Malaysia wants to introduce cleaner fuels. But that isn’t easy in a country where fuel prices are subsidized. Jonathan Nonis and Yen Ling Song teamed up to look at the issue in this week’s Oilgram News column, Regulation & Environment.

Malaysia’s plan to implement cleaner gasoline and diesel standards are likely to continue getting hampered by the government’s fuel subsidy policy and a lack of refining capability to supply the tighter spec fuels.

The Malaysia Automotive Institute in February said that it had started a two-month study on the refining sector’s readiness to supply Euro 4 gasoline and diesel throughout the country by 2015 – the government’s targeted date for the roll-out.

The plan to upgrade to Euro 4 fuels — known domestically as Euro 4M — from the current Euro 2 has been brewing for years and would result in a shift from 500 parts-per-million sulfur content for both gasoline and diesel to 50 ppm.

This target is driven primarily by a need to address pollution and fuel efficiency concerns, particularly when the automotive industry contributes significantly to the economy.

The latest automotive policy road-map calls for increased development of the sector so that Malaysia can become a hub for energy efficient vehicles.

The existing Euro 2M fuel standard was introduced in September 2009 after a two-year delay due to debates over the higher subsidy costs to be incurred as a result of the switch.

One key factor that will signal Malaysia’s successful transition to cleaner fuels would be the government’s approach to fuel subsidies.

Facing a growing debt burden, the government of Prime Minister Najib Razak, who was re-elected in May last year, has pledged to lower energy subsidies and also announced plans to implement a 6% goods and services tax from 2015 as part of efforts to strengthen the country’s fiscal position.

Following an 11% hike in 95 RON gasoline and diesel prices in September 2013 — the first price hike in nearly three years — the fuel subsidy in February works out to around MR 0.73/liter (23 cents/liter) for 95 RON gasoline and MR 0.83/liter for diesel, according to a source from Malaysia’s Ministry of Finance. According to the source, fuel subsidies changes from month to month depending on foreign exchange rates and the international price of oil.

The aim to introduce cleaner transport fuels could raise the government’s subsidy burden further.

One quick way around this would be to supply 4-M motor fuels at market prices, without additional subsidies, according to one economist.

“Realistically the [Malaysian] government will probably introduce both 2-M and 4-M simultaneously at the pump stations,” Chief Economist at Maybank Investment Bank, Suhaimi Ilias told Platts. “So that those who can afford and require the higher grade diesel will be able to buy them at market price while the government gradually reduces subsidies on the lower-grade diesel. This dual-system fuel prices already exist in Malaysia, given the subsidized RON 95 and the non-subsidized RON 97 gasoline at the petrol station.”

Another question is whether the refining sector is ready to supply cleaner fuels.

Shell last year commissioned a new 45,000 b/d gasoil hydrogen desulfurization unit at its 156,000 b/d Port Dickson refinery, which the company said would enable it to use a wider variety of crudes and increase gasoil output. While the refinery now adheres to the Euro 2M product specifications, the new unit is capable of being expanded to produce Euro 4 products in the future, Shell said in February.

This new unit means the country is well placed to meet any move to Euro 4M diesel, said Suresh Sivanandan, downstream analyst at Wood Mackenzie.

The outlook for gasoline however, is not so clear as no other upgrades at existing refineries have been announced. Petronas’ greenfield RAPID project, underpinned by a 300,000 b/d refinery in the state of Johor, has faced delays and is now scheduled for start-up around 2017-18, if at all. Shamsul Azhar Abbas, CEO of Petronas, said March 4 that the company was still studying the viability of the RAPID project and would defer it if the economics aren’t workable.

“We don’t see much of new investment to the existing [refinery] infrastructure to produce 50 ppm motor fuels,” a Singapore-based gasoil trader said. “With the lack of ability to produce the cleaner grades, and with RAPID delayed to 2018, will Malaysia then rely on imports of such fuels, if so is the infrastructure for imports in placed, and what will be the cost?”

“I think Petronas is banking on the RAPID project for meeting the [new] specifications,” said Sivanandan. “Our view is that [the] 2015 [timeline for the new fuel specifications] is a bit ambitious, I think it will take some time.”

Woodmac estimates Malaysia to have been a slight net importer of gasoil last year, of around 20,000 b/d, although net imports of gasoline were higher, at around 106,000 b/d.

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