After Sakhalin

Dec 13th 2006 | MOSCOW
From The Economist print edition

What does Shell's capitulation to Gazprom mean for the Russian energy industry?

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“GIVE me the man,” ran an old KGB adage, “and I will find you the crime.” A similar rule now seems to apply to energy companies in Russia. For Yukos, once Russia's top oil firm, the crime was allegedly unpaid taxes; with the giant oil and gas project led by Royal Dutch Shell on Sakhalin island, in the Russian far east, it was environmental violations. In both cases the outcome was broadly similar: state-controlled firms ended up taking control of prize assets.

The huge Shell-led project known as Sakhalin II would be unusual anywhere, and in Russia it is unique. It involves the country's first liquefied natural gas (LNG) plant, which will serve lucrative new markets in North America, South Korea and Japan. Sakhalin II is almost finished: it is already producing oil, and LNG shipments are supposed to begin in 2008.

Until this week, though, there were also some perilous peculiarities. Sakhalin II was the only big energy operation in Russia that did not involve a Russian firm: Shell's partners are Mitsui and Mitsubishi of Japan. (Rosneft, a state-controlled oil firm, has a stake in a rival Sakhalin consortium led by Exxon Mobil.) The Shell- and Exxon-led projects were the only two exceptions to the monopoly on gas exports held by Gazprom, the state-controlled gas giant. Along with a Siberian development led by Total, they were also the only projects governed by “production-sharing agreements” (PSAs), contracts signed with the government in the 1990s that some Russians now consider unfairly generous.

The “crime” needed as a pretext to rectify these peculiarities was not hard to find, or invent. The sea around northern Sakhalin, in which the project's offshore drilling rigs stand, freezes for half the year and is home to a rare whale. The twin pipelines that will deliver the oil and gas to the island's southern tip cross around 1,000 rivers and streams, many of which are used by spawning salmon. A few months ago, Russian environmental regulators began to complain and they have since suspended licences and threatened the Sakhalin II consortium with criminal action.

Gazprom was already negotiating for a stake in Sakhalin II when the consortium announced last year that its costs would nearly double, to around $20 billion. Under the terms of the PSA, that will reduce and delay the state's returns. The environmental pressure also raised the prospect of costly delays, to the ire of the customers who have pre-purchased much of the anticipated gas.

Shell has evidently decided that the threat of delays and obstruction was less palatable than cutting its Sakhalin stake. The cuts in proven reserves that will result are a heavy price for a company that is already short of oil. The deal is still being negotiated, but it emerged this week that Gazprom will probably end up with a controlling stake. In return, instead of a share of a Siberian gas field that was once on the table, Shell and its Japanese partners will get cash (though whether they would want more Russian assets must be open to question). The regulatory shenanigans are likely to continue until the price is agreed.

What will that mean for the salmon, the whales and the rest of Sakhalin's beautiful but fragile flora and fauna? Environmentalists have made common cause with the government, but they may find that, despite its failings, the consortium was greener than Gazprom will be. After all, unlike its new Russian partner, the consortium needed to secure loans from multilateral institutions and was sensitive to bad publicity. It will be interesting to see how the environmental regulators behave once Gazprom is installed. The massive tax debts attributed to Yukos's main production subsidiary were magically reduced by the courts after the unit was expropriated by the state and sold to Rosneft.

Shell's capitulation and the Yukos case exemplify the state's ever-increasing role in the energy industry. A second question is how far that trend will go. State-controlled firms look destined to get preferential treatment in the future allocation of extraction licences, and the role of foreign firms looks certain to be tightly circumscribed from now on. (Just how tightly will be partly decided by a new law.)

But what of Russia's existing private firms? Yukos's remaining assets seem likely to be redistributed in another fake auction. More controversial will be TNK-BP, an Anglo-Russian company that is half-owned by BP (foreign and therefore bad) and half by a clutch of tycoons (unpopular and therefore vulnerable). The firm has been hit with big tax bills and other misfortunes; persistent rumour has it that a change of ownership is likely next year. Russian history suggests that all this is unlikely to boost production.

Still, with the world's energy reserves distributed as they are—mostly in places at least as unstable and inhospitable as Russia—the oil majors will not be easily deterred. The enormous Shtokman gas field in the Barents Sea could be an early test of international sentiment. The Kremlin for years tantalised foreign companies and their governments with the prospect of a role in the Arctic project. Then, in October, Gazprom said it would go it alone.

Now Vladimir Putin says foreign partners might be welcome after all. Whether this confusion stems from extreme negotiating tactics or sheer disorganisation is unclear. Either way, as Sakhalin proves, the Kremlin evidently feels it can afford to dispense with the niceties.

Shot Across the Stern

Dec 13th 2006
From The Economist print edition

Was Sir Nicholas's big report on climate change egalitarian, inegalitarian—or both?

TO SHOW that you are up to speed on global warming, you need to know your Rio summit from your Kyoto protocol; your Greenland pump from your carbon sink; and your Harald Sverdrup (a Norwegian oceanographer, who measured sea currents) from your Bjorn Lomborg (a Danish controversialist, who annoys greens). And as if all that were not enough, Sir Nicholas Stern's big report on climate change, published by the British government in October, has forced greenhouse gasbags to master another bit of esoterica: the Greek alphabet.

Actually, just two letters will do: delta and eta. The characters are Sir Nicholas's shorthand for two concepts. Delta determines the weight he places on the welfare of future generations that are not yet here to stick up for their own interests. Eta governs his answer to a different question: how much weight should be given to the consumption of the rich relative to that of the poor?

Just to recap, Sir Nicholas's report concludes that if greenhouse-gas emissions continue on their current path, the cost over the next couple of hundred years in terms of lost output could be colossal. The shorter-term costs of switching away from carbon need not be, however.

His judgments have been controversial, and none more so than his use of Greek, which has been questioned by two eminent economists and a flotilla of economic bloggers. The weight he gives to future generations is too high for the taste of William Nordhaus of Yale University. By contrast, the figure he picks for eta is too low for the comfort of Sir Partha Dasgupta of Cambridge University, who would give the consumption of the poor rather more emphasis than Sir Nicholas does in his treatise.

Sir Nicholas thinks a person born in 2106 should count for as much as one born in 2006. In his defence he cites some big thinkers, including Roy Harrod, a British economist best known as a growth theorist and a biographer of John Maynard Keynes, who thought discounting future generations was just a “polite expression for rapacity”. He admits there is a slim chance these prospective generations will not in fact exist: the earth might be wiped out by a meteorite, for example. For that reason, and that reason only, he discounts their welfare by just 0.1% for every year that passes before they appear.

Sir Nicholas's ethics may be appealing, but according to Mr Nordhaus the economics that follow from them are absurd. Barring any celestial collisions, there will be countless future generations, each with a claim on our consideration equal to our own. Suppose, he argues, that all these generations to come will suffer some minor inconvenience (a few extra mosquitoes, say) that we today could prevent at great cost to ourselves. By Sir Nicholas's moral calculus, even small harms amount to big losses when added up over enough cohorts. Thus we should take even crippling action to avert trivial hardships that may befall our long, long line of descendants.

The present deserves a break for another reason, Mr Nordhaus says. Future generations will not only be born later than us, they will also be richer—much richer. He points out that if consumption per person grows by 1.3% a year, it will rise from $7,600 today to $94,000 by 2200. And yet Sir Nicholas asks the present generation to make an economic sacrifice to help its richer successors.

Alphabetagammadelta soup

Redistribution from poorer to richer seems a bit perverse. Most people accept that a dollar is worth more to a pauper than to a plutocrat. But how much more? Sir Nicholas picks a value for eta of one, which means a dollar is worth ten times more to someone with one-tenth of the income. This may sound like a big difference. But it means a 10% gain in the consumption of the poor—an extra ten cents for someone on a dollar a day—is worth no more in his moral calculus than a 10% bonus for the rich—an extra $100 for someone with a daily budget of $1,000.

Sir Partha thinks this gives the poor short shrift. He argues that an eta of between two and four yields “more ethically satisfactory consequences”. If eta were equal to two, a dollar would be worth one hundred times more to someone ten times poorer.

These shots at the Stern report whistle in from different directions, but Mr Nordhaus and Sir Partha both agree on one point: Sir Nicholas's choices are inconsistent with each other. If Sir Nicholas is such a staunch egalitarian between the future and the past, Sir Partha complains, he should be more egalitarian between the rich and the poor.

For his part, Mr Nordhaus argues that if Sir Nicholas insists on a relatively low value of eta, he must pick a higher value of delta: something like 3% not 0.1%. Otherwise, he argues, the present will always be held hostage to the future, forgoing its own consumption to further enrich all the generations to come.

Opponents of action on global warming have seized upon Sir Partha's sally against Sir Nicholas. But Sir Partha himself supports such efforts. “I have believed for some time that climate change is the most all-embracing problem humanity faces today,” he has written, “and would be happy to vote [to spend] 1.8% of the GDP of rich countries to confront the problem.”

His argument is not as self-contradictory as it sounds. The costs of fighting climate change would fall mainly on today's more affluent nations. Conversely, the benefits that will emerge in the distant future will be felt mostly in poorer countries. Bangladeshis or Somalis should be much better off in 50 years' time than they are now, but they will still be much less prosperous than the average American or western European is today. The high value of eta that Sir Partha advocates may not match that chosen by the Stern review. But it would still justify hefty sacrifices on the part of the rich to shore up the consumption of the poor, even if they have not yet been born.

Why a Hydrogen Economy Doesn't Make Sense

Another study, reported in PhysOrg.com reaffirms my belief that the hydrogen economy is not energy efficient.

In a recent study, fuel cell expert Ulf Bossel explains that a hydrogen economy is a wasteful economy. The large amount of energy required to isolate hydrogen from natural compounds (water, natural gas, biomass), package the light gas by compression or liquefaction, transfer the energy carrier to the user, plus the energy lost when it is converted to useful electricity with fuel cells, leaves around 25% for practical use — an unacceptable value to run an economy in a sustainable future. Only niche applications like submarines and spacecraft might use hydrogen.

Even though many scientists, including Bossel, predict that the technology to establish a hydrogen economy is within reach, its implementation will never make economic sense, Bossel argues. ... more

Safer, Sustainable Energy Investigated

PhysOrg.com reports that In the future a new generation of nuclear reactors will create energy, while producing virtually no long-lasting nuclear waste, according to research conducted by Wilfred van Rooijen, who will receive his Delft University of Technology (Netherlands) PhD degree based on this research subject on Tuesday, 12 December.

Wilfred van Rooijen's research, conducted at the Reactor Institute Delft, focused on the nuclear fuel cycle and safety features of a Gas-cooled Fast Reactor (GFR), one of the so-called 'fourth generation' nuclear reactor designs. These designs have a sustainable character: they are economical in their use of nuclear fuel and are capable of rendering a great deal of their own nuclear waste harmless. The ability to actually build such reactors is however still in the very distant future. ... more

This is further confirmation that a GFR is one of the safest reactors on the drawing board while they reduce nuclear waste considerably.

How Long will the PV Silicon Shortage Last

Red Herring has an article telling of SolarWorld forming a joint venture to "turn dirty metallurgical-grade silicon into high-purity solar-grade silicon." They also report that: "According to SolarWorld, the joint venture will develop and build a manufacturing plant to produce, initially, 1,000 tons (per year?) of solar-grade silicon from metallurgical-grade silicon."

They also report on other recent entries into the solar silicon market and quote Jesse Pichel, a vice president and senior research analyst of technology at Piper Jaffray as saying“There’s no reason to go to metallurgical silicon,”

The article goes on to question this statement.

From all that I have read, the silicon shortage will not go away in a couple of years as some say, but will continue as long as sales of solar modules continue to grow at 25% to 35% a year. This rate of growth is necessary for an extended period if silicon PV solar is to continue to be the major source of PV modules and PV solar becomes the alternative energy source of choice. The only fly in the ointment is if CIGS and/or CIS technology develops as proponents say and it becomes the low cost source. I have no knowledge of the merits of metallugical silicon.

Solar Energy Tax Credit Extended One Year

From the Solar Energy Industries Association via Neal Dikeman in the Cleantech Blog:

"In its waning hours, the 109th Congress today passed legislation that would extend the 30% solar energy investment tax credit (ITC) for homeowners and businesses for one additional year, through the end of 2008."

Neal has some good, bad and ugly comments on this legislation.

Economist Featured Article of The Week

The petrodollar peg

Dec 7th 2006
From The Economist print edition

America should worry more about fixed exchange rates in the Gulf than the gently rising Chinese yuan

AMERICAN politicians and businessmen view China's undervalued exchange rate and its huge current-account surplus as the main cause of America's vast deficit. Thus next week a high-powered delegation led by Henry Paulson, America's treasury secretary, will fly to Beijing to persuade China to take measures to reduce its surplus. But are they heading to the right place? At the global level, the biggest counterpart to America's deficit is the combined surpluses of the oil-exporting emerging economies. They are expected to run a total current-account surplus of some $500 billion this year, dwarfing China's likely surplus of $200 billion (see chart).

Counting only the Middle East oil exporters, the surplus has surged from $30 billion in 2002 to an estimated $280 billion this year. One reason why this gets much less attention than the smaller $160 billion increase in China is that only a fraction of it has gone into official reserves, which are publicly reported. Most of it is stashed in government oil-stabilisation or investment funds, such as the Abu Dhabi Investment Authority, which are much more secretive than the People's Bank of China—but which probably hold just as many dollar assets.

One big difference is that China is now allowing the yuan to rise against the dollar. The exchange rate is up by an annual rate of almost 7% since September. In contrast, the six members of the Gulf Co-operation Council, or GCC (Saudi Arabia, United Arab Emirates, Kuwait, Bahrain, Oman and Qatar), which account for virtually all of the Middle East's surplus, still peg their currencies firmly to the dollar. This is partly in preparation for the GCC's plan to adopt a single currency by 2010. But the bizarre result is that over the past four years of soaring oil prices, their real trade-weighted exchange rates have fallen.

The Gulf economies are running an average current-account surplus of 30% of their GDP, well in excess of China's surplus of 8%. Oil exporters cannot spend their windfall overnight and it makes sense for them to run a surplus when oil prices rise, as a buffer for when oil prices fall. Even so, one can have too much of a good thing.

It might be best for the Gulf states as well as the world economy if they abandoned their dollar pegs and shifted to some sort of currency basket. A more flexible exchange-rate regime would allow them to regain control of their monetary policies and so cool down their overheating economies. By pegging their exchange rates to the dollar, they have had to adopt America's monetary policy, leaving real interest rates too low (often negative) for such fast-growing economies. Credit is growing too rapidly, inflation is rising and the prices of assets, especially property in places such as Dubai, have exploded.

Official price indices almost certainly understate inflation. According to government figures, prices are rising in the UAE at an annual rate of 7%, but independent estimates put it at 15%. The dollar's slide against other major currencies is pushing up the price of imported goods. Only 10% of the GCC's imports come from America (compared with one-third each from Europe and Asia), so from a trade-weighted point of view, the dollar peg makes no sense.

In theory, a higher oil price should imply a rise in oil exporters' real exchange rates; and it is better if this occurs through a rise in the nominal rate rather than higher inflation. The main argument against allowing the exchange rate to rise is that it would harm the competitiveness of the non-oil sector in economies that need to diversify. However, pegging to the dollar has not always been a boon to the economies as a whole. When the dollar strengthened in the late 1990s, non-oil industries were squeezed at the same time that the price of crude was sliding. This is another reason why pegging to a trade-weighted basket would make much more sense.

Oiling the world's wheels

Brad Setser, an economist at Roubini Global Economics, a research firm, argues that the dollar pegs of the Gulf states are also preventing some necessary rebalancing in the world economy. The recent depreciation of their trade-weighted currencies has raised the price of foreign goods and thus may be one reason why the increase in their imports has been unusually weak relative to the increase in exports. If, as seems likely, the dollar continues to fall, it will further drag down their currencies and thus keep external imbalances large.

A fully floating exchange rate would lead to too much volatility, but a bit more flexibility could usefully help oil exporters to adjust to fluctuations in oil prices. A trade-weighted basket, in which the euro had a large weight, would help to stabilise the real exchange rate of the GCC countries and so protect their competitiveness. It still would not ensure that oil exporters' currencies moved correctly in line with the oil price, however.

Some economists have therefore suggested that oil exporters should link their currencies in some way to the oil price. Currencies would rise when oil prices are high and fall when prices were weak. This would help to boost countries' external purchasing power and hence their imports when oil prices boom. It would also help to smooth the local currency value of oil revenues and hence government income, helping to avoid big deficits in bad times and huge surpluses in good times.

Oil exporters argue that they peg to the dollar because oil is priced in dollars and they want to avoid exchange-rate risk. But exchange-rate stability does not guarantee economic stability. On the contrary, a more flexible currency would allow economies to manage oil-price shocks better.

However, a rise in petro-currencies would not be a cure by itself for America's deficit (nor, for that matter, is a dearer Chinese yuan). The main solution to global rebalancing is for America to save more and for surplus countries, including both the oil exporters and China, to spend more. A rise in oil exporters' currencies could play a part in that.

Hydrogen Storage Using Polymeric Foam as a Hydrostatic Pressure Retainment Structure

Two publications suggest a means of containing hydrogen in a pressure vessel that is conformable, lighter and safer than a simple pressure vessel. The potential methods of storing in a vehicle are numerous and none have surfaced that are ideal. This is a rather novel one, but does not strike me as the ultimate answer. The real answer, in my opinion, if hydrogen is needed at all for cars, is to use it in fuel a cell as a replacement for the ICE in a plug-in vehicle.

Examination of Poylymeric Foam as an On-Board Vehicular HPR Hydrogen Storage Media

Hydrostatic pressure retainment (HPR) is an innovative theory for gaseous pressure vessels. An ideal HPR pressure vessel contains an array of spherical cells arranged in a homogeneous fashion that may be likened to a simple-cubic (SC), bodycentered cubic (BCC), or face-centered cubic packing structure (FCC)

The main advantages of HPR pressure vessels over traditional pressure vessels are threefold. First, because an HPR pressure vessel essentially is a matrix of multiple spherical pressure vessels, the outer shell need not be spherical or cylindrical. Rather, the outer shell may take on a conformable geometry, making it more convenient to have a larger tank volume within an automotive assembly. ....

Hydrogen Storage for Automotive Tanks Using Using Hydrostatic Pressure Retainment (HPR) Microstructure

Gas is stored in small bubbles of a foam matrix, thereby forming a series of small spherical pressure vessels. The resulting stress in the material between the bubbles is in a hydrostatic state of tri-axial tension. ....

Agencies line up for plug-in cars, (CNET News.com)

State and local governments are launching programs to see if it's possible to convert their hybrid cars and trucks into plug-in cars. ... The New York State Energy Research and Development Authority recently solicited contract bids for nine plug-ins, said Ray Hull, an official at the agency. If the trial succeeds, the state will try to convert the 535 hybrids it owns into plug-ins. ....

A good article summerizing the status of plug-in vehicles.

Teacher Saves Two-Thirds of his Electricity

The Christian Science Monitor had an article on saving energy at home, that reports on a high school science teacher, Ray Janke, who decided to see what he could do to save on his electric bill.

He exchanged incandescent bulbs for compact fluorescents, put switches and surge protectors on his electronic equipment to reduce the "phantom load" - the trickle consumption even when electronic equipment is off - and bought energy-efficient appliances.

Two things happened: He saw a two-thirds reduction in his electric bill, and he found himself under audit by Mass Electric. The company thought he'd tampered with his meter. "They couldn't believe I was using so little," he says.

Twenty-two percent of all energy in the United States is used for residential purposes. (Transportation accounts for 28 percent.)

Cutting back on electricity used for lighting (9 percent of residential usage nationwide) presents the quickest savings-to-effort ratio. The EPA estimates that changing only 25 percent of your home's bulbs can cut a lighting bill in half. Incandescent bulbs waste 90 percent of their energy as heat, and compact fluorescents, which can be up to five times more efficient, last years longer as well.

This is going to be my major campaign, to reduce use of electricity in the home and I will continue to refer to articles on this subject. If everyone were to be energy conscious at home we could slow down greatly the need for new power plants and in the extreme eliminate any new plants.

The US government has a home energy saver calculator at: hes.lbl.gov. The Energy Star program website is: www.energystar.gov . For tips on sealing your home, go to: www.energyconservatory.com .

Shell/Saint-Gobain to Produce CIS Solar Panels

Shell Erneuerbare Energien GmbH ('Shell') and Saint-Gobain Glass Deutschland GmbH, have announced a joint venture to begin solar power panel manufacturing based on advanced CIS (copper indium di-selenide) technology. The joint venture was recently approved by the European Commission.

The new entity AVANCIS KG will commence construction of the production facilities with operations likely to commence in 2008. The initial annual capacity of the plant will be 20 MW with options for rapid expansion. The joint venture will combine Shell's CIS technology expertise, supported by eight years of CIS marketing experience, with Saint-Gobain's global and in-depth know-how of glass processing and building material manufacturing. Graeme Sweeney, Shell's Executive Vice-President of Renewables, Hydrogen and CO2 said: "Based on our R&D experience in Munich, where the laboratory line delivered record 13.5% efficiency, we believe this facility can achieve industry-leading performance amongst thin-film technologies." This is another effort trying to capitalize on the shortage of silicon with a thin-film technology that may be superior in cost to silicon, but which would have had a much harder time cracking into the market were it not for the silicon shortage. CIS is another solar cell technology with advantages very similar to CIGS technology. Earlier this year Shell sold its silicon cell facilities to concentrate their efforts on CIS.

ExxonMobil Exec: US Gas Demand Will Be 90 Bcf/d by 2030

Dow Jones Commodities News via Comtex - Daily demand for natural gas in the U.S. will jump almost 40% by the year 2030, and half of that demand is expected to be met by imports of liquefied natural gas from abroad. Daily U.S. gas demand is expected to surge to 90 billion cubic feet per day, compared to the roughly 55 bcf/d of current demand, said Richard Guerrant, vice president, Americas, ExxonMobil Gas & Power Marketing, during a presentation at the 2006 Deloitte Oil & Gas Conference.

The U.S. will compete with industrial demand for gas supplies in emerging world markets, and residential demand in China, Guerrant said.

"Europe will need twice the supply of Asia and North America" in 2030, he said.

It isn't just oil, gas is likely to be as big a problem or more so than oil. All these gas peaking power plants are really eating up our gas supply. Geothermal heat pumps,with electricity generated from renewables, carbon free coal plants and nuclear, in that order of preference, are the answer to our electric power needs. Its too bad renewables can't grow fast enough too be the major source. Importing gas is a big enviornmental and logistics problem, and I think the industry is using scare tactics to get some LNG terminals approved.

EIA Annual Energy Outlook 2007 (early release) Published

The Energy Information Administration has just published the 'early release' version of the 2007 Annual Energy Outlook.

The Annual Energy Outlook presents a midterm forecast and analysis of US energy supply, demand, and prices through 2030. The projections are based on results from the Energy Information Administration's National Energy Modeling System. The AEO2007 Early Release includes the reference case. The full publication, to be released in early 2007, will include complete documentation and additional cases examining energy markets.

Overview

Energy Trends to 2030
World Oil Price Concept Used in AEO2007
Economic Growth
Energy Prices
Reorganization of Fuel Categories in AEO2007
Energy Consumption
Energy Intensity
Electricity Generation
Energy Production and Imports

This is one of the must have publications for those of us interested in energy and energy statistics.

Putting the malaise into Malaysia

Nov 30th 2006 | KUALA LUMPUR
From The Economist print edition

As the country approaches its 50th birthday, racial and religious tensions are jeopardising its economic and social success

UPROAR is still raging in Malaysia over inflammatory speeches at the annual congress of the ruling United Malays National Organisation (UMNO) in mid-November. One delegate talked of being ready to “bathe in blood” to defend the race and religion of the Malay Muslim majority against the ethnic Chinese and Indian minorities. The education minister, no less, brandished a keris (traditional dagger), only to be urged by another delegate to start using it. The affair has brought into focus Malaysians' worries that, as their country nears its 50th birthday next year, its remarkable economic and social success is at risk from the increasingly separate lives its three main races are living.

Last weekend these anxieties were voiced by the crown prince of Perak, one of the country's constituent states. He recalled that in his boyhood the races mixed far more freely; nowadays most children go to single-race schools. The prince regretted that some Malay-majority schools have made girls wear headscarves and even told pupils to avoid non-Malays' homes. Malaysians' spirit of give-and-take, he lamented, had been replaced by the idea that progress was a zero-sum game among the races.

Apart from some deadly riots in 1969, the country has so far done remarkably well in handling the awkward racial mix it inherited when the Malaysian peninsula gained independence from Britain in 1957 (Britain's colonies on Borneo joined the union later). The Chinese, now around a quarter of the population, arrived in colonial times to work the country's tin mines. The Indians, now around one-tenth, mainly came to work on plantations. Neither group intended to stay forever but many did. The Malays' fears of being marginalised in their own land grew as the Chinese came to dominate business and the Indians the professions.

At independence, a “social contract” was struck in which the Indians and Chinese got citizenship while the indigenous peoples received privileged access to state jobs and education. After the 1969 riots, a far-reaching positive-discrimination policy was introduced, with the aim of increasing the indigenous groups' share of business ownership from just 4% to 30%.

Supporters of this policy say it has kept the peace, enabling Malaysia to achieve impressive economic growth. Opponents say it has widened the divide between rich UMNO wheeler-dealers and their less fortunate Malay brethren. UMNO itself, having led the country's development for decades, has become perhaps its greatest handicap. The Malay chauvinism and economic nationalism in its ranks are hobbling progress towards reforming and privatising the big government-linked companies, thereby discouraging both domestic and foreign private investment. The fate of Proton, a carmaker (see article) is emblematic: the government has dithered for months over whether to risk UMNO's ire by selling it to a foreign buyer.

Once an emerging Asian champion, Malaysia is slipping down the league. Its stockmarket is falling behind its rivals (see chart). Last year, foreign direct investment was worth only $4 billion, down from $4.6 billion in 2004. Despite having a big base in Malaysia, Intel is putting its new chipmaking plant in Vietnam. A key test of whether the government can boost investment, says Vince Leusner of the American Malaysian Chamber of Commerce, will be agreement on a free-trade pact it is negotiating with America. Concessions will be needed on such tricky issues as letting foreign firms bid for government contracts. To win greater access to the American market—Malaysia's largest—the prime minister, Abdullah Badawi, must brave the wrath of his UMNO backbenchers.

Nor Mohamed Yakcop, the deputy finance minister, points out that the government has a good record on delivering economic reforms—such as last year's loosening of the ringgit's peg to the dollar—despite political noise. But with Vietnam, China and India competing harder for investment, Malaysia has to build on its strengths as a relatively advanced, liberal country and seek more high-technology and creative businesses. Such businesses need talented people—and the widening ethnic and religious gap is encouraging a brain drain, says Azmi Sharom, a law lecturer at the University of Malaya.

Although a national discussion is plainly needed on how to renew Malaysia's social contract and stop its races growing further apart, Mr Badawi has so far tried to close down this debate. He rejected proposals to create an “inter-faith council” and has told Article 11, a group named after the constitutional clause guaranteeing religious freedom, to stop organising public discussions. Malik Imtiaz Sarwar, a Muslim lawyer and leader of Article 11, says that UMNO leaders feel compelled to emit fiery religious rhetoric to outflank PAS, an Islamist opposition party.

Mohamed Jawhar Hassan, the head of ISIS, a think-tank, says that Malays' desire for more overt expression of their Islamic faith, and Chinese and Indian parents' desire to educate their children separately, are “social forces, much more powerful than any government”. Passing laws may not be enough to stem the drifting apart of the races. But there are few other ideas on how to preserve social harmony and prosperity, two huge achievements of which any country turning 50 could be proud.

PROTON - A fork in the road

Nov 30th 2006 | HONG KONG
From The Economist print edition

Malaysia's crisis-ridden national carmaker faces a stark choice

APHanging by a thread

WHAT will become of Proton, Malaysia's struggling carmaker? A political project set up in the 1980s, it never picked up speed, has been overtaken by foreign competitors and has become embroiled in a struggle over its future direction. With its cash reserves running low, it is now in danger of breaking down altogether. The government, which hopes to place the company with a “strategic partner” by next February, simply wants to extricate itself from the mess with the minimum of humiliation. Which route it will take is the subject of feverish speculation.

Proton was set up by the government in 1983 and started building cars two years later in association with Mitsubishi of Japan. It was a central part of the strategy laid out by Mahathir Mohamad, the prime minister at the time, to transform Malaysia into an industrialised nation by 2020. The idea was that a big carmaker would create jobs, provide access to technologies, bring in export earnings and spawn a host of supporting industries. But Proton never got big. Although it once had 65% of the local market, output never rose above 227,000 cars a year and exports never exceeded 20,000 units annually. In an industry dominated by a handful of global giants, each producing 3m-6m cars a year, Proton remains a minnow.

Yet it has refused to scale down its ambitions. Proton has built factories capable of churning out 1m cars a year and has launched a range of models. But quality is poor and low volumes mean it is not able to compete on cost. Even local consumers have become fed up with Proton's cars, with their sharply declining second-hand values. They have switched loyalties to what was once the second national carmaker, Perodua, which is now controlled and very competently run by Japan's Daihatsu, part of Toyota. Proton's market share in Malaysia has fallen steadily in the past few years and is now just 31%.

The crisis has intensified in recent weeks because Proton's cash is running out. In 2003 it had 3.8 billion ringgit ($1.1 billion) in the bank, but today it has only 500m ringgit, half what it had in March. Hence the government's recent announcement that it was in new talks with two big European car groups, Volkswagen and PSA Peugeot Citroën, with a view to selling part or all of its stake to one of them or forming some kind of strategic alliance.

The trouble is that Proton is not just an ailing carmaker. It is also a political hot potato, since it is caught up in the feud between Dr Mahathir and Abdullah Badawi, who succeeded him as prime minister in 2003. Mr Badawi sees the firm as a liability, but to Dr Mahathir any sale would be tantamount to dismantling his legacy. Khazanah, the national investment authority and Proton's main shareholder, is also reluctant to sell because of the write-down it would take. To complicate matters further Proton's management, in an effort to assert control, has signed vague letters of intent with carmakers including Peugeot and China's Chery. And three local car importers, DRB-Hicom, Naza Group and Mofaz, separately offered to buy Proton in order to keep it in Malaysian hands.

But even if a buyer can be found, a sale would cause other problems. Foreign buyers would be interested mainly in access to the market, not in Proton's factories, models or headstrong managers, who insist that a little more investment is all that is needed to turn the firm around. And although another carmaker could use Proton's manufacturing plants, it would make little financial sense, since most parts would have to be imported. Foreign component-makers, put off by Malaysia's rules that give advantages to ethnic Malays, have set up shop in Thailand instead.

Malaysia's government, the prime minister and his meddling predecessor do not have long to decide which way to turn. Should Proton give up and become a tiny part of a global carmaker, or should it struggle on in the hope that things will somehow improve? Selling out to a foreign firm would be humiliating. But Proton's struggles are already a national embarrassment as it is.