Energy: Malaysia’s Political Football
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Time is running out for Malaysia’s Prime Minister Najib Razak to call a general election, which is constitutionally mandated to take place by April 2013. Many observers expect Najib may announce a November polling date, timing it to fall just after the Hajj, an important date on the religious calendar for this majority Moslem nation.
Malaysian consumers benefit from generous energy subsidies by the government, consuming some of the cheapest gasoline and electricity in Asia. Although these subsidies have been exposed as unsustainable, the government has been loath to risk its already uncertain popularity by rolling them back with an election looming. As a sluggish world economy continues to undermine Malaysian exports, the government cannot rely on trade to drive its economy, further weakening any incentive it may have to move towards market-determined energy pricing.
Meanwhile, the state-owned oil company, PETRONAS, has been growing ever more vocal in expressing its discontent over its role as the chief source of funds for government subsidies and pet projects. Reuters has reported that figures from PETRONAS indicate some 55% of the company’s net profits are paid to the government and these “dividends” account for up to 45% of the government’s budget. With its export revenue flagging, PETRONAS has been aggressively pursuing a program of exploration and acquisition, and is eager to use more of its profits for investment. The company is increasing pressure on the government to reduce the share of profits it appropriates to a level more typical that paid by other national oil companies which is around 38%. Political opponents of the government have added their own demands for change, calling for phased reduction of subsidies and an end to corruption and cronyism.
Hungry PETRONAS Being Bled White
PETRONAS is the jewel in Malaysia’s economic crown, with the distinction of being the country’s only Global Fortune 500 company and ranked by Fortune as Asia’s most profitable company in 2012. PETRONAS also has a reputation for being well-run, receiving good marks for its fiscal responsibility and corporate governance in a number of independent studies of national oil companies.
PETRONAS has successfully extended its reach abroad, boasting many overseas subsidiaries, interests in many other countries, and partnerships with other companies. In June, it was reported that PETRONAS and Hess Corp. (NYSE: HES) had signed agreements to develop gas fields in the North Malay Basin. In the last few days, shareholders in Canada's Progress Energy Resources Corp approved a takeover by PETRONAS, giving the Malaysian company access to North American shale gas.
Despite its global strategy, PETRONAS reported a nearly 30% drop in earnings for the second quarter ending June 30, as its revenues were impacted by unstable crude oil prices and a sputtering world economy. Adding to these woes, PETRONAS now faces the shutdown of its production in South Sudan as the two Sudans standoff over pipeline rights. PETRONAS complains that it is hobbled in its efforts to respond to these challenges by the high proportion of profits it is required to pay to the Malaysian government.
The Quest for Renewables
Malaysia is a net exporter of both oil and natural gas. Oil and gas dominate domestic energy consumption with oil accounting for about 40% of the total and natural gas 50%. Coal and hydro make up nearly all of the remaining 10%. While historically natural gas made up the lion’s share of power generation, increasingly Malaysia has turned to coal. Although Malaysia has its own coal reserves, it is a net coal importer. In pursuit of Malaysia’s goal of energy independence, hydro can play only a limited role, so the country has turned to biomass to fill the energy generation gap.
A star of the renewables pantheon featured in the government’s economic planning, is palm oil. Malaysia is a leading producer of palm oil, second in the world only to Indonesia. Palm oil is Malaysia’s top agricultural commodity both in terms of production and export. All of this means that Malaysia can produce sufficient palm oil to provide a credible long-term energy alternative to soak up excess marginal demand; provided the country can get the processing and distribution infrastructure in place necessary to bring the fuel to market. That market is only just being created through a mandate to use B5 blended diesel (5% biodiesel) nationally. The iShares MCSI Mayalsia Index ETF (NYSEMKT: EWM) is heavily weighted towards palm oil and PETRONAS’ subsidiaries, with more than 20% AUM devoted to these sectors.
Palm plantations can produce as much as 700 gallons of diesel fuel per acre. Prices should remain steady even in the face of huge acreage growth happening around the equator in places like Nigeria, Colombia and Benin. High soybean oil and Brent Crude prices, the two main competitors to palm oil, will ensure a strong bid from both of palm oil’s main uses as food and energy.
The coordinated global QE program will ensure that both food and energy prices will rise in the long-term. Both the US Brent Oil Fund (NYSEMKT: BNO) and the iPath Dow Jones UBS Agriculture Total Return Sub-Index ETN (NYSEMKT: JJA) will hit all-time highs in the near future. Brent Crude is the world benchmark oil price at this point. Until the U.S. restructures its pipeline system to feed oil produced in the Bakken and elsewhere to the refineries on both coasts, the effect of increased U.S. production will not be felt and the Brent-WTI spread will continue to be $16-$20 per barrel. Between QE now and the current drought in the U.S. which will have a huge effect all up and down the food supply chain, prices in major grains like corn and soybeans will continue to push relentlessly higher over time. As ASEAN grows their demand on the food and energy complex will push prices higher as well.
In the 9th Malaysia Plan (9MP), the government proposed an ambitious program to develop and distribute biodiesel derived from palm oil to be a mandated and subsidized additive to diesel fuel. Although the lofty targets of 9MP were not met, the government continued to develop the goal of increased reliance on renewables in 10MP; undertaking to increase the renewables portion of power generation from its 2011 level of less than 1% to 5.5% by 2015, with biomass to account for the largest part of that proposed growth. Time will tell whether this government or a successor will take the steps needed to implement its goals.
The longer the Malaysian Prime Minister continues to procrastinate, the more insistent grow the demands for an election and for reforms. Support for the governing party is sufficiently compromised that whether or not Prime Minister Najib’s UNMO achieves electoral victory, many observers anticipate the long-promised phase-out of subsidies is inevitable in coming months. While this may cause some hardship in the short run for Malaysian consumers, it will allow market forces to rebalance the country’s economy to a more sustainable form.
It will also be good news for PETRONAS, which no longer will be deprived of the investment capital necessary to fulfill its exploration and acquisition plans. In the meantime Malaysia’s economy will benefit from the flood of money in the West propping up their economies setting the country up nicely for the coming free-trade region that ASEAN will implement in 2015.
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