July 12th, 2008 by Hafiz Noor Shams
MP Jeff Ooi said:
Yesterday, all four petrol companies in Singapore – Shell, Exxon-Mobil, Caltex and Singapore Petroleum Company – reduced their pump prices by 4 cents a liter for petrol. Diesel price remained unchanged at S$2.033/litre.
Currently, Malaysia retails petrol at RM2.70/litre and diesel at RM2.50/litre.
Incidentally, oil prices have fallen by about 7% since hitting a record high last Thursday. Oil prices fell to US$136 per barrel on Tuesday. (See Crude Oil price chart on the top right hand corner of this blog)
Will Malaysia defy the law of gravity, that what goes up must come down, and reduce the fuel burden on Joe Public? [Petrol price down… in Singapore. Screenshots. July 10 2008]
He seems to suggest that Malaysia should lower local fuel retail prices after global crude oil prices suffered a dip. Just like Singapore. He of course failed to identify or mention that prices in Singapore are free whereas Malaysian prices are inflexible due to our fuel subsidy regime.
As Friday has proven, the dip is merely temporary and more about fluctuation and not a general trend. I am wondering if he would agree to increasing the retail prices whenever the global prices are up…
Whatever the MP feel, it would definitely be interesting if we have subsidy in an ad valorem manner. Under this arrangement, local prices will fluctuate according to global prices while the subsidy is set as a percentage of the fuel prices.
Regardless the cost and benefit of maintaining a subsidy, subsidy ad valorem-styled will certainly be a more robust policy compared to the current structure. More importantly, ad valorem subsidy will allow prices to act as a signal better compared to the current Malaysian policy.
The graph below illustrates the current subsidy program with local prices fixed regardless of global prices. The blue color represents the size of subsidy while yellow represent the amount paid for fuel by consumers. It makes our model far simpler if we assume that the consumer purchase only an unit of fuel per day. This assumption is made for simplicity’s sake and nothing else.
As you can see, the subsidy merely acts as a buffer to fix local prices. If global prices actually go below the fixed level, tax is automatically introduced. Given expensive crude oil prices and the size of current subsidy at the moment, I doubt a tax would be introduced.
This policy probably be good if there is a tendency for global prices to revert to a mean. The fixed local prices can be the mean and this will mean in the long run, the cost of running the policy is zero, at least nominally.
The graph below illustrates ad valorem subsidy with the subsidy itself assumed to be at 40%:
As you can see, the local price is capable of going low as global price drops, unlike as shown in the fixed local price structure. Depending on the subsidy, the size of subsidy can be made lower than what it will be under the other model.
The only weakness of ad valorem subsidy is that the subsidy lives on forever as long as the rate is above 0%. Compare this with the introduction of tax in the first scenario.
Due to reasons stated earlier — concerning signaling and robustness, as long as global prices do not fall below local fixed prices — regardless of my support for total elimination of fuel subsidy, ad valorem subsidy is better than the current fuel subsidy policy practiced by Malaysia.
And there you go: a simple analysis comparing two different subsidy policies.
I have a feeling that what Jeff wants is this…
…which is totally an unreasonable and irresponsible policy.
 NEW YORK, July 11 (UPI) — Crude oil prices eased back after setting a record above $147 per barrel on the New York Mercantile Exchange Friday. [Oil prices ease after record Friday. United Press International. July 11 2008]