Bankruptcy of Emfesz will ‘Justify’ Hungarian State Intervention

If there is ever an excuse that could be used for greater government intervention it is the bankruptcy of a company. I don’t think I need to go into great detail, but only to refer to the current players in the economic crisis. The pending bankruptcy of Emfesz gives the Hungarian government the excuse for further involvement in the energy sector.

"Any advice on dealing with foreign energy investors"

The insolvency of Emfesz, as reported, was widely assumed to be coming, since the inability of Emfesz’s previous owner Dmytro Firtash to access his cheap gas stored in the Ukraine in January 2009. Before then, he was undercutting retail market prices by around 10%. However, in April 2009, he then lost his company to RosGas through a Swiss engineered corporate takeover for $1.00.  It is speculated that Gazprom was behind this takeover. This last statement maybe should be rephrased to consider that maybe it was just a faction in Gazprom/Russian oligarchy circles that pulled it off. Because it is clear now, the move was unsustainable (I think parallels could be drawn with the Russian takeover/near bankruptcy of MALEV).

After the Rosgas takeover, it was unclear where Emfesz would buy gas. But then, as media reports show, a new deal was struck between Emfesz and E.On in which the gas would be purchased from E.ON’s Hungarian gas storage company, E.ON Földgáz Trade Zrt. However, the delivery of gas from the upstream supplier Gazprom would be carried out by the previously established Panrusgaz. This company is a joint venture of Gazprom Export (including its subsidiary Centrex Hungaria Zrt.) and E.ON Ruhrgas. Therefore, it seemed that everyone could be a winner. However, it then became clear that the price Emfesz was paying for the gas was essentially the same price as other market participants – even E.ON itself. But Emfesz was still offering lower prices. Not even Russian or Hungarian accounting tricks could make this company viable with this strategy.

So we end up with Emfesz owing several billions of Forints. There are two things to consider, first, the Hungarian authorities were probably letting this drag out to see how negotiations with the Russians went this past November. Since nothing happened (as I predicted in October 2010),  the Hungarians are now taking the logical step that a government and regulator must take. Revoke the license.  This of course, can also be used to send a signal to the Russians, as the Hungarians are probably mad that nothing did come out of the November meeting between the Prime Ministers Putin and Orban. In a way it is a pithy response, if it is one at all, just as shooting a lame horse is sometimes the only response.

The closing down of Emfesz and using it to send a message to the Russians is probably not the best way to capitalize on the bankruptcy of an already weak company. Rather, the Hungarian government (and here is another prediction) will be using this event to highlight the dangers of allowing private companies to operate in the energy sector. Of course there are some inconsistencies in this, since they have imposed the tax on energy company revenues and labeled it a ‘temporary crisis tax-which-soon-will-be-a-permanent-tax,’ due to the profitability of energy companies. But this is unimportant.

Energy companies in Hungary are already on ‘no investment mode’ after the imposition of  the ‘crisis tax’ and because of the inability to raise rates to match commodity and wholesale energy price increases. Therefore, the government is undermining necessary infrastructure investments and the basic financial health of energy companies. Why should a German firm (or any company) incur losses because they cannot even pass along wholesale market price increases? Particularly, when the increase is partially the result of a weaker Forint and the rise of government risk ratings.

The government will spin the bankruptcy of Emfesz as an indication that private investors threaten the countries security of supply, and if they are not being paid high profits for their services then they are not interested. When the current private energy companies try to leave Hungary citing ill financial health, the government will engineer their exit on favorable terms for the state (there are some international treaties that protect private investment and these have to be softly walked over).

With some (not all will be able to leave) significant government ownership, the Orban government will realize its objective of imposing state ownership over the countries energy assets – and somehow keep prices low. (I actually feel crazy writing this as a government objective – but it is logically based on actions and statements of this government). As owners, the government can figure out how to pay for gas at higher market rates and the lower rates that homeowners and (SME) businesses pay. But by then, the pension money will be spent and Hungary’s credit rating will be in the garbage.

With the removal of foreign owners, control over the media cemented, Hungary will (somehow) be a strong country. However, just as the Russians in Emfesz couldn’t figure out how to break a fundamental economic rule of profits and losses,  the Hungarian government won’t be able to break this rule either. It is just too bad that the Hungarian people will have to deal with the aftermath.

Happy Holidays!

In the spirit of the internet and of Christmas I’m embedding the following video to link the two.

My apologies for not finding one energy related. Buy may the gas continue to flow for all over the yee olde holiday.

Have a great New Year,

Michael LaBelle

Would Surgut investment in MOL save CEE oil flow?

The question should be asked whether an emerging decline in oil being shipped to  Central Europe could be stopped if Russian investment took place in the region’s refinery sector. And more pointedly, whether Surgutneftegaz’s investment in MOL could save the CEE region from declines in Russian oil shipments. According to this well written analysis from EurActiv.com,

Russia’s growing oil exports to Asia and the Baltic have unsettled European traders and refiners, who fear shortages on the Black Sea and in Central Europe should Russian output stall or decline.


The point that makes this report credible is that the decline is not from a coordinated policy, but one that is emerging gradually over time, due to new supply routes and customer base. While, shifting the supply of Russian energy sources have been threatened in the past, it appears that a coordinated strategy has yet to be implemented. This decline appears to be emerging from the gradual growth, from more localized and less coordinated infrastructure building.

The northern European markets and the Asian markets, with new pipelines and oil terminals coming on line, may reduce the flow of oil through the Druzhba oil pipeline, the article states.While the analysis on EurActiv concentrates on the impact on Poland and Germany and forcing traders in these countries to buy through Baltic ports, there may be a more severe impact on more landlocked countries of Central Europe that are more highly dependent on Druzhba for oil.

The other oil import options open to Slovakia and Hungary are primarily through the existing pipeline connected to  Krk in Croatia. However, a trial of this a few years ago, showed that the oil was more expensive to import than through the Druzhba pipeline which Hungary is (basically) totally dependent on. This make sense even when you consider the lower cost involved in pipelines.

But then we have the obligatory quote concerning the death of Druzhba.

“With the Chinese pipeline due to start any day and the launch of Ust Luga, I’m wondering if we will witness the death of Druzhba. Merkel should call her ‘friend’ Putin to figure out what’s going on,” one trader with a Russian major said.

The slow decline, or rather, slow drying up of Druzhba may occur because of a lack of interest of Russia into the region. While it is unfathomable to think that Russia would let the grapes wither on the vine in Central Europe, forcing them to seek energy resources away from Mother Russia; this may happen through unprepared policies or a lack of foresight into the oil sources necessary for the delivery to Central Europe. Overtime a slow shift may occur.

The fact that Russia/Surgutneftegaz is interested in operating through/with MOL by owning 20% of the company may have secured the region against this slow decline. The involvement in the refinery of the oil produced from Russia adds the value-added and profit level that would maintain Russia’s interest in the region. This does not mean that Russia will pull back ‘purposely’ from the region, but rather if the oil does fetch higher prices through other routes, then a reduction of flow to the region cannot be ruled out.

Hungary and MOL have blocked the investment avenue that Moscow and Surgutneftegas were seeking in the region. There is no doubt that the Russians maintain a strong interest in the CEE/SEE region and for operating more in the refinery sector (and gas is of course always an interest). But reduced oil flows to Hungary and Slovakia will not necessarily increase the countries’ security of supply by forcing them to diversify to a more expensive source. The fact that the pipeline already exists to Croatia adds the necessary security of supply element, expensive oil does not have to be shipped through it to actually improve supply diversity. The higher price to be paid for shipments through Croatia, and the fact that in this one area, Russia has been a reliable supplier, may just mean consumers will have to get used to higher oil prices.

In providing analysis on the CEE/SEE region, I usually try to take a conservative approach. One of my underlining understandings of how energy markets work, and even life, is that sustained change, is usually not brought about by one purposeful action, but smaller actions that culminate into something big. In the case of oil shipments from Russia, through Druzhba, we may, have an uncoordinated and gradual decline. While this allows the region time to prepare, (if anyone notices) it also means this will come at a much higher cost. For Hungarians, the price for blocking Surgutneftegaz may be higher than whatever they now find under the carpet to give to the Russians.

Hungary goes to Russia with a bottle of vodka

A few people asked me what I thought of Hungary’s Prime Minister Orban’s visit to Russia. To be honest, I was working away under a tight deadline and didn’t have time to follow it. But now as I’ve been trying to catch up on it, probably the best view of the meeting came from one of Hungary’s opposition politicians.

Prime Minister Viktor Orbán‘s recent visit to Russia was a flop, Socialist Party deputy chairman László Kovács told reporters on Thursday. Kovács said the visit did not result in any agreement and it shows defects in preparations.

Apparently, what the Hungarians showed up with to exchange for Surgutneftegaz’s 21% stake in MOL was a bottle of vodka. Which, if you are Russian, you might have some already handy. Actually what they were offering was,

the option to build a $4 billion commerce hub in Hungary in exchange for Surgutneftegaz’s stake and also offer Russian companies the chance to take part in the expansion of the Paks nuclear plant and may sell stakes in natural gas storage facilities to Russia. (BBJ)

Now the Russians are probably already in the forefront to build the Paks expansion, and with the current unpredictability of Hungarian energy and tax policy (demonstrated through further ratings downgrades), there are probably even fewer companies interested now. And in regards to the ‘commerce hub’ which is actually a rail hub it would equally benefit Hungary. So besides the gas storage facility, which is filled with Russian gas, the Russians wouldn’t gain much by participating in this swap.

I think in this situation they would have been better off offering nothing and seeking instead of finding some common ground to build on – which is how they tried to spin it after no agreement was reached. As I have already described how the Surgutneftegaz holding in MOL is going nowhere fast. The Russians are not in a strong position either – unless they Hungarians put them there, which they are. Apparently, it was remarked according to Magyar Hirlap, that

in Orbán, Russia felt “we have someone with whom we can negotiate”, citing an unnamed diplomatic source.

It is always good to negotiate with someone that offers you a stronger negotiating position than you have. With Orban’s negative attitude towards Western institutions, he just may view Russia in a too favorable light and a viable partner for Hungary. Particularly when the criticism from western partners mount against Hungarian economic and social policy. If the description put forth by the head of the Hungarian Monetary council is correct, that only Venezuela has gotten rid of institutions (specifically the monetary council) then Hungary in the future may draw on this budding friendship for further stability.