Fuelling the Bio-Bill

Malaysia

Economic News

22 Jul 2010
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Fuel troubles have been grabbing headlines in Malaysia all month, with shortages of diesel in one town bringing worries over the future end of petrol subsidies.



News on October 12 that the eastern Malaysian oil town of Miri had been hit by a diesel shortage for the second time in six months sparked these concerns, with the Malaysian daily, The Star, reporting reliable sources as claiming that the diesel shortage could spread to other parts of the country as well. The paper's source said that the "diesel quota" allotted by Shell and Petronas for two months had already been used up.



As thirsty vehicles queued at petrol stations, other sources claimed the event was not because there was not enough diesel, but because daily supplies had been reduced in Miri.



Whilst a potential lack of supply is always likely to drive up prices, the underlying concern here is over moves to gradually remove government subsidies on diesel fuel. Malaysia currently has the second cheapest petrol prices in Southeast Asia, but as the government strives to rein in the fiscal deficit, it is a title that cannot be retained.



The recent budget announcement showed that the amount required to keep the cap on fuel prices throughout 2006 would reach RM15.7bn ($4.2bn) compared to RM6bn ($2.38bn) in 2004.



In fact, the government's energy bill this year will end up 35.6% higher than the projected budget deficit for the year. With international oil prices marking increasing gains, the squeeze on the government coffers has to be relieved and so a gradual removal of prices subsidies has been underway - with three hikes so far in 2005.



Neighbouring Indonesia had been in a similar situation until September, when the government there removed subsidies, liberalizing the market in a "shock therapy" approach. With reported price hikes of up to 90%, riots broke out.



Enjoying a stronger economic position gives the Malaysian government some more room to balance the needs of the economy without social unrest, though asking any taxi driver how they feel about the rise of 6.6% in petrol and 45.6% in diesel prices will not yield a polite response.



Keeping economic growth on an even keel requires the gradualist approach, say most analysts. Spiking fuel prices could easily drive inflation, already at its highest since 1999, and effect a wide selection of markets.



Obvious casualties of inflation are those goods and services in which fuel is a direct cost - for example, transport, distribution and industries that rely on these services, such as retail and agriculture. Another, less obvious, knock-on effect could likely be in the residential real estate market, where prices of property away from major commercial centres could be affected, leaving some debt-burdened homeowners in the lurch.



Howecer, some relief on diesel prices could come from government plans to legislate for the use of bio-diesel, a move which would also have the effect of giving a boost to the local palm oil industry.



Bio-diesel, which is already used in some parts of Western Europe as a substitute for diesel, mixes normal diesel with another organic oil, in this case palm oil.



And while the chosen blend of 95% diesel and 5% palm oil will by no means be a panacea, there is scope for reducing the demand for diesel - some say by as much as 10%. In the short term, this will potentially relieve the government's financial burden and, as the subsidies come off, lessen the impact of rising prices.



Indeed, the Ministry of Plantation Industries and Commodities is tabling a bio-fuel bill this October which, if the ministry gets its way, will see Malaysia become the first Asian country to make the sale of bio-diesel compulsory.



Various incentives have also been put in place and the government is working in partnership with the private sector to set up three palm oil bio-diesel commercial plants with a combined output of 180,000 tonnes a year.



Goodies for those dabbling in renewable energy production were sweetened by an increase in tax exemptions for firms granted "pioneer" status from 70% to 100%, and a risein the rate of investment tax allowance for those firms from 60% to 100% for five years.



Markets have already been reacting to the news on bio-diesel use. Palm Oil Plantation firms have rallied on Bursa Malaysia and the price of the commodity has recently risen slightly.



The exchange's main board plantation index reached its highest level since early 1997 in early October and was up 18.5% year-on-year compared to the Kuala Lumpur Composite Index's 2.2% rise.



Some fund managers point straight to the bio-diesel development in explaining the sector's rally, although some still maintain a neutral view and have shied away from the bullish run on plantation stocks until the bio-fuel bill is finalized.



Analysts are much firmer that Crude Palm Oil (CPO) prices are set to recover; forecasts expect the price to be between RM1500 ($397) and RM1600 ($424) per tonne at the end of 2005, having been below the RM1300 ($344) mark in January.



The news is surely welcome among the palm oil producers, whether this will eventually reduce diesel prices or not. However the hope is that the successful use of the alternative fuel will visibly relieve the effects of high international fuel prices attracting customers for exports of Malaysian bio-diesel. Such a move should help ward off another scare like Miri.

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