Growing Champions: Remove energy subsidies smartly

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Malaysia is moving ahead with its plan to gradually reduce gas subsidies to the power and industrial sectors. Unlike oil subsidies, gas subsidies are not direct subsidies, but rather an opportunity cost to the country. Instead of selling gas at global market prices, suppliers forgo profits by selling it at much lower prices (albeit still above their cost of production).

There are many arguments for removing this subsidy, from ensuring a long-term supply of domestic gas to not propping up uncompetitive industries and creating additional government revenue. However, it is important to understand the impact of its removal on Malaysian industries and what can be done to mitigate it on the broader economy.

Removing the subsidy can have a significant impact on the economy. It will increase both domestic gas and electricity prices, given that a significant part of Malaysia’s generation mix consists of gas.

This increase in gas prices and electricity tariffs will affect the energy-intensive industries. In a recent study, The Boston Consulting Group (BCG) estimated that the economic impact could be as large as 

RM13 billion for energy-intensive manufacturing industries such as iron and steel, petrochemicals and chemicals, plastics and ceramics.

In addition, removing the subsidy means these industries will either need to absorb the additional cost or pass it on to the end user. If it is the former, companies may be left with insufficient profits to reinvest in their business and may even be forced to shut down.

If it is the latter, higher prices may result in the loss of export competitiveness, which BCG estimated to have an impact of close to RM16 billion on Malaysia’s trade balance. In either case, employment in these industries (and many adjacent sectors) will also take a major hit — close to 16,000 jobs are at risk. The total impact is alarmingly large by any measure.

Given the high stakes from removing the subsidy, it is important to manage this environment carefully and not leave behind key manufacturing industries that Malaysia has built over the past 40 years. These industries continue to make meaningful contributions to our development — from jobs to investments and exports — and ensure that Malaysians can continue to buy local from these industries in the future.

It is critical, therefore, that the removal of the subsidy is done in a gradual and planned manner. First, we need to take into account the implications on regional competitiveness. Today, gas prices in Malaysia are around RM20/MMBTU. Global market prices range from the high 30s to the low 40s and those in neighbouring countries range from the low to the high 20s. One recommendation is to commit to moving gas prices up gradually to RM30/MMBTU, and then pause and assess the situation before moving to full market prices.

Second, some effort can be made to help the affected industries improve their competitiveness. In the short term, this could mean making incentives available to these players to invest in energy-efficient equipment and adjusting existing tariff structures to encourage these heavy users of energy to rebalance their production in a more efficient way. Over the long term, however, a more thorough restructuring would be required for some of these industries to remain relevant and competitive.

For example, iron and steel producers must scale up and invest in next-generation technology such as the blast furnace and basic oxygen furnace, which are both more energy efficient and cost competitive. This would require a significant investment as well as restructuring and consolidation within the industry.

Can Malaysia fund these? Yes! The gradual removal of gas subsidies will result in additional government income. A portion of this additional revenue should be reinvested to modernise these vital industries. There can thus be a way to progress without leaving our key industries behind. That is a price worth paying.


Rick Ramli is partner and managing director of The Boston Consulting Group, Kuala Lumpur

 

This article first appeared in Opinion, digitaledge Weekly, on August 24 - 30, 2015.