For the past 50 years, petroleum was widely regarded as the most important natural resource in terms of energy supply. Petroleum was primarily used as an automotive fuel to provide power for motor vehicles. Therefore, it came to no surprise when petroleum consumption increased exponentially due to the increasing popularity of motor vehicles. Malaysia possesses an abundance of oil reserves, with many of the oil wells located some distance off the shores. As the state's flagship company, Petronas is uniquely positioned to tap into the oil reserves that Malaysia has to offer.
The concept of demand and supply are essential tools for economic analysis. It is used to determine the impact of economic environment upon business organizations. Market demand is the amount of products consumers are willing and able to buy at different prices at a specified time period. This means the consumer must not only desire the product but are also able to purchase the product at the given price. Supply is the amount of output that a producer is willing to produce at a given price. Market forces would then constantly try to create a market equilibrium price where demand equal supply. The production of crude oil is highly correlated with the production of its end products (Jaafar, 2011).
The concept of demand and supply are essential tools for economic analysis. It is used to determine the impact of economic environment upon business organizations. Market demand is the amount of products consumers are willing and able to buy at different prices at a specified time period. This means the consumer must not only desire the product but are also able to purchase the product at the given price. Supply is the amount of output that a producer is willing to produce at a given price. Market forces would then constantly try to create a market equilibrium price where demand equal supply. The production of crude oil is highly correlated with the production of its end products (Jaafar, 2011).
Malaysian oil and gas production has relatively plateaued from 2005 - 2009
Petronas subsidiary, Petronas Gas Sdn Bhd estimated that the ASEAN region demand for gas in 2012 is higher than the local output for gas and is expected to continue far into 2030.
Local gas supply versus demand in South East Asia
The graphs shows that market demand for petroleum products in Malaysia are increasing while its production has slowed down in recent years. Market demand may be affected by substitution effect and the income effect. (Graham & Glaister, 2000) found that all countries showed consistent data that the long run income elasticity for petroleum products are 1.1 to 1.3 and between 0.35 to 0.55 in the short run. The findings tells us that income elasticity is inelastic in the short run and slightly less inelastic in the long run. Furthermore, there are no close substitutes for petroleum products such as gas, diesel, petrol and kerosene. Biodiesel and other energy sources do not provide a competitive edge to the availability and price range of petroleum products.
Price elasticity of demand measures the effect of a change in price to the quantity demanded of the product. Economists normally use ceteris paribus which makes the assumption that all other factors remain constant to calculate the responses between two variables.
Price elasticity of demand = %▲Qd
%▲P
Table
Demand for crude oil
Oil consumption Real GDP
% growth % growth Price elasticity
per capita per capita Short-run Long-run
Australia -0.3 1.7 -0.034 -0.068
Austria -0.7 3.1 -0.059 -0.092
Canada -1.3 1.6 -0.041 -0.352
China 3.6 8.6 0.001 0.005
Denmark -2.5 1.5 -0.026 -0.191
Finland -1.2 2.1 -0.016 -0.033
France -1.5 1.7 -0.069 -0.568
Germany -1.4 1.2 -0.024 -0.279
Greece 2.2 1.5 -0.055 -0.126
Iceland 0.5 2.2 -0.109 -0.452
Ireland 0.2 3.9 -0.082 -0.196
Italy -0.4 2.2 -0.035 -0.208
Japan -1.0 8.1 -0.071 -0.357
Korea 8.3 6.4 -0.094 -0.178
Netherlands -0.5 1.7 -0.057 -0.244
New Zealand -0.4 1.4 -0.054 -0.326
Norway 0.2 2.9 -0.026 -0.036
Portugal 3.0 2.9 0.023 0.038
Spain 1.3 2.1 -0.087 -0.146
Sweden 1.3 2.8 -0.043 -0.289
Switzerland -0.7 0.9 -0.030 -0.056
U K -1.1 2.0 -0.068 -0.182
USA -0.7 2.0 -0.061 -0.453
The calculations for China and South Korea are based on the period 1979-2000.
Price elasticity of demand measures the effect of a change in price to the quantity demanded of the product. Economists normally use ceteris paribus which makes the assumption that all other factors remain constant to calculate the responses between two variables.
Price elasticity of demand = %▲Qd
%▲P
Table
Demand for crude oil
Oil consumption Real GDP
% growth % growth Price elasticity
per capita per capita Short-run Long-run
Australia -0.3 1.7 -0.034 -0.068
Austria -0.7 3.1 -0.059 -0.092
Canada -1.3 1.6 -0.041 -0.352
China 3.6 8.6 0.001 0.005
Denmark -2.5 1.5 -0.026 -0.191
Finland -1.2 2.1 -0.016 -0.033
France -1.5 1.7 -0.069 -0.568
Germany -1.4 1.2 -0.024 -0.279
Greece 2.2 1.5 -0.055 -0.126
Iceland 0.5 2.2 -0.109 -0.452
Ireland 0.2 3.9 -0.082 -0.196
Italy -0.4 2.2 -0.035 -0.208
Japan -1.0 8.1 -0.071 -0.357
Korea 8.3 6.4 -0.094 -0.178
Netherlands -0.5 1.7 -0.057 -0.244
New Zealand -0.4 1.4 -0.054 -0.326
Norway 0.2 2.9 -0.026 -0.036
Portugal 3.0 2.9 0.023 0.038
Spain 1.3 2.1 -0.087 -0.146
Sweden 1.3 2.8 -0.043 -0.289
Switzerland -0.7 0.9 -0.030 -0.056
U K -1.1 2.0 -0.068 -0.182
USA -0.7 2.0 -0.061 -0.453
The calculations for China and South Korea are based on the period 1979-2000.
The following is the short run and long run elasticity of demand for crude oil in 23 countries (Cooper, 2003). The research concludes that all estimated short-run elasticities suggest that crude oil demand is highly price-inelastic in the short run. Although China and Portugal recorded positive short run elasticities of demand, its t-statistics test shows that the short run elasticities of demand for both countries are statistically close to zero. In 2008, Universiti Tunku Abdul Rahman conducted a study on the effects of the change in petrol price to the change in traffic flow. (Ling, 2008) concluded that changes in petrol price only slightly affects the amount of traffic flow in the set area. As it is, it confirms the observation that demand for petroleum products are inelastic and that price changes does not affect the demand greatly.
Externalities can cause market failure if the price mechanism does not take in full account the full social costs and social benefits of production and consumption. Externalities are unavoidable in the petrol market as countries strive for economic growth. However, an increase in demand for petroleum products inevitably increases the global carbon footprint. Global warming and air pollution are some examples of the social costs that society has to bear. Generally, the externalities of producing petroleum products were summed up in the graph below.
Externalities can cause market failure if the price mechanism does not take in full account the full social costs and social benefits of production and consumption. Externalities are unavoidable in the petrol market as countries strive for economic growth. However, an increase in demand for petroleum products inevitably increases the global carbon footprint. Global warming and air pollution are some examples of the social costs that society has to bear. Generally, the externalities of producing petroleum products were summed up in the graph below.
The petroleum producers would like to produce at Q1 quantity to maximise their revenue. However, the marginal social costs would be higher than the marginal social benefit. Society would prefer a lower production at Q2 quantity which is the socially optimum output.
Oil producers are responsible for the externalities that they produce. As a state owned corporation, Petronas is conscious in the type of externality that it produces. In recognition of the negative externalities it produces, Petronas rectifies the problems through various initiatives (Petronas, 2011). One such initiative was the implementation of its preliminary product carbon footprint (CFP) assessment which was used to detect unnecessary wastage to reduce the carbon footprints of its products. For 2010, Petronas achieved top quartile performance in efficiency using the Solomon benchmarking methodology. Petronas also undertook the soil remediation project for the decommissioning of its two land treatment facilities in Melaka. The project was designed to remove contaminants that might be harmful to the environment and the society.
Petroleum products are expensive due to the high market demand and artificial inflation by the Organization of the Petroleum Exporting Countries cartel (OPEC) agreement.The exorbitant prices are a huge cost to society because petrol is a necessity good. The income gap restricts the poor from obtaining fuel thus creating inequality in the market. Therefore, the market has failed to allocate petrol goods efficiently using the price mechanism. Government intervention is needed to correct the distortions created by the market. The Malaysian government practices blanket fuel subsidy which reduces the prices of fuel dramatically in the nation. In 2012, the Malaysian government subsidy for RON 95 is 70 cents per litre (AsiaOne, 2012). For every subsidy approved by the government there is an opportunity cost. However, the Malaysian government was able to push some of the cost to another party. Petronas was forced to fork out some of its own revenue to pay for the government approved fuel subsidy. Petronas chief executive officer, Tan Sri Shamsul Azhar Abas reported that it paid an average of RM 18 - 28 billion a year for fuel subsidies and the number is expected to increase (TheStar, 2012). Due to prolonged fuel subsidy, Malaysian consumers did not use the scarce oil resources efficiently. This continued inefficient allocation of scarce resources may cause Malaysia to become a net importer of oil products by 2013.
Oil producers are responsible for the externalities that they produce. As a state owned corporation, Petronas is conscious in the type of externality that it produces. In recognition of the negative externalities it produces, Petronas rectifies the problems through various initiatives (Petronas, 2011). One such initiative was the implementation of its preliminary product carbon footprint (CFP) assessment which was used to detect unnecessary wastage to reduce the carbon footprints of its products. For 2010, Petronas achieved top quartile performance in efficiency using the Solomon benchmarking methodology. Petronas also undertook the soil remediation project for the decommissioning of its two land treatment facilities in Melaka. The project was designed to remove contaminants that might be harmful to the environment and the society.
Petroleum products are expensive due to the high market demand and artificial inflation by the Organization of the Petroleum Exporting Countries cartel (OPEC) agreement.The exorbitant prices are a huge cost to society because petrol is a necessity good. The income gap restricts the poor from obtaining fuel thus creating inequality in the market. Therefore, the market has failed to allocate petrol goods efficiently using the price mechanism. Government intervention is needed to correct the distortions created by the market. The Malaysian government practices blanket fuel subsidy which reduces the prices of fuel dramatically in the nation. In 2012, the Malaysian government subsidy for RON 95 is 70 cents per litre (AsiaOne, 2012). For every subsidy approved by the government there is an opportunity cost. However, the Malaysian government was able to push some of the cost to another party. Petronas was forced to fork out some of its own revenue to pay for the government approved fuel subsidy. Petronas chief executive officer, Tan Sri Shamsul Azhar Abas reported that it paid an average of RM 18 - 28 billion a year for fuel subsidies and the number is expected to increase (TheStar, 2012). Due to prolonged fuel subsidy, Malaysian consumers did not use the scarce oil resources efficiently. This continued inefficient allocation of scarce resources may cause Malaysia to become a net importer of oil products by 2013.
Malaysia may become net oil products importer by 2013 (above 0 = surplus, below 0 = deficit)
The Malaysian government is beginning to realise the need to reduce fuel subsidies. The government plans to reduce fuel subsidy gradually (Lee et al., 2012).
An oligopoly is a market dominated by a few producers. There is little room for product differentiation due to goods being homogeneous in nature. Entry barriers are also high which restricts new firms from entering the market. Oligopolistic firms are sensitive to the behaviours of its competitors because it affects their profit margins. Oligopolistic firms may face the prisoner's dilemma on whether should they pursue self-interest or cooperate with each other to get better profits. The petrol market is a oligopoly market due to domination of the market by large firms such as Petronas, Royal Dutch Shell, Caltex and BHPetrol. All of the firms mentioned above are sensitive to price changes of its competitors. If Caltex were to reduce its price tomorrow, the other firms may be forced to follow suit to keep their customers. New firms also find it hard to tap into the market due to the high costs needed to invest in building a new plant. The plant cannot be reused for a different purpose making it a sunk cost. Petrol as a product is homogeneous in nature although there are some degree of brand loyalty and product differentiation between the firms. The petrol market is regulated by the Malaysian government. The Malaysian government introduces a price ceiling for the price of petrol, gas, and other relevant petroleum products to prevent collusion and volatile global oil prices (The Malaysian Insider, 2008)
Constant growing demand for petroleum has resulted in sky high prices in the petroleum market in Malaysia. Government taxation on petroleum has provided funds for the economic growth of the country. However, some of the funds were used inefficiently to provide prolonged subsidies to the nation. This article also concludes that the market demand for petroleum products in Malaysia are inelastic as Malaysians are heavily dependent on the petroleum market. The Malaysian petroleum market is also classified as an oligopoly with heavy government regulation on the market. The Malaysian government should gradually reduce fuel subsidies to encourage efficiency of resource consumption. It also should encourage free market policy for petroleum products to reduce its opportunity cost of having to subsidise fuel.
An oligopoly is a market dominated by a few producers. There is little room for product differentiation due to goods being homogeneous in nature. Entry barriers are also high which restricts new firms from entering the market. Oligopolistic firms are sensitive to the behaviours of its competitors because it affects their profit margins. Oligopolistic firms may face the prisoner's dilemma on whether should they pursue self-interest or cooperate with each other to get better profits. The petrol market is a oligopoly market due to domination of the market by large firms such as Petronas, Royal Dutch Shell, Caltex and BHPetrol. All of the firms mentioned above are sensitive to price changes of its competitors. If Caltex were to reduce its price tomorrow, the other firms may be forced to follow suit to keep their customers. New firms also find it hard to tap into the market due to the high costs needed to invest in building a new plant. The plant cannot be reused for a different purpose making it a sunk cost. Petrol as a product is homogeneous in nature although there are some degree of brand loyalty and product differentiation between the firms. The petrol market is regulated by the Malaysian government. The Malaysian government introduces a price ceiling for the price of petrol, gas, and other relevant petroleum products to prevent collusion and volatile global oil prices (The Malaysian Insider, 2008)
Constant growing demand for petroleum has resulted in sky high prices in the petroleum market in Malaysia. Government taxation on petroleum has provided funds for the economic growth of the country. However, some of the funds were used inefficiently to provide prolonged subsidies to the nation. This article also concludes that the market demand for petroleum products in Malaysia are inelastic as Malaysians are heavily dependent on the petroleum market. The Malaysian petroleum market is also classified as an oligopoly with heavy government regulation on the market. The Malaysian government should gradually reduce fuel subsidies to encourage efficiency of resource consumption. It also should encourage free market policy for petroleum products to reduce its opportunity cost of having to subsidise fuel.
Reference List
Jaafar, E.Y. (2011) Securing a Sustainable Energy (Gas) Future for Malaysia [online]. pp. 4,11,12. (Accessed 30 May 2013)
Cooper, J.C.B. (2003) Price Elasticity of Demand for Crude Oil : Estimates for 23 Countries. pp. 3-5. [Accessed 30 May 2013]
Petronas (2011) Sustainability Report [online] pp. 23-29 [Accessed 6 June 2013]
Ling, K.H. (2008) Analysis of the Fuel Price Flactuation Impact on Travel Demand : A Case Study on the Klang Valley Region. Available from: http://www.utar.edu.my/contentRandD.jsp?catid=9&contentid=417&2ndcontentid=1940 [Accessed 7 June 2013].
Lee, B., Preston, F., Kooroshy, J., Bailey, R. and Lahn, G. (2012) Resource Futures. pp. 94. [Accessed 7 June 2013].
Hamid, K.A. and Rashid, Z.A. (2012) Economic Impacts of Subsidy Rationalization Malaysia. [online]. pp. 212-216. [Accessed 7 June 2013]
Asia One. (2012) RON 95 Subsidy to Continue.10 June, [online]. [Accessed 7 June 2013]
Sipalan, J. (2012) PM: Country Can't Run Forever on Fuel Subsidy. The Star. 2 July, [online]. [Accessed 7 June 2013]
Ye, M., Zyren, J., and Shore, J. (2003) Elasticity of Demand for Relative Petroleum Inventory in the Short Run. pp. 88-89. [Accessed 8 June 2013]
The Star. (2010) Malaysians Consume More Fuel. 24 May, [online]. [Accessed 8 June 2013]
The Malaysian Insider. (2008) Petrol Ceiling Price to Remain at RM 2.70 Until Year-End, Says Shahrir. [online] [Accessed 8 June 2013]
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