Time to Safeguard Oil Revenue

By Dr Fong Chan Onn

Malaysia is at a critical crossroads – we could plunge into an economic trench or succeed to enjoy the fruits of our labour. In part two this week, Sunday Star looks at a new model of management of our oil revenue which should be implemented.

How do we compare with the above five oil producing countries, in terms and management of the oil revenue and its spending? I venture to argue while we certainly have not done too badly, we can still do better, in fact much better.

On the macro policy side it is clear that, instead of using our oil revenue to encourage high income generation activities in the last 1990s, we have continued to rely on labor-intensive manufacturing. Instead of restructuring wage policies, price controls, and subsidies (which cause distortions to the economy) we have continued to rely on these traditional policies resulting in oil subsidies constituting 30% of government operating expenses in 2008.

With as much as 45% of the government revenue coming from oil, and knowing that Petronas has cash reserves of RM 121.2 billion in 2009, government policy makers find it difficult to breakout from this easy source of income. We become too comfortable to think of innovative ways of finding new sources of growth compared with countries with no natural resources. We have also refrained from making bullet-biting policies, and stick to implementing the tough decisions that are needed to restructure the economy.

This dependency syndrome on easy oil revenue cannot be allowed to continue.

This is because, due our failure to reform the economy and the growing competitiveness of other Asian countries, our manufacturing sector growth rates have been falling since 2004, from 17% to 8% in 2008 (see Chart 1). The service sector similarly has also experienced falling growth rates, from 14% in 2004 to 11% in 2008 (see Chart 2).


FDI has also fallen 72.9% from US$ 12.9 billion in 2008 to US$ 3.6 billion in 2009. Declining manufacturing and services sector growth rates, coupled with falling FDIs, are strong symptoms of the on-set of delayed Dutch Disease and our depleting global competitiveness.

Our country now lies on a critical crossroads on which we could plunge into an economic trench or, we could succeed to enjoy the fruits of our labor. Clearly, a new model of management of our oil revenue has to be implemented.

To suggest a new model for oil revenue management, I need to estimate the proportion of annual net profits made by Petronas that is retained as cash reserves for its future use (or for the needs of our future generations).

Petronas has publicly stated that its cash reserves at 2009 stood at RM 121.2 billion. But its cash reserves for other years have not been publicly reported. Further net profits figures of Petronas have been publicly reported only since 1992.

But assuming a conservative cash reserves of RM10 billion (accumulated over the 17-year period of 1974-1991) at 1992, and calculating from the net profits of the company reported (publicly) from 1992 to 2009 while assuming a conservative 5% annual rate of return and ignoring foreign exchange losses or gains, Petronas’s cash reserves of RM121.2 billion at 2009 implies a reserves retention rate from net profits of only about 21% (see Chart 3), with 79% of net profits being paid to government for its operating expenditure, or Petronas itself investing on mega projects.

Given our depleting oil reserves (we could become an net importer of oil within a decade) is this low retention rate fair to our future generations?

Chart 3 also shows that had Petronas’s reserves retention rate been set at 33% its cash reserves could be at RM 177.7 billion at 2009; had its retention rate been at 50%, its reserves would have been at RM 256.9 billion in 2009 - more than double of the present RM 121.2 billion.

The Alaskan Model of a Citizen Fund indicates that 25% of oil revenue is set aside every year for the direct needs of its people; profits from the fund are then paid as cash dividends equally to all Alaskans. In a poor egalitarian society like Alaska, this may be fair, but in Malaysia we have always advocated the policy “it is always better to teach a man how to fish, then to give the man the fish”.

A State Fund (Future Malaysian Fund) could be set up; requiring Petronas to deposit say 25% of its annual net profits into this fund, to be managed by Bank Negara for the needs of our future generations. For the remaining 75% of its net profits, the government could decide the proportion that could be allocated as government revenue, and the proportion to be held as retained revenue by Petronas. A suggested formula could be 25% of net profits to be used by government as revenue, with Petronas retaining the remaining 50% for reinvestment purposes. For the year 2009, for example, this formula would imply that out of the RM52.5 billion net profits, the Future Malaysia Fund and the government would receive RM13.1 billion each, and Petronas could set aside RM26.2 for reinvestment purposes. For comparison, Petronas paid a dividend of RM30 billion to federal government in 2009, and retained RM 21.9 billion for reinvestment.

More importantly, this formula would enable Petronas to channel a quarter of its annual net profits to meet the needs of the future generations, when our oil reserves have dried up. Also with a smaller allocation from oil revenue as government revenue, we would be forced to implement bullet-biting reform policies to strengthen our economy with an improved competitiveness and new innovations.

The implementations of the Future Malaysian Fund Model notwithstanding, Petronas should not be denied of its present independence, given its own track record of par excellence; growing from anonymity in 1974 to being listed on Fortune 500 today. It should not be subjected to the wimps and fancies of the government of the day, nor should it be concerned about the nuts and bolts of running huge non-oil infrastructural projects.

My key concern is related to how the government chooses to utilize the earning streams as the reserves for meeting the needs of our future generations.

It is sufficed to say that the current scenario of wage restraints, price controls and subsidies is untenable. Given the global fluctuations and political volatility, it is only fair to the people of Malaysia that we revisit the Petroleum Development Act to seek more stable and transparent policy in the long term management of our oil reserves, for the sake of our future generations.