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Target subsidies based on vulnerability, not usage, says Lantau Group MD

“Electricity is, of course, an essential staple of life, but that does not mean it is free,” says Mike Thomas, Managing Director of The Lantau Group, a strategy and economic consultancy focusing on the Asia Pacific energy industry.

“The idea of targeting [subsidies] is that whilst no one likes the price of anything to increase, subsidising those who can afford it is costly, can be thought of as unfair, and may leave less support for those who cannot.” Of course, this can mean there may be some sacrifice during periods of higher prices,” he continued.

Shifting from broad ‘untargeted’ subsidies to vulnerability-based targeted support is a big change and may be initially an uncomfortable one for many Malaysians — a nation with a long legacy of heavily subsidised and cheaply priced commodities, especially essential ones such as petrol and electricity.

Even today, Malaysia continues to provide one of the lowest domestic electricity tariffs in the world — much of which is due to a combination of government subsidies on natural gas that the consumers enjoy via a mechanism called Imbalance Cost Pass-Through (ICPT) as well as the effect of cross-subsidies whereby other customer classes pay more so that domestic customers can pay less.

“The price of electricity in Peninsular Malaysia is, for most domestic customers much too low compared to the cost of supplying that electricity. I imagine that after so many years of subsidy and protection, most customers aren’t even aware of this,” asserted Thomas.

Pricing electricity to incentivise energy efficiency

On 23 June 2023, the government announced a subsidy allocation of RM5.2 billion (USD 1.12 billion) for the next ICPT implementation period (1 July —31 December 2023) to protect roughly 99% of Tenaga Nasional Berhad (TNB) customers in Peninsular Malaysia from the impact of higher fuel costs, costs which make up 65% of the country’s tariff.

According to Thomas however, the reality is that while the government has taken steps to protect citizens, the brunt of globally increased fuel costs has been held back from consumers and instead borne by TNB so far, who have yet to recover those costs; a situation that is also unsustainable. Customers would not want to buy insurance from financially unstable insurers, fly on airlines that do not have sufficient capital to make necessary investments in safety and maintenance, or seek shelter in homes and buildings that were not built to standards.  Things cost what they cost.  Like a bamboo, bending this rule too much or for too long will eventually cause it to snap with consequences.

“This is the crux of the problem. Malaysia has been hit hard by rising fuel costs. It may take months or years to sort through the deficit and restore balance, as fuel costs have not yet reverted to lower earlier levels. We may be in for a longer period of higher costs of electricity than any of us are used to,” said Thomas.

According to Thomas, targeted protection to vulnerable groups, while ensuring electricity prices reflect market reality is the most common, practical, solution globally. This format, he proposes, also incentivises greater adoption of energy efficiency and conservation measures.

From a market perspective, transparency and visibility of electricity pricing provide investors with clear signals about the future value of energy resources. This can lead to increased investment in long-term projects from local and foreign parties especially as Malaysia looks towards accelerating its energy transition agenda.

“A blanket ICPT subsidy sends a signal that electricity is less expensive than it really is, which may cause people to undermine the value of energy efficiency investments or behaviours,” he said.

“An ideal approach would be to separate support, or targeting, from electricity pricing: get the pricing right so that decisions made about electricity usage are efficient and smarter. Then, use other mechanisms that can allow the targeting of vulnerable customers. Ideally, this would be based on income or similar vulnerability assessment data,” he continued.

Targeting based on vulnerability

Currently, the subsidy proposed by the government targets beneficiaries based on usage data, not actual vulnerability. This was premised on the rationale that the affluent Top 20 (T20) of the population consume more electricity by using energy-heavy electrical appliances such as industrial air-conditioners and dryer machines, compared to the Bottom 40 (B40) and Middle 40 (M40).

This, however, is an inaccurate basis for targeting, according to Thomas. “For example, some who use very little electricity are very wealthy. Some who use more electricity are very poor, due to large households or families. Usage will always be an inaccurate basis for targeting.”

He added that the way that other economies have managed to remain competitive is that subsidies are more accurately targeted based on income or other characteristics, which keeps energy costs whole and lower.

For example, between October 2022 to March 2023, the UK Government offered a one-off ‘Warm Home Discount’ of GBP 150 (USD188) to eligible low-income households that faced high electricity bills. This support came during the period of the energy crisis caused by the Russia-Ukraine conflict and other supply crunch issues.

“This is one of many simple examples where electricity tariffs remain true to its costs and any government assistance is delivered to targeted eligible recipients in a non-tariff measure,” shared Thomas.

Developing smoothing mechanisms and funding

 To improve the accountability and effectiveness of targeting, Thomas suggested leveraging on the government’s current multi-ministries’ efforts to consolidate a number of national databases for the purpose of eligibility screening. Malaysia also currently runs the KWIE (Kumpulan Wang Industri Elektrik) fund, which has established good governance and could be leveraged as a platform to deliver more effectively targeted subsidies.

“In statistics, there is something called ‘type 1’ and ‘type 2’ errors. A type 1 error is when you protect someone you do not need to protect. A type 2 error is when you fail to protect someone you want to protect. Of course, this is difficult and few systems with such good intentions ever perfectly deliver,” said Thomas.

“Smarter policies take aim at both of these errors. Often, this requires a process by which those who merit support are able to signal or petition for relief if for some reason they have not been included. Smart targeting is comprehensive but should also be dynamic and agile.”

Looking beyond the crisis

 It is true that Malaysia’s current policies are founded heavily on the notion of social inclusivity. Yet, according to Thomas, Malaysians’ over-reliance on subsidies is quite unique, internationally.   “The first question is whether subsidies are really necessary for normal times. If the concern is mainly the recent fuel market shock, then just about every country has been challenged. But what happens after the shock is over? Even as we scramble to get through a crisis, there is a need to plan for the recovery and return to normality,” said Thomas.

“Policymakers here are trying to do something important and useful, but they are limited by the inherent challenge that usage of electricity does not correspond well enough to income or vulnerability. Why not work to improve the targeting so that fewer well-to-do customers receive it and none who need a subsidy are overlooked?” he added.

Such a balance is not easily achieved, but must nevertheless be strived for. Malaysia, along with the electricity sector, must move forward carefully and strategically, lest it wastes resources on those who do not need it and leave out those who do.

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