sum. RM3 billion extended to the most hard-pressed section of our society against an estimated RM4 billion in compensation to toll concessionaires should provide a different perspective in the debate on subsidy removal.

One may argue that the RM3 billion subsidy cost will balloon up as the crude oil price soars in the future. But Malaysia is still an oil producing country with the current production of 650,000 barrels of crude oil each day. An increase in crude oil price will also increase the income to the government. This comes in a few forms such as the oil royalty, supplemental payments (depending on the production sharing contacts/PSCs signed), duties, petroleum income tax, corporation tax and dividends from PETRONAS.

A rough calculation (taking into account the structure of PSCs in existence, reimbursement of cost oil and availability of profit oil as dividends) of income stream to the federal treasury from PETRONAS and domestic oil and gas industry shows that for each USD5 per barrel increase in crude price (on annual average), the government will earn an estimated RM4 billion in extra taxes, royalties, duties and dividends annually.

Thus, not only that the annual income from the nation’s hydrocarbon resources (drawn at an average of RM81 billion each year from PETRONAS for the last 5 years) is adequate to pay for the RM3 billion fuel subsidy targeted at the needy groups, any crude oil price hike should yield additional income that can cover the increase in subsidy cost.

The rest is a question of political will.

Will the Prime Minister continue to push for subsidy removal that affects the masses while being non-committal with the massive RM19 billion gas subsidy given to the IPPs?

Will the Prime Minister continue to tolerate PEMANDU’s failure to come up with a practical mechanism to streamline fuel subsidy to the needy groups, as this should have been the prerequisite before any decision to remove fuel subsidy was made?

The public will expect the government to set its priorities right in managing the gradual removal of the subsidies, so that we do not penalise the groups still dependent on subsidies on essential goods to help make ends meet.

A Malay proverb aptly describes this balancing act as “bagaikan menarik rambut dari tepung, rambut yang ditarik tidak putus, gandum tidak rosak”.

This article was published in my column in The Edge (the published version could have been edited slightly)

One thought on “Subsidy Rationalisation: A Question of Priority and Affordability?”

  1. I agree with your assessment of the actual subsidies.But there are a few issues that needs consideration;

    1.Two tiered pricing between consumers and industry is not easy to manage or police.
    2.Any increase to industry will trickle down to the consumers.And sometimes disproportionately eg> teh tarik up 20 sens 2moro
    3.Export related industries should never be subsidised. and especially those with minimal value add to Msia
    4.Non necessities eg Coke,McD,Cadbury etc should never be subsidised.
    5.IPPs have long term contracts with clearly laid out “pass through” mechanism on the fuel component.Thus,they are well protected.However,as coal is much cheaper then gas TNB shld max their coal IPPS>>check out why they are not doing that.Similarly check out whether the gas consumption is based on ACTUAL or COntract efficiencies (Heat Rate).

    Finally,a word of caution.Subsidies do distort and may not encourage optimal behaviour,Thus a little pain is sometimes good for a growing child but of cos,you would not want to permanently scar him.
    So,the first child which seems so sacred to the BN govt must be the first to be tasked to be competitive and given no protection..later we deal with our anak bongsu.

Leave a Reply

Your email address will not be published. Required fields are marked *

Time limit is exhausted. Please reload CAPTCHA.