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Pricing reform on Malaysian government agenda

The country's costly fuel subsidies are in the spotlight as Najib Razak's government sets its policy priorities for the coming years. Damon Evans looks at the issues

Following elections held in May, the outlook for pricing reform in Malaysia is positive, although change may take some time.

Malaysian Prime Minster, Najib Razak, told the Asian Oil & Gas Conference (AOGC) that there is an urgency to rework pricing and that "we must do more" to rationalise subsidies. But he stopped short of announcing any clear policy initiatives as his Barisan Nasional (BN) coalition, which was narrowly reelected in May, strives to cut its fiscal deficit.   

Given the slim victory, the United Malay National Organisation-led (UMNO) coalition is expected to reduce subsides very slowly and will be cautious about making any formal announcements that could dent electoral support further, Ryan Lawrence, a Malaysian-focused analyst at consultancy Facts Global Energy (FGE) told Petroleum Economist

Last year, Malaysia's deficit-to-gross domestic product (GDP) ratio was one of the region's largest at 4.5%. The figure across the rest of southeast Asia is usually under 3%. Yet, as it moved towards the general election, the government did little to rein in public debt, which has been steadily rising, hitting 53.7% of GDP in 2012, just below the country's debt-ceiling threshold of 55%.

Malaysians frequently lament the rising cost of living, making subsidies a political hot potato. Yet with the highest dollar-per-capital subsidies in the region they pay among the lowest petrol-pump prices and electricity rates in Asia.

But it's crunch time. Najib, a 59-year old former finance minister and economist, aims to claw the deficit-to-GDP ratio down to 3% and public debt-to-GDP to 50% by 2015. This will be achieved through expenditure and revenue reforms, with subsidy cuts, particularly to fuel, possible as early as this year, Su Sian Lim of HSBC said.

Ratings agencies and analysts alike have been alarmed by the government's increasing reliance on national oil company (NOC) Petronas' payments to plug fiscal holes.

The government's revenue stream, which has remained "unimpressively low, is too heavily reliant on Petronas", which provides about a third of the budget, Liam Hanlon, a political analyst at Cascade Asia Advisors wrote in the run-up to May's election.

But Petronas's position as a source of funds will likely remain unchanged. It pays between 26bn and 28bn ringgit ($8.1bn to $8.7bn) per year, despite the company's proposal to cap dividends paid to the government - its sole shareholder - at 30% of its net profit starting from 2014.

The NOC is anxious to cut the dividend to preserve more cash for global investments as domestic oil production dwindles and its hydrocarbon reserves at home remain relatively flat.

Speaking in an interview with the Financial Times in March, Najib seemed in no mood to renegotiate the dividend. However, this could change over time. "We are quite happy at the present level but what happens in the future has to be taken in a bigger context of the total [revenue]; the government can expect," he told the newspaper.

But a balance needs to be struck with Petronas's profit falling - net profit dropped 17.2% to 49.4bn ringgit for the year ending December 2012. It paid dividends of 28bn ringgit - more than 50% of its net profit and around 14% of the government's estimated revenue of 207.2bn ringgit in 2012.

On top of this, it covers the subsidies bill, as well as pays royalties and taxes, with its total contribution to government coffers nearer 40%.

Poisoned chalice

At AOGC, Petronas chief executive, Shamsul Azhar Abbas, described subsidies as a "poisoned chalice" which distort the true picture of energy pricing.

The NOC will spend about 10bn ringgit this year covering transport fuel subsidies, which retail about one-third less than international oil markets. It will also pay around 19bn ringgit to subsidise natural gas consumption.

During the conference, the head of the NOC lamented that the subsidies affect more than fiscal considerations; they depress growth, deter new investments and promote inefficient industries. "Over the next two years, the government could make a move to rein in transport fuel prices, eventually moving towards market prices. But we're talking parity in 2020 at the earliest. It will not be a sudden overnight change," said HS Yen, a petroleum specialist at FGE.

Malaysia subsidises 95 RON gasoline and diesel, the prices of which were last officially raised by 0.05 ringgit/l to 1.90 ringgit/l and 1.80 ringgit/l, respectively, in December 2010.

Unofficially, the subsidies are tweaked slightly depending on market movements. Since the end of 2010, 95 RON gasoline prices have fluctuated, at one point hitting 2 ringgit/l.

Subsidies for 97 RON gasoline, which fuels newer and larger cars, were removed in July 2010 with prices tracking international markets.

Any measured price rises will not effect gasoline demand, which is more inelastic in the longer term, given Malaysia is a fairly mature economy by southeast Asian standards, added Yen.

FGE forecasts gasoline demand rising from 235,000 barrels a day (b/d) last year to 290,000 b/d by 2020.

Subsidies for natural gas, which while manageable now, send out the wrong pricing signals and will be untenable in the long-run, as Malaysia increases imports of costly liquefied natural gas (LNG), Graham Tyler, a southeast Asia gas specialist at energy research firm WoodMackenzie told Petroleum Economist.

The government has not announced any new mechanism to reform gas prices - now 13.7 ringgit per million British thermal unit (Btu) and among the lowest in the world - since 2010.

Back then ministers agreed to raise the price by 3 ringgit/million Btu for end-users every six months until 2015, when gas prices were targeted to meet market parity. But only one price increment took place, in June 2011, as the government put the plan on ice ahead of the elections.

Still, it could easily be reenacted. But Tyler expects "a slow retrenchment of natural gas subsidies rather than a big bang approach".

Increasing prices in gas-short peninsular Malaysia would improve the economics of exploring and developing domestic fields, whilst increasing the attractiveness of the nation as a gas import market.

But one thing is clear, future upstream development - experiencing something of a renaissance - will decline if long-term gas prices are not reformed and Malaysia will be increasingly dependent on imported LNG.

WoodMackenzie forecasts LNG imports up from virtually nothing now to just below 3m tonnes per year (t/y) by 2015.  Petronas has completed the country's maiden import terminal in Melaka - it received its commissioning cargo at the end of April - offering an open access system to domestic users.

The research firm predicts imports will rise to 5.3m t/y by 2020, down slightly from earlier estimates, as coal looks set to play a bigger role in the power mix.

Post-2020, more LNG demand is expected as natural gas imported through pipelines from Thailand and Indonesia drops off.

Energy security at risk

But without further reforms Malaysia's energy security will be at risk,  Abbas warned. "We cannot fall into the lure of short-term gains at the expense of long-term energy security," he said, referring to the need for market-led investment to underpin further economic growth. 

As part of the nation's economic transformation programme, the government wants the energy sector to contribute 241bn ringgit to gross national income in 2020, up from 110bn ringgit in 2009.

Enhancing energy security is the single biggest challenge facing Asian nations in the foreseeable future, stressed Abbas. This goes some way to explaining the escalating upstream investment strategies designed by the Asian NOCs, particularly Petronas.

Petronas is considered "exceptional" as unlike many of its contemporaries, it has much greater flexibility through its access to rising imports and exports, said Fereidun Fesharaki, chairman of FGE.

Malaysia is the second-largest LNG exporter in the world, thanks to the Petronas-operated 24m t/y Bintulu LNG complex in Sarawak, west Malaysia.

Much of the LNG is sold through long-term contracts and makes up an important source of revenue for the government, which would be sacrificed if it sold its LNG to the domestic market at subsidised prices.

Domestic production capacity will be boosted through a 3.6m t/y expansion at its Bintulu plant in 2016. Meanwhile, its maiden 1.2m t/y floating LNG unit is expected online by the end of 2015 and a second 1.5m t/y floater is targeted by the end of 2016.

The NOC is also expanding its overseas footprint. It is planning a 6m t/y export scheme in British Columbia after its successful $5bn-plus takeover of Canada's Progress Energy - its biggest-ever overseas acquisition - last year. A final investment decision is eyed in late 2014 with first shipments expected by late 2018

It also has a 27.5% stake in the Santos-led Gladstone LNG project in Australia and is signed on for 3.5m t/y of LNG over a 20-year term.

A 5m t/y LNG regasification plant is also under consideration as part of the proposed $20bn refinery and petrochemical integrated development (Rapid) in southern Malaysia.

The LNG hub will cater to the needs of the Rapid project - designed to produce 9m t/y of petroleum products and 4.5m t/y of petrochemicals - and help diversify gas supply sources to meet existing and future demand in peninsular Malaysia.   

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