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Subsidy burden may push fuel market reform

With oil prices expected to remain above $100 per barrel into 2013, the fuel subsidy burdens shouldered by many Asian governments will speed up the pace of market deregulation and could cut oil demand growth, consultancy Wood Mackenzie believes

The firm estimates that refining and marketing companies in India, China, Malaysia, Indonesia, Taiwan and Vietnam made a combined loss in the range of $70 billion to $80bn last year as governments intervened to control consumer pricing.

As a result, there is mounting pressure on governments to cut unsustainable subsidies and allow market forces to determine prices. This puts a downward risk on oil demand expansion in key markets, such as China, India, Indonesia and Malaysia, Sushant Gupta, senior Asian downstream analyst at Wood Mackenzie said.

Asia is expected to account for much of the 1 million-1.5m barrels per day (b/d) world demand growth forecast by 2013. The bulk of oil demand is expected to be driven by the transportation, petrochemical and power sectors in Indonesia, China, Japan and India.

Asian nations have battled to keep fuel prices low, but their spending on subsidies has ballooned as global oil prices stay above $100 per barrel.

In a bid to control this spending, governments are increasingly focused on deregulating domestic markets. However, in some nations politicians struggle to maintain their popularity – and their electability - once fuel subsidies are cut.

Gupta told Petroleum Economist that the most notable success has been seen in China and India, two of Asia’s biggest markets. In 2009, China revamped its pricing mechanism and subsequently retail prices have risen much quicker. Chinese retail gasoline prices are now higher than the US.

In September this year, India increased diesel prices steeply, despite public protests and national elections due in 2014. New Delhi is now moving towards deregulating diesel prices. India started deregulating the retail gasoline market in 2010.

Elsewhere, pressure is mounting on Indonesia and Malaysia to deregulate. Both countries have so far caved in to public protests over subsidy cuts. But high oil prices leave both nations with little room to manoeuvre.

Malaysia has the highest dollar-per-capita subsidies in the region and Kuala Lumpur is being forced to rethink its policy. However reforms are not likely before elections due later this year. Malaysians pay among the lowest electricity rates and petrol-pump prices in Asia

Malaysian national oil company Petronas’ growing pique at its government over subsidies – for which Petronas foots the bill - flared into public view in early June at the World Gas Conference. Chief executive Shamsul Azhar Abbas took to the stage and declared that the government’s policy of subsidising fuel was, quite simply, wrong.

The polite but pointed disagreement was the latest sign of assertiveness from the oil company. Recently tension has been rising over how much money Petronas hands over to the government in the form of fuel subsidies, dividends and taxes. The Malaysian government’s increasing reliance on Petronas’ payments to plug fiscal deficits has begun to alarm ratings agencies and analysts. These payments have grown as oil prices soared. But so too has government spending.

Unlike other oil-rich nations such as Saudi Arabia, Brazil or Norway, Malaysia runs chronic, large budget deficits that expanded as oil revenues climbed. Last year’s fiscal gap, at 5% of gross domestic product, trailed only India’s for the dubious distinction of biggest in emerging Asia, and it may widen this year.

Subsidies account for a big portion of the deficit. But they have other downsides as well. Subsidies distort transparency, reduce competition and deter new investments, noted Shamsul, adding that Petronas paid between 18bn and 20bn ringgit ($5.9bn-6.6bn) per year to subsidise gas consumption.

Elsewhere, the Indonesian government is exploring ways to curb the nation’s soaring oil subsidy bills after its failure to push through domestic price rises earlier this year.

Jakarta had to abandon plans to increase prices of subsidised products by 33% in April because of public protests. The price rise would have been the first in nearly four years. But lawmakers left the option open for price increases later this year if Indonesian crude rises by an average 15% from the government’s budgeted $105 a barrel for a six-month period.

Subsidised fuels make up more than half of Indonesia’s total oil products consumption of around 1.3m b/d. The nation imports about 350,000 b/d of products.

A quota of 40bn litres has been set for subsidised fuels in 2012. But actual consumption of subsidised fuels could exceed these projections.

Jakarta estimated in its revised annual budget in April that oil subsidies will cost it around 137.4 trillion rupiah ($14.5bn) this year, up from its previous estimate of 123.6 trillion rupiah. Indonesia’s oil subsidy bill has jumped by about 65% from 2010, when subsidies cost the government about 83 trillion rupiah.

The government estimates that continually paying fuel subsidies to keep up with global oil prices could widen the budget deficit gap to 3.4% of GDP, above the 3% cap allowed by law. The 2012 deficit target is currently just over 2%.

Oil prices have been a politically sensitive issue in Indonesia since price rises in 1998 led to riots that contributed to the downfall of long-standing president Suharto.

Governments around the region have all experienced public pressure to maintain high subsidies. But the International Monetary Fund describes the subsidy burden as a costly, inequitable and a rising drag on these emerging economies.

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