Malaysia embarks on fuel subsidy rationalization-

Close to 90 per cent of the electricity generation mix in Malaysia comes from fossil fuels – natural gas (45 per cent), coal (38 per cent), and oil (5 per cent), while hydro (10.5 per cent) and renewable energy sources (1.5 per cent) make up the remainder. Malaysia spends billions of dollars annually on fossil fuel subsidies to keep the prices lower than the market rate, thus ensuring the affordability of fossil fuels for its population. Thanks to subsidies, Malaysia has the second lowest end-user gas prices in Southeast Asia, behind Brunei.

However, due to rising population and urbanisation, the demand for primary energy (such as coal, oil, and biomass) and electricity has increased at a compound annual growth rate (CAGR) of 2.5–3 per cent. At the same time, fossil fuel subsidies grew at an estimated CAGR of 11 per cent between 2009 and 2012. According to the International Energy Agency, the Malaysian government spent about $8.5 billion on fuel subsidies in 2012. These subsidies have affected the government’s budget and had an adverse impact on the country’s macroeconomic scenario. Together with global factors like the US Fed tapering programme, the slowdown in Europe, and the decline in the prices of key export commodities such as crude oil and natural gas due to the shale gas “revolution” in the US, they have added to the country’s economic woes.

Based on projections, Malaysia’s 2013 gross domestic product (GDP) growth rate is 5 per cent, lower than the 5.6 per cent in 2012. Its budget deficit has hovered at over 4 per cent of GDP for the past three years. In view of Malaysia’s weak economic fundamentals, Fitch Ratings revised Malaysia’s sovereign credit rating outlook from “stable” to “negative” in July 2013. This development has, in turn, placed tremendous pressure on the government to achieve fiscal consolidation in order to restore confidence in the markets.

Reining in fuel subsidies

Fuel subsidy rationalisation constitutes the first step in the country’s endeavour to improve public finances. According to a press statement by the Malaysian Prime Minister’s Office: “The moderation in the current account of the balance of payments, coupled with continued fiscal deficits, pose medium-term risks to the economy. Hence, strengthening the fiscal position is vital to sustaining the resilience of the economy, as well as further enhancing public and investor confidence. Towards this, subsidy rationalisation will be carried out in many stages.”

In September 2013, the Malaysian government increased the prices of RON95 petrol and diesel by 20 sen per litre. This is the second such hike after the first one in 2010. So far, the government had been subsidising 83 sen for every litre of RON95 petrol and RM 1  for every litre of diesel. Even after subsidy rationalisation in September, the government was still providing a subsidy of 63 sen per litre of RON95 and 80 sen per litre of diesel. Total fuel subsidy allocation was RM 24.8 billion in 2013.

Since fossil fuels are the main source of electricity generation in Malaysia, a hike in their prices had to be followed by electricity tariff revision. In December 2013, the government announced a revision in electricity tariffs with effect from January 1, 2014. The average electricity tariff in peninsular Malaysia will increase by nearly 15 per cent from 33.54 sen per kWh to 38.53 sen per kWh. Meanwhile, for Sabah and WP Labuan, the average electricity tariff will go up by about 17 per cent from 29.52 sen per kWh to 34.52 sen per kWh. The tariff increase consists of two components – a base tariff hike of 2.69 per cent for the country’s leading integrated electricity utility, Tenaga Nasional Berhad (TNB), and a price hike in domestic gas, liquefied natural gas (LNG), and coal prices. According to the Ministry of Energy, Green Technology and Water, the subsidy for the year 2012 was around RM 12 billion ($3.6 billion).

Finally, the government has also raised the rate of the cess collected from consumers for the renewable energy fund from 1 per cent to 1.6 per cent for customers with consumption above 300 kWh per month.

Impact on stakeholders

At a broader level, the fuel subsidy rationalisation measure will help to alleviate the strain on the government’s budget. Projected near-term fiscal savings from the 20 sen per litre hike in the price of subsidised fuel products are RM 1 billion in 2013 (0.1 per cent of GDP) and RM 3 billion (0.3 per cent of GDP) in 2014, according to Fitch Ratings.

Apart from the government, electricity companies will also be able to generate the much-needed revenues for infrastructure expansion. For instance, prior to the tariff revision, Sabah Electricity Sendirian Berhad’s tariff covered only about 68 per cent of the actual cost of electricity generation (which was 43.46 sen per kWh). After the revision, the utility will be able to recover about 80 per cent of the actual generation cost. The additional revenues can be used by the utility for augmenting electricity supply infrastructure in its region.

In the electricity tariff revision notification, the provision of a base price hike augurs well for TNB, Malaysia’s leading integrated electricity utility. It will boost the company’s earnings and help it meet its increasing capital expenditure requirements. The base tariff hike is the first crucial step towards the rollout of the long-awaited incentive-based regulation mechanism for TNB. The mechanism, whose final features are expected to be finalised soon, will be administered by the Energy Commission. In addition, analysts believe that the regulatory framework may soon put in place a fuel cost pass-through mechanism under which the tariff will be revised every six months, in line with fuel price fluctuations.

PETRONAS, the state-owned integrated oil and gas group, will also benefit significantly from subsidy rationalisation. PETRONAS has been selling domestic and imported gas to electricity generators at a controlled price, thus forgoing significant revenues in the process. The group’s forgone revenues due to the gas subsidy were estimated at RM 20 million in 2011. A move towards prices of fossil fuels, which are more reflective of the market, will directly contribute to PETRONAS’s earnings. The group could then invest more in exploration and production, as well as setting up LNG regasification facilities.

Based on the above discussion, it is evident that subsidy rationalisation is an overdue measure for removing market distortions. The chief factor that had stalled reforms for a long time had been the public sensitivity over the issue. The public and industries expressed significant resistance to the electricity tariff revision, as it had come upon the heels of the announcement of the petrol and diesel subsidy cuts.

In actuality, the tariff revision will not affect households that consume less than 300 kWh per month. Essentially, 70.67 per cent of domestic consumers in peninsular Malaysia and 62 per cent of consumers in Sabah and WP Labuan will still enjoy subsidised electricity prices. In addition, the government will continue to give rebates to consumers whose electricity bills are RM 20 and below until December 31, 2014.

The primary groups affected by the measure are the industrial and commercial consumers that consider the tariff hike to be “quite steep”. According to the Federation of Malaysian Manufacturers that represents over 2,500 manufacturing and industrial service companies, the manufacturing sector is disappointed with the hefty 16.85 per cent increase in electricity rates for the industrial category and the effective date for the increase, which gives them only a month’s notice. This hike in rates will significantly increase the cost of doing business in the country.

In particular, the input costs of companies operating in energy-intensive industries such as steel and cement will increase considerably. For instance, Malaysia Steel Works, the country’s leading steel manufacturer, is likely to see earnings for financial year 2014 slashed by over 50 per cent due to increased tariffs, says RHB Research. Electricity costs make up about 10 per cent of its total production cost. However, on a positive note, the tariff hike may motivate industries to move towards energy efficient practices in a bid to reduce their costs.

No turning back

The recent subsidy rationalisation steps are just a beginning. Weak economic conditions are the foremost driver of subsidy reform. The country still faces the risk of a downgrade in its sovereign ratings by international credit rating agencies, which will adversely impact investment inflows. Therefore, more such cuts are expected in the future, which is in line with the government’s objectives of achieving federal government deficits of 3.5 per cent and 3 per cent of GDP in 2014 and 2015, respectively.

As outlined in the Tenth Malaysia Plan (2011–15), the government intends to move towards market-determined rates for energy resources by 2015. The plan highlights the government’s intention to revise gas prices for the power and non-power sectors every six months. It also plans to follow a decoupling approach for energy pricing under which the subsidy value will be clearly mentioned in consumer energy bills. Targeted assistance will be provided for low-income households.

However, since subsidy rationalisation is politically sensitive, the pace of these reforms is likely to be slow. Even so, policymakers have realised that subsidies are unsustainable in the long term. Market-based pricing for energy resources will not only free up capital for the development of energy infrastructure, but also attract new players into the sector.