How Regressive Are Fuel Subsidies?

My colleague Nurulhana wrote this for our internal blog. Since its self explanatory, I'll leave it here without comment and unedited. Side note: this was written last month, so the drop in oil prices since then implies a lower retail petrol price and hence, lower subsidy. Nevertheless, the point remains valid.

Fuel subsidy helps the rich

A colleague highlighted this estimation by Tengku Zafrul today on the impact of high global oil prices on current fuel subsidy spending.

According to the article, the actual market price for RON 95 is currently at RM3.70/litre. And if the global oil price remained above the USD100/bl, the MOF estimated that the government would spend RM28bn on overall subsidy alone for 2022 (2021: RM11bn).

The First 100 Days

I’ve had multiple requests to comment on this, but haven’t had the time. To be honest, I didn’t read either side’s political manifesto too closely, as most election promises are so hedged with operational realities that the likelihood of full implementation was never going to be very high, when political idealism meets unyielding economic realities. However, now that we have some clarity on the direction forward, it’s time to seriously assess Pakatan Harapan’s manifesto.

I won’t go over the whole thing, just the 10 items that were promised for the first 100 days, and even then only those that are economics related. So, no comment on investigating scandals or the stature of Sabah and Sarawak.

Chart of the Week: RON95 Petrol Price Vs Volume

Malaysian consumers mostly responding to price signals (quarterly MYR average prices, log annual and quarterly changes):

When the administered RON95 price was raised in 2013, there was little change in demand growth. It was still running at roughly 5% per annum. However, when the oil price drop in 2014 started feeding through into retail petrol prices, there was a steep rise in demand. A bit of an oddity, considering that the economic situation was less than ideal – or maybe it was because outbound tourism became more expensive, so people took to domestic travelling more.

In any case, the volume has lately become much more sensitive to prices (a signalling effect from monthly/weekly price volatility? worth keeping track of). For 1Q17, there was a sharp drop-off in purchases of petrol. From my point of view that’s ideal – a Pigovian tax on petrol (like tacking on GST) would then have the desired effect on consumer behaviour.

One thing the charts above don’t show however, is just how much petrol Malaysians are consuming. It’s sobering (index numbers; 2010=100):

Consumption of petrol is 70% higher than it was in 2010, and 2/3rds of the increase has come over the past three years alone.

Technical Notes:

1. RON95 retail prices from Galvin Tan’s blog and press anouncements
2. Retail fuel volume data from the Quarterly Distributive Trade Index reports from the Department of Statistics

5 Thoughts on the OPR Cut

At the risk of getting a phone call from across the road, here’s what I think of last week’s 25bp OPR cut:

1. Surprise!

One of the reasons the move came as a surprise to the markets and everyone else was that it was not telegraphed beforehand. Nobody got a hint of any change in policy, right up to the announcement. On the one hand, this breaks with recent practice around the world, where guidance is given so that markets adjust in a relatively orderly fashion. On the other hand, if you believe in the neutrality of money and rational expectations, surprise changes in monetary policy are the only changes that work. More on this in a bit (see point 5).

Pigovian Taxes: Are We Finally Ready For It?

This past week, I met up with a senior official at MOF, and he surprised me by supporting a resumption of duty on petrol (via GST). Relief had been granted for RON95 since GST was implemented, and before that, relief from sales tax had already been in force for years.

It turns out he (and I) are not alone:

Debate on petroleum tax

Amidst the falling price of crude, a question that is being debated by some within and outside the Government is whether there should be a tax on petrol.

The current automatic pricing mechanism (APM) for determining petrol prices comprises multiple components, including product costs, operation costs, vendor margins and a tax, among others.

Notably, the current managed float system is based on monthly reviews on the APM based on prevailing crude oil prices and the margins enjoyed by petrol dealers are closely monitored by the government.

Before the APM came into place, for each litre of petrol the tax portion was 58 sen.
However because of the high oil price, the government did not collect the tax and instead subsidised petrol to keep prices low.

Now the question being asked is whether the Government should reduce its relief on RON97 since petrol is a consumption item and involves draining the natural resources....

The discussion is starting to surface, though I would have been happier if this was pushed through in stronger economic times. Has the time finally come for doing the right thing?

Why Fuel Subsidies Had To Go

All explained in two slides from last week’s BNM Annual Report Briefing:

You can find the box article these were taken from here.

Queuing For Petrol

If you’re the type to queue up for petrol before prices are hiked, make a note to fill up this Saturday:

Since hitting bottom in the second week of January, Brent crude oil has rebounded to around the USD60-USD55 per barrel range (about 20% higher), compared to the USD47.80 average for January.

While Malaysia’s APM pricing is based on MOPS, not Brent, there’s an obvious correlation involved (MOPS includes refinery costs). February’s average Brent prices are pretty close to December’s (the difference is just USD1-USD2 per barrel), so we’re likely to see petrol and diesel prices close to those prevailing in January – RM1.91 for RON95 and RM1.93 for Diesel.

I’m expecting CPI inflation to now hit 0.3% in February, before rising to 1.1%-1.2% in March.

Dec 2014 Consumer Prices

With the (slight) fall in petrol prices, the aggregate price level moved a little lower in December (log annual and monthly changes):

Notes On Oil

I came up with some talking points for a presentation last week, and since so many people have been asking for a comment on the drop in oil prices, I thought I might as well publish them.

Why is the price of oil dropping?

Essentially, its a demand and supply imbalance. On the one hand, China has been slowing down while Europe has backslid and Japan went into technical recession after implementing a sharp increase in its consumption tax. The only two real bright spots of growth in the developed world is the US and UK, and the US has rapidly developed its domestic oil supply in the last five years. To compound this, the energy intensity of growth (how much energy is required to support a higher standard of living) has been declining for decades.

Bye-Bye Fuel Subsidies

The Government has had an outbreak of common sense (excerpt):

Hasan Malek: No more RON95 petrol, diesel subsidies from Dec 1

PUTRAJAYA: All subsidies for RON95 petrol and diesel will be stopped beginning Dec 1, said Datuk Hasan Malek.

The Domestic Trade, Cooperatives and Consumerism Minister, who announced this at a press conference here on Friday, said the retail prices for RON95 petrol and diesel will be fixed according to a managed float, similar to the mechanism dictating the RON97 petrol price.

Hasan said there would be an announcement at the end of each month to set the following month's fuel prices.

He said it would be determined based on a monthly average price….

There’s still the super-subsidy on diesel (for public transport and fishermen) and subsidies on natural gas (which are huge), but the latter has been starting to be phased out as well. The gas subsidy in particular has been prone to abuse, with businesses using gas cylinders intended for households.

In any case, we’re well rid of the dangerously complicated multi-income-tier subsidy idea that the government has been mulling over. With global oil prices so low – for November, it appears that consumers have actually been paying a small tax on petrol – there would have been no better time for this move to have been made. We had that opportunity once in 2009-2010, and missed the chance. I’m happy it wasn’t missed this time.

If global oil prices stay low, and this is the scenario market participants are looking at at least for the next couple of years, then well and good. If prices move back up, then the government will no longer have to bear the cost of subsidising petrol and diesel, and use the increase in revenue on something more important – like public transport for instance, or education, or *gasp* paying down debt.

Having said that, we’re still not home free. Prices going forward will still fall under the Automatic Pricing Mechanism, which means profit margins are guaranteed for distribution and retailing. Oil retailers in Malaysia have been used to competing on a non-price basis; that’s not necessarily the optimum for consumer welfare. The next step should be to free up the market, and let the oil companies compete on price. That should give back to consumers some of the welfare loss associated with being exposed to global oil price volatility, essentially sharing some of the risk with producers.

I know, I’m asking for the sky. Still, I’m pretty happy with the decision today. It’s been a very long journey over the last five years.

Tiered Fuel Subsidy System: Please Don’t Go There

The floodgates are opening (excerpt):

Full fuel subsidy only for those earning under RM5,000 monthly

KUALA LUMPUR: Those who earn more than RM10,000 per month will not enjoy any fuel subsidy under the subsidy rationalisation scheme to be implemented next year.

In announcing this Monday, Second Finance Minister Datuk Seri Ahmad Husni Hanadzlah said the programme would be divided into three tiers.

After early whispers before the budget, it’s now way out in the open. But, there’s much better ways of managing this than shifting to a convoluted system that’s going to be full of holes. Here’s one fellow Tweeter’s take on it (it’s in BM, but that shouldn’t be a problem, right?).

Subsidy Cut

So, effective yesterday, petrol prices at the pump have been raised to RM2.30 and diesel to RM2.20.

Ballsy move, and to me, completely unexpected. With the 20sen cut in the petrol and diesel subsidy, Malaysia is within striking distance of abolishing fossil fuel subsidies entirely – at least, at the retail level. We still have the gas subsidy to deal with, but that’s less important for a couple of reasons: gas is a cleaner fuel (no negative externalities) and there’s also less implications for the government budget.

Resistance, compared to the similar 20sen cut last year, seems to me to be a lot more muted this time around. Nevertheless, resistance there is.

Estimating Costs Of Global Fuel Subsidies

There are costs, and then there are costs (abstract):

The Economic Cost of Global Fuel Subsidies
Lucas W. Davis

By 2015, global oil consumption will reach 90 million barrels per day. In part, this high level of consumption reflects the fact that many countries provide subsidies for gasoline and diesel. This paper examines global fuel subsidies using the latest available data from the World Bank, finding that road-sector subsidies for gasoline and diesel totaled $110 billion in 2012. Pricing fuels below cost is inefficient because it leads to overconsumption. Under baseline assumptions about supply and demand elasticities, the total annual deadweight loss worldwide is $44 billion. Incorporating external costs increases the economic costs substantially.

Subsidy Rationalisation: Some Pointers From The IMF

(H/T Jason)

The cost of petrol and gas subsidies in Malaysia are likely to be in the region of RM45-50 billion this year, if not higher. Some of that comes directly from the government, while the rest are borne by Petronas or TNB.

Whether or not they appear on the government’s books, these subsidies simply have to go. First because of the actual fiscal costs of keeping the present subsidy system in place; second because of the opportunity costs for both the government and Petronas in terms of investment; and third because of the economic inefficiencies engendered by distorted prices. On top of that are the negative externalities arising from hydrocarbon use and the fact that the primary beneficiaries are corporations and the higher income households.

What If Everyone Had A Car?

I’m on my hobby horse today. From the BBC:

What if everyone had a car?

Technology offers potential solutions to traffic congestion and pollution – but getting there will take time, R&D dollars, and an incentive for people to make the shift to smaller, more fuel efficient vehicles.

For starters, how about getting rid of subsidies and taxing petrol use?

1Q 2012 Federal Government Budget Update

The 1Q2012 numbers for the government’s accounts were published along with the April 2012 Monthly Statistical Bulletin from BNM. There’s some good and bad points, but the general tenor is that there’s been some improvement in the government’s overall fiscal position (RM millions):

More On Dropping The Petrol Subsidy

There is, as one commentator put it, more than one way to kill [sic] a cat. I’ve been open about my support for dropping petrol subsidies in favour of taxes which cover the overall costs to society imposed by fossil fuel use i.e. a Pigovian tax.

There’s actually some method to my madness.

Petrol Subsidies: Time To Go

I read this last night, and I wholeheartedly agree (excerpts):

For Global Gasaholics, Ending Subsidies Is the First Step: View

Jan. 10 (Bloomberg) -- Fuel subsidies are the crack cocaine of global economic development: easy to get hooked on, hard to give up. And as every addict knows, there are good and bad ways to try to kick the habit.

Consider Nigeria and Iran. In Nigeria, the government’s recent decision to remove fuel subsidies and more than double the price of gasoline has led to riots and now a nationwide strike. Two years ago in Iran, an initiative to cut subsidies and almost quadruple the price of gas (as well as boost the price of food and water) provoked little unrest, lowered oil consumption and bolstered the economy and the government.

The differences between the two efforts offer valuable lessons about the best ways to eliminate fossil-fuel subsidies - - a staggering global misallocation of resources that does little to help the poor, distorts markets and pumps more greenhouse gases into our atmosphere.

The Argument For Taxing Energy

N. Gregory Mankiw points us to this article by Yale Professor William Nordhaus:

Energy: Friend or Enemy?
William D. Nordhaus

...The two faces of energy are the primary reason why energy policy is so controversial and tangled. We need national policies that address the enemies of pollution and global warming. But because energy is such a large part of consumer budgets and so central to our advanced economies, people are reluctant to allow energy prices to reflect the true social costs of energy consumption. We see this tradeoff play out in energy and environmental policy year in and year out...

...An externality is an activity that imposes uncompensated costs on other people. Externalities from energy use include the deadly air pollution emitted by cars and power plants, oil spills, radioactive emissions from nuclear power plants, sludge from coal mines, and congestion from overloaded streets and highways. More recently, scientists have focused on greenhouse gas emissions, such as the carbon dioxide that comes from burning fossil fuels, as a particularly dangerous externality...

Peak Oil: The New (Old) Reason For Business Cycles

Chris Sebrowski argues that whether or not we’re coming up against geological peak oil, we’re likely to come up against economic peak oil first (excerpts, emphasis from source):

A Brief Economic Explanation of Peak Oil

For a number of years there has been an arid debate between economists and geologists about Peak Oil. The geologists maintain that Peak Oil (maximal production) is a geological imperative imposed because reserves are finite even if their exact magnitude is not, and cannot be, known.

In contrast many economists maintain prices will resolve any sustained supply shortfalls by providing incentives to develop more expensive sources or substitutes. The more sanguine economists do concede that the adaptation may be slow, uncomfortable and economically disruptive.

The reality, I believe, is that both groups have part of the answer but that Peak Oil is, in fact, a complex but largely an economically driven phenomenon that is caused because the point is reached when: The cost of incremental supply exceeds the price economies can pay without destroying growth at a given point in time. While hard to definitively prove, there is considerable circumstantial evidence that there is an oil price economies cannot afford without severe negative impacts.

The corollary is that if oil prices fall back to and sustain levels that do not inhibit growth, then economic growth will resume, with both recoveries and downturns lagging oil price changes by 1-6 months.

The current failure of most western economies to achieve anything more than minimal growth this year (2011) is most likely because oil prices are already at levels that severely inhibit growth. Indeed, research by energy consultants Douglas-Westwood concludes that oil price spikes of the magnitude seen this year correlate one-for-one with recessions...