Economics information on PETRONAS

As compared to large corporations all over the world, PETRONAS is ranked at the place of 75 in Fortune Global 500 in year 2013. PETRONAS is predicted to have revenue at the value of $94.3 billion and profit of $16 billion, which are MYR299.36 billion and MYR50.79 billion respectively at current rate of exchange.

Petroliam Nasional Bhd (PETRONAS) is Malaysia’s national oil and gas company. As PETRONAS is a government-owned corporation, the company holds entire ownership and authority of petroleum resources within the country. It belongs to the fuel industry and it was founded on 17 August 1974. As PETRONAS has a great variety of business activities, the trading and production of crude oil, petroleum and petrochemical products will be the concentrated topic in this Weblog. There are a few types of goods by PETRONAS that are for sale to the public, which includes 2 types of gasoline (RON95 and RON97), diesel and natural gas. All these goods sold are considered as complementary goods. Why is it so? According to Tucker (2008), complementary good is a good that has to be consumed jointly with another good in order to utilize the functions of both goods. In this case, these fuels are used to complement the function of vehicles.

Demand and its determinants

Based on the law of demand, with other determinants remaining constant, the higher the price of a good, the lower the quantity demanded of it and vice versa (Parkin, 2014).

Figure 1: Shift in Demand curve of PETRONAS

One of the most evident determinants of demand for petrol is the expected future price. On 2^nd of September 2013, as soon as the increase in RON95 petrol and diesel by 20 cents per litre was announced, most Malaysians have shown increment in demand for petrol by rushing to all petrol stations. However, as the time interval between the announcement and establishment in increasing price was short, the impact of rapid growth of demand for petrol and diesel only lasted shortly (less than a day). Momentarily, the equilibrium price was driven up and market price was supposed to increase as well but the market price was controlled by government. 

Figure 2: This picture was taken before the increment of fuel prices. Many cars are in queue to pump petrol before the price rises. (Sources from Avineshwaran, 2013)

Other than that, the growth of population and also the change in consumption pattern in Malaysia has also significantly increased the demand for transportation. In Asia, the total number of vehicles is doubling every seven years as a result of industrial and economic development (West-East Center, n.d.). From 1991 to 2009, the growth of population in Malaysia is approximately 1.5 times where the growth in total amount of vehicles is approximately 4 times (Indati, Ghate and Leong, 2013). This is vital in causing the increasing demand.

In addition, price of vehicles also brings impact in the demand of fuels. To illustrate, assuming prices of car has been brought up by 10%, there will be a reduction in the demand for fuels. This is due to the relationship in both that fuel complements function of vehicles. When price of vehicles increases, the society may not be able to accommodate the price of cars, bringing down the demand for it. The effect is especially strong among households and private sectors as they own them privately, their purchasing power may not allow demand for it. As a result, the demand for fuels may decrease.

Supply and its determinants

According to the law of supply, with other determinants remaining constant, the higher the price of a good, the greater the quantity supplied for it and vice versa (Parkin, 2014).

Figure 3: Shift in the Supply curve of PETRONAS 

One of the determinants of supply is availability of resources needed in production. The production is in decline since 2005 as maturing field are experiencing natural field depletion (Thean, 2013). As petroleum is a non-renewable and natural resource, it cannot be grown or made artificially. This has influenced the production of fuels to be lower as there are enough resources to supply it. However, the current level of supply for gasoline and diesel still fulfills the demand in Malaysia, hence, there isn’t a shortage on supply that changes the price.

Besides that, advancement of technology may influence the production. In theory, better technology leads to higher production. In Malaysia, fuel production was rising since year 2002 due to the new development of offshore (Fatimah and Nasir, 2009). New development of offshore fuel enables more fuel to be excavated. This has caused the production of fuel in Malaysia to reach at peak of 755.35 thousand barrels per day in 2004, according to United States Energy Information Administration (IndexMundi, 2013). 

Oligopoly

To be precise, PETRONAS is operating in the market structure named Oligopoly. Industries in this market structure prevent the entry of new firms by barriers and only a few firms compete among each other (Parkin, 2014). For identification, there is only limited number of fuel companies, there’s existence of barriers to entry, the nature of fuel is undifferentiated and the demand curve for fuels is inelastic.

Limited number of firms

In Malaysia, the major firms supplying and producing fuels are only limited to Shell, Cartex, BHP, Esso and Mobil. All the fuel companies available in Malaysia's fuel industry currently are only this few.

Nature of goods is undifferentiated

All these fuels companies in Malaysia sell undifferentiated goods. This is as seen in every petrol station that the fuels that they sell are only limited to RON95, RON97, diesel and natural gas.

Barriers to entry

In the petroleum industry, one of the barriers to entry is applying and obtaining the license. In Malaysia, all the petroleum resources are owned by PETRONAS (PETRONAS, 2012). In brief, there’s no access to the natural resources for anyone to start-up a petrol company, unless with approval of PETRONAS. It is definitely difficult to obtain the license as government of Malaysia tries to limit the number of petrol companies for easy governance.

Another barrier is the inability to compete with existing firms. As we all know, most petrol companies in Malaysia have been operating for a long time. Established and experienced firms have prior knowledge in management, production and marketing as compared to new firms. They operate in the manner where there are always economies of scale and operating costs is the lowest and by utilizing the most efficient techniques, most reliable suppliers and also best rate in finance (Tucker, 2008). To be able to start-up and compete, a huge amount of capital will incur. These two barriers prevent new firms from entering the industry.

Inelastic demand

As an oligopolistic firm, the demand for goods produced by PETRONAS is inelastic. This means that big changes in price will only bring small changes in the quantity demanded. This is because the Malaysian society treats transportation as a necessity by owning car or at least using public transportations. Petroleum as a complementary good becomes a necessity as well.

In addition, there’s no close substitutes that is close to replace the function of petroleum for vehicles. Lately, natural gas is treated as a substitute for petroleum. However, it can only be used for natural gas vehicles (NGV) and there’s only a small portion of this type of cars in the current market. Moreover, natural gas is also supplied by petroleum suppliers. Therefore, the demand for fuels such as petroleum, natural gas and diesel supplied by PETRONAS is still quite inelastic.

Inelastic supply

The supply of petroleum by PETRONAS is inelastic. According to Rooke (2007), a supply is inelastic is suppliers are unwilling or unable to produce more even if the prices has increased.  A fuel-supplying firm cannot increase the supply as anytime they like. This is because fuels are depleting and non-renewable resources, even if market prices are much higher (regardless of government intervention), the supply is unable to increase correspondingly as oil field requires many years to develop. 

Government intervention

Due to the inelastic demand for petroleum, PETRONAS and other fuel companies are classified as price-makers in the market. This is one reason why government has to intervene by a few approaches.

The first approach of government intervention is through price control. In Malaysia, Automatic Pricing Mechanism (APM) determines the retailing price of petrol since 1983 (Economic Planning Unit of Malaysia, 2005). The format for APM is shown as below:

Product Cost

+ Operational Cost

+ Company Margins

+ Petrol Station Commission

+ Sales Tax

= Actual Price

- Sales Tax (Exemption)

- Subsidy

= Retail Price

Figure 4: Automatic Pricing Mechanism (APM) in Malaysia

This APM functions as a price ceiling and a price floor. All fuels retailers must calculate the retail price of petroleum product following the mechanism. Setting price higher or lower than that price is illegal in Malaysia. This mechanism functions to stabilize and regulate the price during economic fluctuation.  

Another government intervention on fuel trading companies is contributing through subsidy. Subsidy is defined as payment by government to business to encourage production of a particular commodity (Jackson et al, 2004). According to United Nations Public Administration Network (2002), Sales Tax Act 1972 states that the maximum sales tax applicable by the government for petrol is MYR 0.5862 for petrol per litre and MYR 0.1964 for diesel per litre. As at 2^nd of September 2013, the Malaysian government has announced to deduct the subsidy for RON95 and diesel by MYR 0.20 as an approach in reducing the fiscal deficit. According to the Prime Minister Datuk Seri Najib Tun Razak, MYR 1.1 billion per annual is to be saved by the government establishing this approach. As a result, price of fuels have increased by the amount of deduction in the subsidy, causing the current retail price of RON95 to be MYR 2.10 per litre and MYR 2.00 for diesel.

Reference:

Avineshwaran, T. (2013) Fuel Price Hike: Last Call for Cheaper Petrol. Available from: http://www.thestar.com.my/News/Nation/2013/09/02/fuel-price-hike-petrol-stations-packed.aspx [Accessed 22 October 2013]

Cooke, R. (2007) The Elasticity of Oil Production and Consumption. Available from: http://www.resilience.org/stories/2007-03-22/elasticity-oil-production-and-consumption

 [Accessed 21 October 2013]

East-West Center (n.d.) Population, Natural Resources and Environment. Available from: http://www.eastwestcenter.org/fileadmin/stored/misc/FuturePop10Environment.pdf [Accessed 23 October 2013]

Economic Planing Unit of Malaysia (2005) Oil Prices and Subsidies: An Explanation. Available from: http://www.epu.gov.my/c/document_library/get_file?uuid=f438db0e-8106-489b-ac5e-2ee3f04d2575&groupId=283545 [Accessed 24 October 2013]

Fatimah, M. A. and Nasir, S. (2009) Implications of Oil Price Increase on the Malaysian Food System. Available from: https://www.pecc.org/resources/doc_view/397-implications-of-oil-price-increase-on-the-malaysian-food-system [Accessed 21 October 2013]

Tucker, I. B. (2008) Economics for Today’s World. 5^th ed. Canada: Thomson South-Western.

Indati, M. S., Ghate, A. T. and Leong, Y. P. (2013) Towards Greener Environment: Energy Efficient Pathways for the Transportation Sector in Malaysia. Available from: http://iopscience.iop.org/1755-1315/16/1/012122/pdf/1755-1315_16_1_012122.pdf  [Accessed 22 October 2013]

IndexMundi (2013) Malaysia Crude Oil Production by Year. Available from: http://www.indexmundi.com/energy.aspx?country=my&product=oil&graph=production [Accessed 22 October 2013]

Jackson, J., Mclver, R., Bajada, C and Hettihewa, S. (2004) Economic Principles.

Australia: McGraw-Hill Australia.

Lee, Y. M. (2013) RON95, Diesel up 20sen from Midnight. Available from: http://www.thestar.com.my/News/Nation/2013/09/02/ron95-up-20-sen.aspx [Accessed 24 October 2013]

United Nations Public Administration Network (2002) A Summary of Tax System (MALAYSIA). Available from: http://unpan1.un.org/intradoc/groups/public/documents/apcity/unpan005060.pdf [Accessed 22 October 2013]

Parkin, M. (2014) 11^th ed. Economics. Harlow: Pearson.