Tag Archives: CEE

Inter-European Gas Wars: Europe’s pursuit of Energy-cide

Also published on Natural Gas Europe.

There is a gas race in Europe. This rivals the well reported US – Europe gas price difference, due to cheap US shale gas and high European imported gas prices. In an attempt to compete against the US European industry just got handed a price break in the form of lower support payments for the renewable energy sector. However, European countries also compete against each other over the price of electricity, a race to the bottom, or rather Energy-cide: the destruction of sovereignty in the pursuit of lower energy prices.

This price war also forces countries to develop strategies to keep electricity prices low. An example is Hungary’s deal with the Russians for a ‘low’ cost nuclear power plant. This inter-European energy price war holds significant long-term political and economic costs, which can hobble Europe’s competitiveness and political independence.

nuclear

The result of this inter-European price war is Russia captures the Crimean prize by understanding how the game is played. The limp EU financial sanctions to hold Russia in-check are framed as the EU punishing Russia. But this is Europe, the ‘unified’ EU action mask the inter-country price wars raging between member states. In each region this plays out differently, for those in the west of Europe (old member states) it is the result of the high initial cost of shifting towards renewable energy and the impact on industry; for those in the east (new member states), it is reliance on Russian gas and householders proportionally high utility bills.

The impact of this price war can be seen playing out in Berlin and Brussels in April, 2014. First the German government approved amendments to its renewable energy law, lowering the cost of German industry financing for renewable energy. Second, the European Commission voted to reduce payments energy intensive industry make to fund the renewable energy shift. The pressure is now intense in Western Europe to reign in energy prices and the real and potential threat of industry flight to the United States. The US, and its cheap shale gas, is held up as a magnet sucking European jobs. Europe feels the coming climate change apocalypse, just as much as a faltering economy, Russian tanks in the Crimea are simply less threatening. But this is a Brussels’ view of the world, in the east the people and politicians feel the heat from Russia.

The Hungarian government continuously lobbies against sanctions on Russia for the violation of Ukrainian sovereignty. With Hungary dependent on Russia for gas and nuclear power, its current charade of low energy prices can only be maintained by the wishes of Russia. The Hungarian government secretly inked an agreement with Russia to take a 10 billion euro loan to build two new reactors. Despite no social or political debate, the overriding excuse for such a deal by Hungary’s Prime Minister was lower energy prices – even if the numbers show a doubling of electricity prices. He envisions to have Europe’s most competitive electricity cost for industry and be more competitive than the Czech Republic or Germany. Hungary will be a manufacturing powerhouse fuelled by cheap Russian nuclear power. In return, the Russian’s hold over Hungary a huge mountain of debt which they’ll use to manipulate Hungary’s foreign and domestic policies.

Other countries in Eastern Europe are the same, Bulgaria has been plagued with violent riots over electricity and gas bills. The country’s seven member energy and water regulatory commission had 17 different members and six different chairman in 2013. Poland has lost an environmental minister due to bungling the country’s shale gas ‘revolution’ – it still awaits a commercially viable well. Each country in Eastern Europe has the stated aim of having the cheapest gas and electricity and literally being a regional powerhouse. Each country wants to compete and attract industry from Western Europe. Poland wants chemical manufactures from Germany. Hungary wants auto manufacturers to set up shop. It is a continental race to the bottom.

Russia benefits in spades from intra-European conflict over energy prices while the continent as a whole attempts, by any means, to close the price gap with the US. In 2012, the German border price for gas was four times higher than the US Henry Hub price (even if this is a flawed comparison, it is often made as an excuse for needing lower EU energy prices). To close the price gap, somehow the solution is more Russian gas. Russia’s South Stream pipeline project will avoid Ukraine and deliver the same gas to Europe, without Ukrainian interference. The pipe will traverses the Black Sea, landing in Bulgaria and connecting Serbia, Hungary and Austria. When the going got tough over a year ago for South Stream’s competitor, Nabucco, which would bring non-Russian gas to these same countries, both the United States and the EU failed to step up to ensure its success. The project offered to diversify Eastern Europe’s gas supply. Instead the EU accepted another gas pipeline to Italy – a long running ally of Russia and thus acceptable to both those in Brussels and in Moscow.

nabucco and gazprom v4

The evolving gas map keeps the east boxed in: South Stream and Nord Stream. There is almost zero western support for diversification, the result is high prices and Russian dependency with low security of supply.  But is this paranoia? Not when the German partner of South Stream remarks over EU blocked talks with Russia, “If anything, the approval procedures should be accelerated, not delayed,” said Rainer Seele the Chief Executive of Wintershall.

Should the only means of leverage Ukraine holds over Russia be sped up? Just so Ukraine can be eaten faster by Russia? Hungary’s Orban signs secret deals with Russians because he knows he needs to compete against the west on price, Berlin or Paris aren’t going to send cheaper electricity or gas to the east.

The true price masters are the Russians. They see this intra-EU country price competition. They see political leaders hanging by economic-popularity threads, industry bent over a Russian pipeline – sucking gas, Bulgarians protesting over prices and burning utilities’ cars, while Viktor Orban proclaims an energy price war against Brussels while furtively flying off to Moscow. Even the ‘green’ German consumer demands cheaper electricity. Industry perception of the energy system as a whole matters, even if Russian gas is marginal in Western Europe. The closure of German nuclear was perceived as a blow against German industry, another blow is unwelcomed.

The Russians hear from European industrial and political leaders, “take the Crimea, but just help us compete against our European neighbors and America.” Energy-cide, the destruction of sovereignty in the pursuit of lower energy prices. Russia is the cat and Europe is the mouse. Russia eats part of Ukraine, while Russia also politically binds the Bulgarians, Hungarians and Germans over gas prices. Unless Europe stops its Walmart-like energy price race to the bottom, and shores up energy diversification routes for Eastern Europe, Russia will continue to be the top consumer.

The Russian Rock: Re-landscaping CEE energy (in)Dependence

The recent ‘war of independence’ against Western European owned utilities in Central Eastern Europe (CEE) and South East Europe (SEE) sets the stage for re-integration into Russia’s energy sphere – and dependence. A war against electricity, gas and water prices has been raging in Hungary since 2012 while SEE countries have a longer history. The firm rejection throughout the region of privately owned utilities managed by independent regulatory institutions limits capital inflow to upgrade and diversify the region’s energy infrastructure.

Omul de tinichea transfagarashan

Benefiting from the ‘war’ against Western capital is Russia. State owned Gazprom remains the dominant and stable supplier of gas to the region’s state owned firms and centralized energy systems. The CEE (including Poland) and SEE regions reject complex market structures with competition and diversified generation technologies pushed by the EU. Full independence from Russia is no longer sought, rather a ‘safety’ margin to weather a Russian gas storm provides a low cost diversification option. Three historical periods are discussed, with the third marking the re-integration into the Russian fold.

  • Stage one, fully dependent on Russian resources and technology;
  • Stage two, building an energy system semi-independent of Russia;
  • Stage three, ‘(in)Dependence’ on Russia’s energy wealth, the recognition of benefits gained from dependence coinciding with diversification of energy sources.

The CEE and the SEE regions see energy dependence as strategic while allowing for new infrastructure, such as gas interconnectors, shale gas and LNG terminals to rebalance the energy landscape and provide space for energy independence, rebalancing the historical Russian dependence. The term, ‘(in)Dependence’ provides a encapsulating expression of how Russia remains firmly positioned in the CEE/SEE regions’ energy landscape. It is the rock in the region that despite the best efforts of multiple countries, governments and international organizations, Russia remains firmly positioned in the CEE/SEE energy landscape.

Dependence

The Central Eastern European Region, including the Southeast of Europe, is heavily dependent on Russia’s energy resources. This includes gas, oil and nuclear technology. The ability to cement through physical infrastructure and human capital during Communist period established a robust connected system of resources and expertise between the region’s countries and Russia. The headlines hold that gas security is the most contentious issue. But finding a solution to this dependency requires a complex and stable energy investment climate. Since the fall of the Berlin Wall and 2004 and 2007 eastward expansion of the EU, diversification away from Russia for CEE countries was the overall most important headline issue. Despite concerted efforts the region has failed to find alternative sources for Russian gas and remained wedded to Russia. The era of Russian energy dependence can be seen to have evolved over decades under the technical capabilities of the Soviet Union.

We see the impact that this uncoordinated, but regional consistent energy strategy has on the CEE region: Complete reliance on Russian gas and oil imports. After the political winds shifted in 1998 and the region shifted towards Western Europe for political and economic integration these energy links were viewed as high risk entrapping the region into an almost single sided relationship where the terms are dictated from Moscow. The region may have gotten democracy and removed overt economic and political control but the energy infrastructure is a strong reminder that continues the previous political-economic relationship.

Independence

The launching of the energy independence period, away from Russia, began in the mid-1990s.  Privatization of energy assets and the establishment of energy regulators brought private capital into the energy system, transforming the role of the state. Market considerations would help guide and fund development of the national energy system. Technocratic independent regulatory institutions would oversee the region’s energy system.

Privatizations of energy companies, mainly electricity and distributions companies were never very popular, but the politicians making these decisions were aware the state was incapable of funding a renewed energy system able to operate efficiently. Bloated inefficient companies, were typical and unable – or unwilling due to political pressure, to collect from large and small consumers. In Macedonia at the time of privatization there were 500,000 individual court cases filed over fee collection. Large state owned factories paid little or nothing. Other countries mirrored this systemic inefficiency resulting in underfunded and crumbling energy systems. The entire CEE and SEE region made the hard decision to bring in mainly Western European energy companies to fund the renewal of power generation and electricity and gas distribution systems. These important energy assets were privatized, in some countries more than others, but each country, usually with strong encouragement from international organizations, did privatize. Enough to place the energy sector on a market footing.

By the mid-2000s sufficiently robust national and regional markets in electricity and gas were well under development in the CEE and SEE region. Strong market and regulatory elements were integrated into the system. Authority of the energy system typically, on a technical level, transferred from an energy minister to an ‘independent’ energy regulator, who set prices and technical standards. This technocratic system was established to ensure the long-term commitment and investments by private energy companies were secured and the system as a whole was managed to ensure its continual long-term development.

Since the onset of the 2008 financial crisis already strained relations between private energy companies and governments escalated. The underlining truth to the ‘Utility Rebellion’ of the CEE and SEE region is politicians had a hard time letting go.  From price setting, control or influence over cross-border electricity and gas interconnectors politicians have a hard time coming to terms with allowing the energy sector to operate like an open, but regulated, market. Repeated attempts to establish a transparent and unified electricity system in the Southeast of Europe has failed, despite consistent support (and pressure) from international organizations and institutions. In 2013, the tension has spilled over into outright social and political rebellion against private owners. This includes (but not limited to) some headline cases:

  • Albania: In January 2013 the energy regulator took away the license of Czech power company preventing it from operating in the country.
  • Macedonia: Disputes between Austria’s EVN and the Macedonia government over debts and investments are on-going since privatization in 2006.
  • Bulgaria: After years of building tensions, including court cases, between private investors (CEZ, EON, EVN), the spring of 2013 saw public street protests erupt over electricity and gas prices resulting in new elections, along with investigations and regulatory changes in Bulgaria’s energy sector. Although the fury is equally directed at state owned companies as well as privately owned ones.
  • Hungary: What was once a success story of privatization and equal risk levels to Western Europe, changed after the 2010 elections with the new Fidesz government.  Extra taxes on energy companies were introduced after which the energy regulator was sidelined and forced legislated price cuts above 20% in 2013, compounded by a proposed law to be passed before the 2014 elections of utilities becoming non-profit entities. Many privately owned utilities are making losses since 2011 and have slashed investments.

 

Markets and independence

The focus on market transformation contributed to two false assumptions: First, from a Western European perspective, overall EU gas supplies were not significantly exposed to Russian gas interruptions – if they were to occur at all. Russia was a stable supplier not willing to use gas as a political weapon and the governments of the CEE and SEE regions could diversify themselves; second, over time alternative sources could be secured from Europe’s ‘near abroad’. During this age of attempted energy independence, the pro-market perspective and activity created an assumption that the market would induce greater supply security, investments by Western European firms would contribute to greater energy security. However, these assumptions came to a head at the start of 2009.

Supply disruptions, between Russia and the Ukraine, were already regular seasonal events, but in 2009 the crisis cascaded into disruption to EU Member States. This disruption showed, what was already known in the region, diversification away from Russia was important for the energy security and security of supply for the region. It was not the overall EU level of dependence that matter, but the regional dependence. EU institutions woke up, but not until after they coordinated a technical response of sending gas to dried up systems in Bulgaria, Hungary and Serbia. Afterwards, the EU threw greater effort and coordination into helping the region diversify and open up alternative routes of supply for the region. These include interconnectors, expanding gas storage, ensuring reverse flow in pipelines and instituting new procedures and guidelines to ensure a timely coordinated action in case of emergencies. However, much of this diversification is funded by national governments. Key diversification projects include:

  • Polish LNG
  • Poland’s push into shale gas
  • Hungary’s oil and gas group MOL upgraded an oil pipeline to the Adriatic, tying the region into global oil supplies.
  • Bulgaria signed an agreement to import gas from Azerbaijan starting in 2019, completely avoiding Russia by transporting the gas through Turkey and Greece.
  • Bulgaria will build interconnectors with Turkey and Greece.
  • Upgrading gas interconnectors between Hungary and neighboring countries, particularly a new Hungary-Slovak interconnector that begins to establish a north-south gas corridor to Poland.
  • Gas storage investments in Hungary and Austria
  • Western interconnectors to Austria and Germany with reverse flow capability are being built or upgraded.

Missing from these ongoing or completed projects, is the most symbolic project of all, Nabucco. The failed bid to transport Azeri gas to the SEE and CEE regions may turn out to be more politically significant than functionally significant. Existing Soviet era transport pipelines to Russia remain the only large supply route of gas into the region. Regardless of boosted interconnectors, regional LNG access or gas storage, Russia will remain the dominate gas supplier to the entire region, all the additional projects provide a boosted level of energy security and improve security of supply in times of emergency. Nonetheless, if the goal is to ensure operations through a cold winter when the gas is cut off from Russia then the region can weather a Russian storm.

The failure of Nabucco to launch prevents the region from adding the significant alternative capacity, which combined with on-going diversification projects, could reduce further Russian reliance. Nabucco, backed by a consortium of CEE, SEE and Western European companies represented the most symbolic effort for energy independence. It was the battle between competing gas pipelines through Europe’s southern gas corridor: Russia supported South Stream vs. Nabucco. The EU backed Nabucco, had the political-economic edge to deliver more gas while increasing energy security. In the end, the pure commercial decision was taken by the upstream consortium to deliver gas into the Italian market through a competitor private pipeline to Nabucco. The downstream activities in the CEE and SEE region prove themselves just as important as the upstream transit routing decisions, which together influence large scale investments into the region.

Building the Nabucco pipeline through the CEE/SEE region would require decades of commitments from all upstream extraction parties tying them into downstream distribution partners. As outlined above, past relations between the region’s governments and foreign energy investors is turbulent. If Nabucco went ahead the upstream suppliers, extracting in Azerbaijan, would be tied to the political whims in the CEE and SEE region. If the original point is to play Nabucco against the Russians, then the tables could be turned to threaten the extra capacity from the older Russian pipelines to drive prices lower once Nabucco pipes are in the ground. Fixed assets and fixed prices are only as fixed as the political winds.

Current actions of governments throughout the CEE and SEE region demonstrate independent energy regulators are used for window dressing to meet EU requirements. Energy regulators were meant to ensure the long-term investments by energy companies were protected. This has turned out to be false. Under current conditions, the forced price reductions, revoking – or the threat of revoking – licenses and continued disputes over the prices of electricity and gas creates a significant challenge to maintain necessary investment levels, upgrade or prevent a company from financial losses. It is hard to imagine the political rhetoric and actions stopping for upstream suppliers physically locked into the region and with alternative sources of gas for governments to buy.

The original energy newcomers to the region, described above, are now withdrawing – or literally being squeezed out, like in Hungary. In short, the energy investment environment has turned negative, price pressures dominate, and political along with social demands result in an unpredictable market. Despite gas being a global commodity, politically mandated cuts in electricity and gas prices force losses onto distribution companies. Building a multi-billion Euro pipeline through the region begins to weaken under the current domestic and regional conditions energy providers are met with.

The loss of Nabucco should send a clear message, and the politicians of the CEE/SEE should hear it: Market fundamentals, are the basis for investments, not political considerations. Politicians can fight downstream electricity and gas companies for lower prices, argue with Russia over contracted prices, but unless governments are prepared to pay a market price for commodities – thus subsidizing their consumers, energy companies will go elsewhere. Private capital doesn’t finance displays of populism and energy independence that in the long-term undermine both security of supply and energy security.

 (in)Dependence

Today, 2013, we have a new era, of energy (in)Dependence. It represents the limits of infrastructure development, alternative import routes and politically induced market risks. Constant political warfare with private energy companies, in most of the CEE and SEE countries, has resulted in depressed incentives for infrastructure upgrades and price instability. Building a non-Russian transit pipeline into a region of significant market instability requires incentives outweighing these negatives. Each country in the region is proclaiming energy independence, which then (laughably) increases their reliance on Russian gas and increases security of supply risks. Resiliency within national systems is less than in regionally integrated systems. Faltering now on regional integration or preventing foreign capital from entering only underfunds alternative energy solutions which displace Russian gas.

The region’s largest gas projects moving ahead mainly rely on government efforts and financing. Gas storage in Hungary, network interconnectors, Polish LNG terminal and shale gas. While these efforts are able to move the ball down the court towards greater energy security, they do not provide substantial regional upstream diversification. The original intent of privatization of energy companies was to infuse capital into the regions’ energy systems to modernize the infrastructure, governments lacked the money to redevelop the basis of their economies. The question must be asked, does this trend continue, or has energy capital taken flight?

CEE and SEE governments cannot finance a new energy system that excludes market based elements and players. EU institutions are pushing for great market transparency, elimination of state aid, stronger energy regulators, stability in prices for private energy investors, and the interlinking of national and regional markets, thus reducing the room for political interference in energy markets.

There are now a number of attraction for CEE/SEE governments to deal with Russia and maintain its dominate position in the region, and in fact, moving away from Russia now appears more dangerous as the original – and justifiable reasons for energy independence fade. Russia remains a single supplier who is ‘simple’ to deal with. The terms of gas supply are clear, ‘You buy it we deliver it.’ Not the Brussels motto of, ‘If you buy it then here are the competitive conditions that have to be fulfilled, here is the transparency that is expected, and we expect the energy regulator to make well-reasoned opinions based on professional decision making process.’ Politically, that EU garbage only works in Western Europe.

Politically for CEE countries, Moscow can now act as a counterweight against Brussels. Whether this is just symbolic or not, the political elite in the CEE region is learning to balance energy relations between the old foe and the new foe. Finding a common cooperative topic with Russia is also beneficial for on-going relations, if not energy than what? Agriculture or software? There’s nothing that says a serious relationship than building long-term energy ties with Russia. Satisfying the strong neighbor, financially and commercially on energy issues distracts them from other issues.

A cooperative relation also demonstrates that CEE countries can stand by themselves with Russia. The rules of the energy sector may be dominated by Brussels and Western European companies, but the national governments of the CEE region still have an important role to play in their national gas markets and pricing. Bilateral relations are fostered and maintained with energy. While Russian gas, in the age of independence, was viewed as a necessity, in the age of (in)dependence, negotiations demonstrate politicians are in control of their country’s energy assets and a solid relationship exists between old foes/friends. This is contrasted against the assumed friendly relations with Brussels and the EU’s demands for an independent and transparent energy sector with complex rules and limited room for political grandstanding and influence. Russia and Gazprom are more than happy to lend to the showmanship, with the price of gas possibly linked to the temperature of relations between countries. Energy (in)Dependence provides security, simplicity, political capital and limits the need for a more complex energy market to replace Russian sourced gas.

The intertwined concepts of finance and market complexity, for alternatives to Russian gas, provide another reason for energy dependence on Russia. Despite alternative gas supplies, like LNG and shale gas, becoming more available, they will only make a small dent into the domestic or regional gas market. Any alternative to Russian gas requires considerable investments into developing a functioning gas market, including a nationwide network with gas power plants. Failure to incentivize private companies to invest in alternatives to Russian sourced gas (such as shale gas) ensures continued Russian dominance, for example in Poland’s gas market. Poland values energy independence, but not even concerted investments into LNG, shale gas and interconnectors can reduce its heavy reliance on Gazprom. The same applies to all the other countries in the CEE and SEE regions.

Conclusion

The political and economic hurdles for energy independence are too high for the CEE and SEE regions: Building a new energy system, funded by private capital, requires competition and complex market structures with limited political involvement.  Extending dependence on Russia energy resources provides the opportunity to maintain centralized energy systems and using Russia as a counter weight to Brussels non-political energy market schemes.

The collapse of Nabucco represented the failure of an energy independence strategy. A high priced, visionary project that was politically supported but without the political or economic stability required for its long term success. The debate over Nabucco overshadowed the on-the-ground work of building and expanding interconnector capacities, LNG terminals, domestic gas deposits and an overall beefing up of security of supply components. Enough so that supply disruptions, from Russia or transit countries, would have a limited impact. Energy independence can be gained by small hedges against Russian agitation and action. Therefore, (in)Dependence provides a lower cost, economically and politically hedged energy strategy that balances the local politics of the CEE/SEE region and the competing demands of Brussels and Moscow. A classic Central European strategy.

 

Visions beyond flat-earthers: Providing leadership on low carbon energy

I sometimes wonder if those top people that fly in and fly out for conferences ever actually remember what they say. The top CEO’s and politicians for events must give the same speech 20 times before they begin to alter it. Well, while I don’t discount this practice, I was struck by Ferdinando Beccali-Falco, the President and CEO of GE Europe and North Asia. This time I heard him at the 21st Economic Forum in Krynica Zdroj, Poland on September 9, 2011.

Getting tired of waiting for the future energy system

Mr. Beccali-Falco was also at the Energy Forum that took place in 2008 in Budapest. The main topic was about regional energy markets. There I remember him, and others, made a good case for the need to increase regional coordination in the energy sector. Although not much has happened since. This year, he even referred to his previous speech in the region and the need to increase economies of scale. He laminated on the lack of progress since then. He places this down to the lack of political will along with not enough vision and understanding that a new energy system can bring. For him, we are hitting the roadblock for implementing policies, with politicians and bureaucracy central in this roadblock.

The speakers at the Economic Forum – generally – could be divided into two groups. The first group had the vision and knowledge that a more integrated, low carbon, and smart energy system can provide – at around the same cost as the current system. The second group, were grappling with old arguments of price and uncertainty that an integrated energy system with high levels of renewable energy sources brings. Thus the second group views gas as an essential element to bridge to a low carbon energy system. Although this is a false view, as enough technologies exist to begin to strongly re-invent the energy system.

My contribution to the conference was in the form as a commentator to the panel discussion on ‘After Fukushima: Europe’s future energy mix.’ Lacking on the panel was someone that represented the renewable energy sector, and while they were present in other sessions, I focused my comments on the strong need to reduce energy use, increase RES and quickly begin the transition to a post-carbon energy system. According to the European Climate Foundation, to make the transition happen within a moderate investment climate, it must begin within the next five years. The inability of governments, regulators and energy companies to cooperate in the CEE region, fails to provide the foundation for this long – but fruitful – transition. (see my earlier post on the necessary cooperation).

Overall, the conference was informative and inspiring. There is widespread agreement, at least in the energy industry, that the smart grid and demand reduction are essential for the future energy system. Both Schneider Electric and Alstrom had strong speakers describing the benefits that a smart grid bring. The political tension that previously marked energy conferences, has given way to more practical and technical issues. However, it can expected that this aspect will emerge again. One of the essential elements of a smart grid is complete market transparency in the electricity system. For those like, Mr. Beccali-Falco who are calling for regional integration and rolling-out new technologies at a large scale, it is distrust and vested interests into nationally controlled energy markets, which remain as the primary barriers for the emergence of the smart energy system of today.

 

Energy investment in the CEE/SEE region suffers from political piracy

Vacations are great. A time to get away and forget about work. Time to spend with the family, to be outside and even meet new people. So while my kids were learning how not to drown in Lake Balaton this year (they are still small), they became pirates and commandeered an inflatable boat from a Romanian family.

The owner of the boat, was also the father of the two boys my kids were playing with. We began to talk. Not so much about work, but rather about the unease – or rather slipping of Hungary and Romania and the lack of economic growth and opportunity. Maybe it was just more middle age settling in for both of us, but the hope and excitement – the vibe, that ran through the CEE region the past two decades, for both of us, has leaked out.

Don't let CEE/SEE politicians sink your energy investment. Get a beer cooler that floats!

Part of my assessment of the region is based on this ‘feel.’ Living and working in Budapest. Traveling around the region is essential for ‘knowing’ what is going on. I am now preparing for my panel discussion next week at the 21st Economic Forum and so I’m putting together my thoughts on what a post-Fukushima energy investment  environment looks like for the CEE/SEE region. While reading the daily headlines, I came across this analysis from Reuters, ‘Analysis: Energy investors should look to East Europe.’

“Oh shit”, I thought could I be wrong, because this goes against my current analysis for the region. It is the feeling that was confirmed by hanging out in Lake Balaton and my experience analyzing and researching the regulatory and political environment and the markets in the CEE/SEE region.

Reading the article, and the ‘opportunities’ that exist in Eastern Europe, I failed to see significant investments and realizable opportunities for companies. There is a lack of widespread and fundamental change in the region to create a broad based reinvigorated investment environment.  Not because the need isn’t here, but rather, because uncertainty and lack of a deep change in mindset that can attract long-term, low risk, investments.

Sure the infrastructure is old and being pressured with the integration of wind power and other RES. The emergence of new generation technology is changing the operations of the grid; it is only set to put greater pressure to open up the region for foreign investment. But the regulatory and political environment is failing to allow the level of investment that is needed to occur, including to meet the significant shift to a low carbon economy that is necessary and will be required by the EU by 2050.

I only needed to find this little gem from Bulgaria, to understand that things are not improving for utilities (and the investment environment in the CEE/SEE region).

In the beginning of April, Prime Minister, Boyko Borisov, declared the three power utilities and the lobbyists who helped implement the present electricity pricing schemes have committed a “daylight robbery,“ vowed to involve the Prosecutor’s Office in the probe and even threatened CEZ, E.ON and EVN with nationalization.

From the study I conducted a few years ago that looked at the privatization process in Bulgaria, Macedonia and Romania, I see things have not changed. I’m not going to state who is right or wrong in this fight, but rather use it as an example of the social and political discourse that governments and private energy companies operate within.

It is this constant bickering and overt political pressure on the utilities and other energy companies. Like forcing losses on gas companies in Bulgaria and Hungary. This is an attempt to keep consumer prices low. Although, this prevents the needed levels of investment into the current infrastructure and to improve it to meet future demands.

Maybe a paintball game can be used as a team building exercise for energy companies and governments.

As the Reuters article rightly points out, there are good returns to be had in the region and there is a need for investment in the chronically under invested sector. One of the reasons for higher returns in the region is because of the higher risk that investors face in the region – from the shifting political winds and constant political attacks that are launched.

Just as the electricity distribution companies that were bought by foreign investors are under a constant barrage of political and regulatory pressure on their prices and internal operations, they also secured (at the beginning) a higher rate of return to reflect this very risk of political and regulatory uncertainty. The politicians have only been too willing to prove the investors right. The article describes an ‘example’ of an opportunity in Romania.

Hidroelectrica, which generates roughly one third of the country’s power production, is seeking investors for its flagship project, a 1,000-megawatt hydro power plant worth some 1 billion euros seen finalized in 2019.

GDF Suez, Iberdrola and RWE and CEZ have walked away while Enel and a local unit of ArcelorMittal remain on board.

What is great about this, is this is EXACTLY what happened when Romania was privatizing the first electricity distribution company. Every potential bidder walked away – except Enel. And now that Enel is heavily invested in the country, along with Arcelor Mittal, it may be worth it for them to participate in a generation project where they can buy directly for their consumers electricity. However, because every possible buyer walked away from the distribution privatization, Enel was able to extract a higher rate of return in the final negotiations.  Treating investors badly doesn’t help your country in the long term.

The risk premium that exists in the CEE/SEE is important to emphasize. Even in Hungary, previously one utility executive I spoke to in 2006, said the risk premium was no higher than in Germany. Well, those days are gone under the Hungarian government’s new desire to drive foreign energy investors from the country.

I will participate in next weeks discussion not on the narrow opportunities that the Reuters article identifies, but on the broader risks and political unwillingness that exist in the region to significantly increase the level of investment. This failure to plan for the long term and to meet current system requirements will begin to bite as the region does build more renewable energy projects (and at high rates of return and/or with large incentives) and even new large centralized generation plants (ditto).

There are three key reasons that privatizations were conducted. Because of the physical state of the infrastructure (also as a result of failure of state owned industry), domestic economic conditions and external pressure by the EU or other organizations. The question is whether the region wants to wait for these conditions to exist again to begin the process of allowing private investment to renew the region’s infrastructure – and at a high cost – or begin to act now to systematically and in a steady manner, lower the region’s risk premium by working with investors – many of whom are already in the region from the first round of privatizations, like Enel.

The gloom that hangs over two middle aged men, playing with their children in Lake Balaton will only be lifted when governments begin to think over the medium and long term, to build a dynamic and innovative energy system (and economy). The good old days of the 90’s and even early 2000s were filled with a sense of optimism and opportunity. The perpetuation of the carbon based regime, marked by constant bickering over unsustainable low energy prices, will continue to dominate until politicians realize money and opportunity lie with a fundamentally different energy system. The broader national economies of the CEE region will continue to reflect the state of their energy systems. Innovative thinking in the energy sector easily passes through to innovative and higher investments in the wider economy. Politicians should choose this path, not Communist era energy policies that discourage investment.

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.

CEE Conference

Maybe it is too late for most. But I thought I would post this for anyone (probably already in Budapest) that is interested in attending a conference. It is called, CEE Energy 2010 and takes place September 30 and Oct 1. It has a nice line up of speakers from the region, so it should be rather informative.

The second day has a panel discussion on the southern gas corridor and whether there is enough room for all of this. This should be interesting. It also corresponds to a survey that will be launched on this blog next week. But I’ll keep that under-wraps for now.

You can see the conference brochure here.