Why Hungary’s revisionist energy strategy will fail

The involvement of the state in the energy sector is based on generating the economic conditions necessary for broad economic growth thereby benefiting society. This includes regulating the activities of the monopolistic portions of the energy sector and providing effective policies and regulations that further ensure sustained technological evolution. The Government of Hungary is now in danger of impaling the Hungarian populace and its industry onto a costly misguided energy strategy that favors ill-conceived expansionist plans based on nationalistic interests rather than national interest.

[Image taken down by the author after a request was made to remove it, November 22, 2011. It displayed the logo of MVM on the background of an Arpad flag. The author has replaced the image with a previously displayed one depicting Hungarians selling bread in Tajikistan, because either way, it is the Hungarian rate/tax payer that has to pay for bad government energy policy.]

Hungarians in Tajikistan selling bread to pay for their MOL shares (click on picture to find out my past analysis wasn't too far off the mark)

To reach my point about the ill-conceived effort by the Hungarian state to not only take a large interests in the Hungarian oil and gas group, MOL, and now to buy gas assets of E.ON in Hungary – which includes the gas import and trading arms as well as the more lucrative gas trading division, I’ll have to cover some brief history of state involvement in the energy sector and the rhyme and reason for privatizing energy companies. After this, I’ll be able to properly explain the disadvantageous that Hungarian rate and tax payers will now endure for a very long time. The pain of state ownership will only grow over time.

Examples from elsewhere

First, all states support and seek to give their own industries, and even energy companies an extra advantage. As I have established in my research (described next), this happens in the EU and in the United States – and no doubt occurs in other regions of the world. My first example is from the US. The ‘deregulation’ of the electricity distribution companies, the companies that delivery the electricity to the consumer, can be seen to be partly a myth. The largest push for deregulation occured in the US Midwest, in the economically faltering rustbelt.

In my PhD thesis I examined the deregulation process and why it occurred in Michigan and Wisconsin. Without going into a long painful explanation it was down to making each state more competitive against other states. Michigan for example, didn’t even create a competitive marketplace, while Wisconsin which went the furthest to promote competition, politically stated they did not want deregulation.

Now, turning to Europe, the role of the state emerges as essential in both the efficiency of energy companies, and even the operation of the market itself. For privatizations this includes the how and the whom energy companies are sold to and under what conditions the new owners are allowed to participate in the market.

There are two key studies I’m drawing from here to make my point.  One examined the privatization processes in Bulgaria, Macedonia and Romania. The other examined the expansion of mainly German and French utility companies (including E.ON) into the CEE/SEE region. There are a number of lessons that these studies highlight, but there are three overarching key lessons most relevant here. They are:

  1. An effective expansion strategy does not only depend on the willing buyer, but the selling country – and their economic and energy strategy.
  2. State run energy companies are HIGHLY inefficient – at least in Eastern Europe (this also applies to Michigan and Wisconsin case studies of protected monopolistic private companies).
  3. The success or level of participation of privatized energy companies is significantly influenced by governmental decision making – regardless of the conditions offered before privatization.

Squeezing the gas from the foreigners

These three points bode ill for the Hungarian government’s domestic and regional expansion strategy. The purchase from Russian Surgetneftegaz and the (stealing from HU private pension fund money) MOL shares taken from private pension fund, now gives Hungary’s government – a 25% stake in MOL. The purchase of E.ON’s gas assets in Hungary, if it does come to fruition will mark another very expensive buy for Hungary’s nationalistic energy strategy.

"Any advice on dealing with foreign energy investors?"

The price is high. In two transactions, 3 billion Euros will have been spent by the Hungarian government to involve the state into gas assets that do little to reduce the country’s dependency on foreign (Russian) gas supplies, or offer much overall security of supply improvement. The E.ON transaction still must be realized, but it is fair to say that this will occur and that the government owned ‘electricity’ company, MVM, will take ownership.  This means another 1 billion Euro, on top of the 2 billion purchase price of MOL, will be spent consolidating the Hungarian government’s ownership in the country’s gas sector – for which they still haven’t made a strong argument explaining how all this money actually improves security of supply. Does Hungary really have to worry about the German’s threatening to cut off gas supplies or unilaterally raising gas prices (which they could not do anyway)? With further analysis, this nationalistic plan becomes even more absurd.

All this buying activity led the Fidesz parliamentary leader to state,

“We want to establish a competitive state player in the energy sector,” Janos Lazar, head of the parliamentary group of the Fidesz party, said in an interview. “I see great potential in MVM, in building it up, on the national and regional level. There’s a lot of money to be made here, a lot of money,” said in a Bloomberg interview.

First, let’s have a good laugh. “a competitive state player.” While this is an oxymoron, the state can’t be a ‘competitive’ player in a game when it is also the referee. Do we really expect that the market that was once dominated by E.ON, (to the point that the EU Commission forced them to have yearly gas auctions), will be just as competitive with new government ownership?  With government ownership in the only other viable competitor – MOL, there will be no competition. The crushing dominance of the MVM and the Hungarian state, will mean only small and limited competition that exists now will continue. Squashing it out would look too bad and bring unnecessary investigations from Brussels, better to have a few ants dancing about.

The losses that the Orban Government has forced onto gas companies, by stipulating the consumer rate, which is lower than the import/market price, is a key reason that E.ON is willing to sell. The screws will only be tightened if they do not sell. In my Energy Policy article, it is clear E.ON was here for the long term. What is ironic is while MOL is justifying its participation in the privatization in Croatia’s oil and gas group, as an effective and stable investor, at home the Hungarian government is running out foreign energy investors.

Now with the Hungarian government in control of gas imports and the wholesale price, it can continue to squeeze other foreign gas firms, like GDF Suez. By forcing losses on these companies, they will – just like E.ON – pressure these companies to sell their business for a cut rate. For the parent company that must make up the losses, Orban’s offer will begin to sound better as the losses and pressure mounts up. Selling to the Hungarian government becomes the only way out – no other foreign investor will want to buy their assets.

It is important to note, that foreign energy companies will feel the bite, not only in their gas distribution businesses (which the government is concentrating on now), but in their electricity generation businesses too, that rely heavily on imported gas to power the turbines. It is important to keep in mind what I wrote in December 2010:

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.

Well, I may have felt crazy writing that, but I was right. The Hungarian government has no respect for foreign investors and will do whatever it can to drive them from the country. A strong statement, but one that is backed up by the facts. But here is where the Hungarian Government strategy will fail.

Regional expansion

To break out of the Hungarian market, and begin to make the ‘huge amounts of money’ that it foresees, it will need to finance this expansion. The ability to finance this through bank loans or bonds is limited due to the current financial difficulties in the country – and around the world. Therefore, it will rely on the trusted method of having the home market – i.e. Hungarian ratepayers finance this expansion strategy. Past expansion strategies are based on the ratepayers in secure markets paying for the risky expansions of energy companies. This happened in the US in the 1990s when those companies went to South America, and in Western Europe, when French, German and Austrian companies expanded into Eastern Europe. Only after the expansion into Eastern Europe and these companies had built up a considerable base, did the home markets begin to open up as well. Also, as a result of pressure from the EU Commission.

Foreign ownership in privatized electricity distribution companies

If Hungary will be out seeking to buy up assets or finance expansions in other countries through MVM or MOL, which may be loss making for a long-time, they will need high capital to finance. The continue tussles in Macedonia, Bulgaria and Romania between the private owners of distribution and power plants with the regulatory commissions and governments demonstrates the protracted fights and losses that can occur. Deep pockets are needed to weather these storms.

The inefficiency of state owned energy companies in Eastern Europe is legendary. And not just for the number of employees that state owned companies employ, compared to their private counterparts (direct comparisons can be made in the Romanian market where private distribution companies operate along with state owned private distribution companies). The losses that the state is willing to incur, through private deals to certain companies, or sectors, or portions of society are also high. The biggest hurdle to moving to a privatized market in Bulgaria, Romania and Macedonia was raising the below market rates for industry and households.

The rates for consumers did not just have to be raised, but had to be maintained at a ‘market’ rate. This is where the investors begin to lose because the rates after privatizations are then forced below the market rate – as just has happened in Hungary. It is important to note, that it is not just the rate that is important but collecting past dues (money owed) from companies, particularly state owned industries. They may be charging a market rate, but if the consumer is not paying or paying fully, then the state, may over the long term, subsidize the consumer.

Would Marx support the nationalization of energy companies for nationalistic ends?

 

And finally, points 1 and 3 are combined here. Just as the Hungarian government has been vicious to foreign energy companies in Hungary, so can other governments make life hell for MVM-MOL. Breaking into a foreign market – whether it is your neighbor or not – is highly dependent on how much the government is willing to accept the presence of particularly energy companies. The continued dominance of Bulgarian state owned energy companies and the fight the Macedonia government continues to engage with EVN (distribution company), demonstrates how the energy market can have favorites and threaten investments of those that the government does not approve of. The nationalistic expansion strategy of Hungary, I believe, will not be received well in other countries.

While Orban and his ministers, may think they are creating the next CEZ (the Czech power company with broad regional holdings), they are wrong. The expansion of CEZ was done with acute market and business insight (along with support by the Czech ratepayers/taxpayers). The problems the Hungarians have is their energy policy is wrapped up in rabid revisionists doctrine that seeks to control and extend the Hungarian state’s influence throughout the region. I don’t think if MVM-MOL invest in Georgia there will be much regard given by the Georgian government. However, if MVM-MOL move into Slovakia, Romania or other countries  (who are now becoming weary of the revisionist discourse emanating from Hungary), they will be sure to maintain tight control over market conditions to ensure domestic firms or less politicized energy companies are favored over a nationalistic Hungarian gas-electricity group.

Conclusion

Forcing out foreign energy companies from Hungary to build a ‘competitive state player’ will only increase electricity and gas rates for Hungarian consumers. The resurrection of state owned energy companies will only bring along with it inefficiencies and favoritism to specific companies. Corruption may even increase, placing legitimate business at an economic disadvantage.

The expansion of a MVM-MOL group/partnership with nationalistic and power overtures will only continue the logic of governments to maintain tight lopsided controls in their energy sectors. Competition will be limited and new entrants -whether Hungarian or not – will continue to face difficulties competing against already favored firms for access to gas or electricity contracts. Cross-border energy trading in the region will continue to be muted. But just as the Hungarian government is abusing foreign investors in Hungary, so too can other governments abuse a Hungarian supported energy firm – with even more justification.