A Late December Post - RM1.80

As usual, petrol prices at the pump have been revised for the second time in a month. I must apologise for having a huge pile of work, inevitably postponing this post. But in these uncertain times, to be laden with work is a blessing. The world economy is suffering a beating and Malaysian employers are expected to lay off workers in 2009. The official estimate is that 102 employers will cut 4,729 jobs. The Malaysian Employers Federation estimates that employers will lay off 200,000 to 400,000 workers in 2009. The Minister of Human Resources, Datuk Dr. S. Subramaniam, reports that:

• in January 2009, 35 employers will cut 3,111 jobs;
• in February 2009, three employers will cut 1,523 jobs; and
• in March 2009, 64 employers will cut 115 jobs.

[Source: Utusan Malaysia Online, 22 Dec. 2008. 4,729 Bakal Diberhenti]

On to the petrol prices. The prices of petrol were revised on 15th December 2008.

• The price of RON97 petrol is now RM1.80 per litre (Ref: Bernama, 23 Dec. 2008. Malaysia To Ride "Bumpy" Economic Journey Next Year)
• The price of RON92 petrol is now RM1.70 per litre (Ref: Utusan Online, 15 Dec. 2008. Minyak Turun Lagi 10 Sen.)
• The price of diesel is also RM1.70 per litre. (Ref: ibid.)

Fishermen have been demanding that the price of diesel be reduced to RM1.00 per litre. It is presently RM1.30 per litre, a reduction from RM1.43 per litre. (Ref: The Malaysian Insider, 18 Dec. 2008. BN Reps Claim Fishermen Want To Sell Subsidised Fuel.)Incidentally, 50,000 litres of subsidised diesel were confiscated recently by maritime police in Sarikei, Sarawak. (Source: Utusan Malaysia Online, 15 Dec. 2008. Polis Marin Rampas Minyak Subsidi 50,000 Liter.)

The Government has decided not to implement a floor price for petrol but has set in place a price cap of RM2.70 per litre. This means that prices of petrol could drop further while petrol prices will be limited to RM2.70 at its highest. (Source: New Straits Times Online, 19 Dec. 2008. Shahrir: No Floor Price For Petrol.)

If you, dear reader, were to take the trouble to look into the links embedded in all the articles, you would notice one prominent name that keeps popping up: YB Dato' Shahrir Abdul Samad, Minister of Domestic Trade and Consumer Affairs. His blog keeps track of consumer affairs and more importantly petrol prices in Malaysia. Kindly pay his blog a visit.

Thank you.

CPO and the Biodiesel Initiative

In a speech on crude palm oil (CPO) on 21 Nov 2008, YB Datuk Ian Chin Kah Fui, Minister of Plantation Industries and Commodities said that:

• Oil palm requires only 1 hectare of land to produce 3.7 tonnes of oil per year, compared with soyabean which requires 10.2 hectares, sunflower which requires 9 hectares, and rapeseed which requires 6 hectares to produce 3.7 tonnes of oil per year. 
• Oil palm is able to produce oil for about 25 years after being planted, a significant advantage over its competitors.

In Malaysia, crude palm oil has been one of the top earners for the agricultural sector. When petrol prices surged in 2008 to the historic high of USD$147 per barrel, crude palm oil (CPO) prices surged as well to RM4,486 per tonne in the first quarter of 2008. Malaysia and Indonesia, taken together, account for 85% of the world's production of crude palm oil. [Source: The Star (Star Biz), 11 Dec. 2008. At page B5. Huge global stock will continue to plague CPO. By Hanim Adnan.] Sadly, this high in the CPO price could not last once petrol prices came down. National palm oil stocks currently stand at 2.01 million tonnes. Crude palm oil is currently about RM1,500 per tonne. According to H. Adnan:

... the longer the inventory piles up, the more discount the CPO price will command due to increasing Free Fatty Acid. .... There is consensus that prices could recover by the first half of 2009 as local planters have recently put on hold or lowered their fertiliser applications, and this may result in lower yields by the third quarter. Efforts are also being made by Malaysia and Indonesia to cut palm oil production by encouraging replanting activities and the implementation of mandatory biodiesel initiatives next year.

As a result of the mandatory biodiesel initiatives that the government is making, palm biodiesel will be made available at domestic fuel pumps by January 2010. YB Datuk Peter Chin, Plantation Industries and Commodities Minister, said that "the Government in talks with independent power producers (IPPs) on burning palm oil as biodiesel." [Source: The Star (Star Biz), 11 Dec. 2008. At p. B10. Palm biodiesel at pumps in January 2010.] The government was considering allowing IPPs to burn palm oil to generate energy in light of the fact that Tenaga Nasional Berhad was not using diesel generators anymore. Datuk Ian Chin forecasted that Malaysia would consume 500,000 tonnes of CPO for transport and industries in 2009. The news report also put Malaysia's annual consumption of diesel at 10 million tonnes a year. 

In an interview with Carotech Bhd managing director David Ho, it was reported that phytonutrient extraction from CPO produces biodiesel as a side product. David Ho said that in order for the extracted biodiesel to compete with fossil fuels, an ideal price for CPO would be about USD200 less per tonne compared to fossil fuels. David Ho also revealed that every 1,000 kg of CPO processed, yields about 700 grammes of vitamin E and carotene combined. At full capacity of 90,000 tonnes of CPO, Carotech can produce about 31,500 kg of vitamin E and carotene yearly. [Source: The Star, 28 July 2008. Carotech sees higher biodiesel output. By Yvonne Tan.] 

Let's talk about the mandatory biodiesel initiatives. What exactly do they cover? They comprise the following:

1. Beginning February 2009, government vehicles will commence usage of Envo Esther Diesel (B5) brand, a type of biodiesel composed of 5% palm oil and 95% diesel. [Source: Bernama, 10 Dec. 2008. Biodiesel to be Mandatory for Transport and Industrial Sectors by January 2010.]
2. The Government expects that by January 2010, 500,000 tonnes of palm based biodiesel will be required for the transport and industrial sectors. It did not state 500,000 tonnes per month, or per year. [Source: Bernama, 10 Dec. 2008. Ibid.]
3. Commercial vehicles will be required to commence usage of biodiesel (presumably B5) in mid-2009. [Source: Bernama, 3 Dec. 2008. Biodiesel Usage May Be Brought Forward To January, Says Chin.]
4. Old oil palm trees would be replanted to cut crude palm oil production and to stabilize the price of CPO to RM2,000 per tonne. [Source: Bernama, 3 Dec. 2008. Ibid.]

Experts in the industry say that biodiesel is the solution for the long term. Biodiesel emits less than half the greenhouse gases and carcinogens that fossil fuel emits. [Source: SpokesmanReview.com, 13 Dec. 2008. Greener biofuels still have environmental impact.] The European Union has agreed to implement a policy that 10% of road transport fuels would come from renewable sources by 2020. These were expected to come from biofuels. However, a stand-off over the biofuels was resolved when the proposal was amended so that one-third of EU's 10% goal would come from electric cars and electric trains. It is possible that the future direction in EU would be the production of green electricity. [Source: International Herald Tribune, 4 Dec. 2008. EU adopts renewable energy proposals.]

Nevertheless the important question for Malaysia is how long will it take before Malaysians actually use biodiesels in the long term. Teething problems may discourage early adopters. Further, due to the theory of economies of scale, there has to be widespread adoption of biodiesels before production can be deemed economically viable. Forcing the oil companies to sell biodiesels may be part of the long term solution. In that respect it will mean that the oil companies will be purchasing crude palm oil in bulk (which guarantees that CPO prices will remain high). 

A note of caution. Bloomberg reports that New Zealand has done away with a mandatory requirement that oil companies sell biodiesel products in addition to their existing product lines. Instead, the New Zealand government is giving tax breaks to oil companies that sell clean fuels that are sourced from sustainable sources. The tax exemptions would be based on the emission levels of such fuels. Critics have said that the effect would be to favour imported ethanol over locally produced biodiesels. [Source: Bloomberg, 11 Dec. 2008. NZ to scrap Biofuel Obligation, Offer Tax Break on Clean Fuel.] Former Climate Change Minister of New Zealand, David Parker, has denounced the move. He said that fledging industries would be destroyed by the move. He stressed that the previous government's efforts to institute a policy of "sustainable biofuels with a strict sustainability criteria" would be wasted. Peter Dunne, United Future Party chairman, said that domestic biodiesel producers would be forced out of business by cheap, unsustainable imports. [Source: Int'l Herald Tribune, 12 Dec. 2008. NZ Govt dismantles climate-friendly policies.]

Interestingly enough, the search for a biodiesel component has recently yielded results identifying wasted coffee grounds as a source of biodiesel. Researchers at Nevada-Reno University found that wasted coffee grounds was a more stable material for biodiesel due to its high antioxidant content. About 16 billion pounds of wasted coffee grounds is produced yearly. [Source: All Headlines News, 12 Dec. 2008. Coffee Grounds Identified As Biodiesel Source.] This can produce about 340 million gallons of biodiesel fuel per year. [Source: Greentech Media, 11 Dec. 2008. Old Coffee Grounds a New Source of Auto Fuel?] Also interesting was this portion of the report, which is best reproduced verbatim:

Although bigger than most fish tanks, 340 million gallons a year is a small amount of oil. The world consumes around 85 million barrels of oil a day right now and there are 42 gallons of crude oil in a barrel (which means 3570 gallons a day) Thus, if you started on January 1 and tried to run the world of coffee biodiesel, we’d run out while most New Year’s Eve parties are still going. But still conservation helps and every little bit count.

You can check out the international price of coffee at the website of the International Coffee Organization.

Royal Dutch Shell Contango

Put simply, a contango is what happens when the price of a commodity is anticipated to go up. A commodity is bought in bulk and stored for a period of time, to be resold at a profit. The cost of storing the commodity is taken into consideration in calculating the future sale price. The main thing is that the commodity must be non-perishable. If it is perishable, the commodity does not fit into the concept of contango, because it will grow stale or mature.

In short, contango means stockpiling for resale (with profit).

From Wikipedia: 

Contango is a term used in the futures market to describe an upward sloping forward curve (as in the normal yield curve). Such a forward curve is said to be "in contango" (or sometimes "contangoed").

Formally, it is the situation where, and the amount by which, the price of a commodity for future delivery is higher than the spot price, or a far future delivery price higher than a nearer future delivery.

The opposite market condition to contango is known as backwardation.

A contango is normal for a non-perishable commodity which has a cost of carry. Such costs include warehousing fees and interest forgone on money tied up, less income from leasing out the commodity if possible (e.g. gold).

The contango should not exceed the cost of carry, because producers and consumers can compare the futures contract price against the spot price plus storage, and choose the better one. Arbitrageurs can sell one and buy the other for a risk-free profit too (see rational pricing – futures).

If there is a near-term shortage, the price comparison breaks down and contango may be reduced or perhaps even reverse altogether into a state called backwardation. In that state, near prices become higher than far (i.e., future) prices because consumers prefer to have the product sooner rather than later (see convenience yield), and because there are few holders who can make an arbitrage profit by selling the spot and buying back the future. A market that is steeply backwardated — i.e., one where there is a very steep premium for material available for immediate delivery — often indicates a perception of a current shortage in the underlying commodity. By the same token, a market that is deeply in contango may indicate a perception of a current supply surplus in the commodity.

There is presently an opportunity for contango in the crude oil market. Many players consider the stockpiling of crude oil as a low risk opportunity, because crude oil may be at its lowest price. Bloomberg reports that Royal Dutch Shell has a supertanker holding up to $80 million of crude oil off the shore of the UK. At least 16 other supertankers are also anchored along with it, altogether capable of holding 26 million barrels worth about USD$1 billion. Shell and Koch Industries have chartered four supertankers to ship crude oil from the Middle East to take advantage of the expected rise in crude oil prices in the coming months. [Source: Bloomberg, 8th Dec. 2008. Contango Pays Most In Decade As Shell Stores Crude]

Parties seeking to capitalize on this opportunity have to act fast. This window of opportunity could close if OPEC decides to cut oil production and therefore remove excess crude oil from the markets. The OPEC meets on 17th Dec. 2008 in Algeria. There is also danger that the contango will need a longer time to bear fruit if China slips into recession and OPEC fails to respond by cutting output. Francisco Blanch, head of commodities research at Merrill Lynch UK, anticipates that in such an event the price of crude oil could come to USD$25 per barrel. [Source: Bloomberg, ibid.]

On the other hand, if the Chinese economy does not falter, Merrill Lynch predicts that crude oil prices will rise to USD$56 by the second half of 2009 and USD$70 by 2010. Joe Petrowski, CEO of Gulf Oil, warned that crude oil prices could fall by USD$20. [Source: Financial Post (Canada), 5th Dec. 2008. The impact of weak oil on gasoline and producers] Sanford C. Bernstein & Co. estimates the break even point for the crude oil industry to be at USD$35 to USD$40 per barrel. [Source: Wall Street Journal, 4th Dec. 2008. Oil's Slide Set To Leave Dark Trail.]

Excess Production, Hedge Funds and Public Transport

The facts show that the price of petrol is dropping, and so is the price of crude oil. Some quarters say that petrol prices in the USA could reach USD$1 per gallon. [Source: AP, 5th Dec 2008. Return to $1 gas? Energy prices evaporate] Tom Kloza, publisher of Oil Price Information Services, speculates that the price of crude oil could dip below USD$40 per barrel. [Source: Speaking of Oil blog, 4th Dec. 2008. Never say never in the oil price business] More interestingly, Nariman Behravesh, chief economist at IHS Global Insight, was quoted saying, "Every 10 cent drop in the gasoline price is the equivalent of a USD$12 billion tax cut." [Source: CNBC, 3rd Dec. 2008. Oil Likely To Stay At $50, But Don't Celebrate Yet. via Tom Kloza's blog]

The main reason that petrol prices are falling is the excess production capacity. According to Ruchir Kadakia, head analyst at Cambridge Energy Research Associates, crude oil spare capacity is currently about 5 billion barrels. He also theorises that financial deleveraging, by redemption calls of hedge funds, also contribute to the slipping price of crude oil. [Source: CNBC, ibid.] More than 80 hedge funds have suspended redemption calls and imposed restriction on withdrawals in the past two months to protect "longer term investors from those who panic and redeem". [Source: Bloomberg, 4th Dec. 2008. D.E. Shaw, Farallon Restrict Withdrawals as Fund Freeze Deepens] In November, George Soros predicted that the hedge fund industry could shrink by 75% next year. Financial Times reports that investors and banks have become more risk-adverse and are cashing out before markets freeze up. [Source: Financial Times, 14th Nov. 2008. Hedge Managers Brace For Shrinking Feeling -- found via Gwen Robinson's blog at FT Alphaville]

In Malaysia, the Government is making money from the slipping price of petrol. The Star reports FOMCA (Federation of Malaysian Consumer Association) secretary-general, Muhd Sha'ani Abdullah, stating that at current prices, the Government is making about RM16.5 million a day. Apparently at current prices the price of RON 97 should be RM1.30 per litre. Sha'ani suggested that the Government should invest the daily RM16.5 million from the "windfall" into public transportation systems. Sha'ani was not in favour of lowering prices to match actual crude oil prices because it would cause traffic congestion to surge. [Source: The Star, 6th Dec. 2008. Government makes RM16 mil a day from fuel windfall]

To this, Domestic Trade and Consumer Affairs Minister, Datuk Shahrir Abdul Samad has responded that a portion of the revenue will go to the consolidated fund as well the fund to improve public transport. He has also clarified that it is not unusual for the Government to "gain revenue" from the sale of petrol when its price is low, as the Government has also subsidised the price of petrol when the price of petrol was high. He also stated that the average price of petrol for the month of November would fix it at about RM1.50 per litre, and not RM1.30 per litre.  [Source: Bernama, 6th Dec. 2008. Not Unusual For Gov't To Gain Revenue From Petrol Sale, Says Shahrir]

Hopefully, the Domestic Trade and Consumer Affairs Minister can go all out to ensure that public transportation is indeed upgraded for the benefit of all Malaysians. The important question is whether public transport was under his ministry to begin with. 

Petrol Prices Down by 10 sen!

December has come. And the good news is that petrol prices have fallen once again. At the petrol pumps, RON 92 and diesel are now priced at RM1.80 per litre. RON 97 is now priced at RM1.90 per litre. This however is still higher than the global price of petrol, which is about RM1.60 per litre. [Source: New Straits Times, 3rd Dec. 2008, 6th Reduction in Petrol Price]

The Government is considering either implementing a "managed float or floor price". The present reduction of 10 sen, as opposed to 15 sen, was necessary to ensure that petrol vendors could make a profit of 2 sen per litre. [Source: New Straits Times, 4th Dec. 2008, Lower Prices: Should We Float Or Fix Minimum Fuel Prices?]

Prime Minister YAB Abdullah Ahmad Badawi was quoted by Bernama stating: "If oil price continue to slide drastically, our revenue will be affected as the percentage of income from oil is high. If our revenue dwindles, it will lead to other problems." [Source: Bernama, 2nd Dec. 2008, Malaysia's Revenue May Suffer If Oil Prices Fall Sharply, Says Abdullah] The same article also stated: "Oil is the biggest revenue contributor to the country's coffers."

While it may be true that oil is the country's biggest revenue contributor, the oil being mined in Malaysia is not being sold in Malaysia. Therefore a floating price mechanism for oil vended at petrol stations may not harm Malaysia's revenues. It will, however, harm the revenues of petrol station owners (i.e. petrol dealers). 

It may be noted that the Opposition has called for the Government to allow petrol stations to set their own prices. Tony Pua was quoted saying that petrol pump prices in the United States were RM1.742 per litre, as opposed to Malaysia's RM1.90 per litre. [Source: New Straits Times, 4th Dec. 2008, Dewan Rakyat: Pua Wants Petrol Stations To Set Their Own Prices] He was also quoted saying:

"It is an anomaly that our country does not allow anyone to sell fuel at a lower price. The government should allow fuel operators to compete among themselves to sell fuel at a lower price as this can translate to move savings for consumers."

This suggestion by Tony Pua represents a new option for the Malaysian government that is more populist and will be well received by the Malaysian public. The options available to the Government, presently include: (a) managed floating price mechanism; (b) price floor (presumably in conjunction with a floating price); (c) free float (following international prices); (d) get petrol stations to fix their own prices. With options (a), (b) and (c), it is likely that the Government will allow for a profit margin so that petrol station owners will not suffer too much. With option (d), it would allow petrol station dealers the opportunity to compete for business, while marketing within their own margins of profit.

If Tony Pua's suggestion is implemented, there is the danger of stiff competition causing profits to plummet, therefore causing the bankruptcies of petrol dealers. This is especially true where there are many petrol stations located close to each other. These petrol stations could co-exist in the past because of fixed (similar) prices and heavy product differentiation -- although, truth be told, petrol is petrol, and is mostly the same from petrol station to petrol station. 

The flipside to Tony Pua's suggestion is that petrol stations located in the middle of nowhere, can probably charge high prices. It would not be illogical to assume that on a stretch of road, on which there is only one petrol station for the next 45 minutes, countless people will queue up to fill up before travelling the following 45 minutes. Petrol stations in new housing areas and new commercial areas, and even quiet industrial areas, would also be able to charge a few sen more per litre as the task of driving to a distant petrol station may consume more petrol than it saves. 

A possible development, if Tony Pua's suggestion is implemented, is that there may be websites popping up to list down the location and prices of various petrol stations. Examples may be found at WhatGas and PetrolPrices. Yet another possible development may be the introduction of automatic price signs, which are popular in Europe and are beginning to become popular in the USA. [Source: Service Station Australia, Winter 2008, Automatic Price Signs Slowly Arriving In The US]