Petrol Price Analysis: The case of Malaysia

Petrol price is the headlines of today as our deputy PM mentioned about the rise in subsidy and hint on the hike of oil price. This will be the headline of Malaysia at least until the end of the year. Air Asia also started the oil surcharge a week ago.

However, very few people in Malaysia seems to understand this problem and will just complain about any adjustment in the petrol price especially petrol price hike. Because of that, I will try to analyse the scenario of petrol price in Malaysia and try to justify the subsidy spending of our government.

As of 11.30 AM today (16/5/2011), the WTI crude oil price is trading at US$98.78 / barrel.

So what's that in Malaysia RM/litre petrol price?

Since 1 oil barrel = 158.99 litres and RM / US$ = 3.0385 as of the same time, crude oil price in Malaysia is at:

(98.78 / 158.99) x 3.0385 = RM 1.888 / litre.

Currently the RON 95 petrol is sold at RM 1.90 / litre while the RON 97 is sold at RM 2.90 / litre.

So, what's the problem when crude oil price is below the selling price of RON95 and RON97?

Of course there are processing and refining costs of crude oil but these costs are fixed costs and are minimally affect the actual costs of per litre petrol. The variable costs of labour is also way too small to include in our estimation.

Since Malaysia is a oil producing country, and when crude oil price is below petrol selling price, why do we need a price hike?

The significant costs of petrol firms in Malaysia such as Shell and Caltex are non-operating costs such as marketing costs, advertising costs, etc. They spend way too much on marketing and advertising that caused their total costs and average costs to rise beyond crude oil price. Subsidy therefore will rise as well.

So back to our question: should petro price rise in Malaysia?

No.

Instead of lowering subsidy and increase the petrol price, government should control or eliminate the marketing and advertising costs of oil firms. By doing so, per litre petrol cost will drop significantly and the current petrol price can be maintained.

The fear and threat of inflation has forced Bank Negara Malaysia to have a rate hike of our Overnight Policy Rate by 25 basis point to 3 percent. This is undoubtedly increase the saving rate as return of saving increase.

Since the equilibrium of Macroeconomics is all about Expenditure = Saving or Injection = Leakages, with the increase in saving, the public expenditure (subsidy) will not be a big problem now as compared to inflationary force.

In the end, using economic analysis or simple mathematics calculation, I think petrol price should not be rise and the opportunity cost of increasing petrol price surpass benefit of reducing subsidy.