The disincentives of subsidies

This is written by my boss.

 A FEW years ago, there was a meeting between an energy association with a group of business executives. The association was trying to convince the executives to use more efficient motors, which are the things that move elevators and escalators. 

Since these equipment virtually run during whole office hours and even 12 hours for shopping malls, using more efficient motors would translate to savings on electricity bills. But the meeting was rather boring as many would rather continue using existing motors that are cheap.

On top of that, electricity is also cheap, so why bother changing, some of them said, in private of course.

As long as power is cheap and subsidised, owners of office building and malls would still make money. The worst case scenario is that power prices jump and demand for efficient and more expensive motors also jumps.

This is hypothetical. But what Tenaga Nasional Bhd (TNB) said a few weeks ago came close to a worst case scenario for the country.

It said power plants were close to breaking point because of a gas shortage.

The lack of gas pushed TNB to squeeze all it can from coal-fired plants and hydroelectric ones. It also subjected gas plants to run on distillates for much longer than they should.

What was scary was that scheduled maintenance for certain coal plants were not done because doing so may take out much needed capacity from the national grid. In certain cases, special waivers had to be sought to do away with maintenance work.

TNB also used more water in its hydro plants to cover demand. Water levels at the Kenyir dam is at historical lows because of this.

This is bad because hydro plants are used to cover spikes in demand due to its quick response time. If it continues to draw too much water, it may not have enough in the future to handle these spikes.

As for gas plants, TNB has been buying so much distillates from oil companies that Malaysia literally ran out of the thing one day in June.

It was such a good customer that Shell decided to treat TNB management to lunch, according to chief executive officer Datuk Seri Che Khalib Mohamad Noh.

The shortage of gas has been well documented for a few years as the power sector and heavy industries that use gas complained about supply. The result now is higher gas and electricity prices.

But why was gas supply running low? Because the price of gas it sold was fixed at rates lower than the market price, Petronas as the supplier had no incentive to invest.

Common sense would dictate, why invest in a business that's not making money. This means it had no desire to look for new supplies or upgrade old facilities.

Petronas admitted as much in its August 23 press release.

"These subsidised gas prices have resulted in minimal investments in the exploration and development of gas projects by oil and gas players, constraining growth in supply capacity. Compounding this tight situation, Malaysia's offshore production facilities have been running at full capacity, exerting tremendous pressure on gas production systems and resulting in the unavailability of margin to absorb fluctuations in gas demand as well as to cater to unanticipated situations."

It is not just power plants that are running flat out, Petronas' gas facilities are also running at full steam.

The funny thing is, the industry knew years ago that something like this would happen.

"As way back in 2007, we worked with the government, TNB and end-users. We told them that if there is something to break, it's going to be massive and true enough, it's this year," Petronas CEO Datuk Shamsul Azhar Abbas told a media briefing last week.

To cap it all off, Petronas announced a fast-track RM15 billion project to look for more gas offshore Peninsular Malaysia. This involves digging into smaller and deeper fields.

What this episode highlights is the danger of subsidies. Not only can it be a burden to government finances, like petrol subsidies, it could even have bigger implications, like the neglect of investments in gas supply.

The cost of it is also great because it involves our reputation at a time when we want more investments, be it local or foreign. Investors will think twice when they think that energy supply is inconsistent.

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