Business Times - 04 Jul 2005

MALAYSIA INSIGHT

Time for Malaysia to rethink fuel subsidies
Scrap gas subsidies to power producers and reinstate formula pricing

By S JAYASANKARAN
KL CORRESPONDENT

MALAYSIA'S power sector has never had it so good. Indeed, it's enjoying
the closest thing to having its cake and eating it too. Ask Hassan
Marican. The chief executive of Petroliam Nasional, or Petronas, was
briefing reporters on the national oil corporation's financial results
on Thursday when he broached the topic of subsidised gas sales to power
producers.

Mr Hassan revealed that since 1997, Petronas has subsidised Malaysian
power producers to the tune of RM25.4 billion (S$11.3 billion) through
absorbing the costs of higher gas prices. For 2004 alone, the oil
company spent RM6.2 billion to keep the price of gas - the fuel of
choice of the power producers - at artificially low levels. All this, of
course, is foregone revenue for Petronas.

The subsidies started in 1997 when the Asian financial crisis began
blowing out the balance sheets of many companies.

Trying to keep a lid on things, the government decreed that power
companies - which used to pay fuel charges based on a formula that took
into account global oil prices - be helped so that consumers and other
companies in turn, could be shielded from higher electricity tariffs.

But Mr Hassan also revealed that three quarters of its subsidised gas
sales were to Malaysia's independent power producers. Now that's
inequity in a nutshell.

Many of the first generation IPPs still enjoy internal rates of return of
20-25 per cent. These are rich, near-extortionate, returns and they come
at the expense of Tenaga Nasional, the national utility. Indeed, it's
long been a bone of contention and it's the primary reason behind the
utility's cash flow problems.

When Abdullah Ahmad Badawi took over Malaysia's leadership in late 2003,
he suggested that privatisation awards and previous contracts that were
lopsided or blatantly unfair to the government should be reviewed.
Everyone agreed but to-date nothing's happened. Not a single contract,
or award, has been reviewed, modified or changed in any substantial
fashion.

Kuala Lumpur should begin with rethinking the fuel subsidies and the role
of the IPPs. The unfair agreements the producers enjoy at Tenaga
National's expense should be scrutinised. For a start, the IPPs should
be persuaded to drop their rates to Tenaga in return for proportionately
longer concession periods.

The gas subsidies to the IPPs should be scrapped and the formula pricing
methodology should be re-instated. This will doubtless affect Tenaga as
well: the national utility buys a fourth of Petronas' gas sales at
equally subsidised rates.

But Tenaga Nasional is also being shortchanged. It deserves a tariff
hike. The last one was allowed by the government seven years ago and
that's a lifetime away. It does not take into consideration the changed
economic climate, the new, post-crisis inflationary period.

The reality is simply this: the days of cheap oil may be over. If the
subsidies are to be removed for the power sector, it will have to be
removed across the board as well. That should include fuel prices and it
will be unpopular. But it can be staggered over time as weaning the
public off cheap fuel won't be easy.

Unfortunately, it will have to be done as it removes surprises,
eradicates economic distortions and makes the broader economy more
efficient. In the final analysts, spoon feeding, over a period of time,
teaches us nothing but the shape of the spoon. It may be good politics
but it's bad economics.

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