Tag Archives: Electricity

Why Russia wins against the EU’s single energy market

A battle of ideologies is underway in the energy sector of the South and Central Eastern Europe. Just as the ushering in of democracy after 1989 was viewed as a done deal, infusing market mechanisms into energy system was also viewed as an obvious choice. In Hungary, preparing energy companies for privatization began in 1989. However, just as democracy is now eroding in the region, so are the neoliberal energy market mechanisms. State ownership in energy is maintained, while formerly privatized companies are bought back. A new era exists of state owned utilities, politicized energy regulators and retreat of private investors marks the EU’s eastern energy markets.

The cost is high for the energy systems of Bulgaria, Hungary and Poland. State ownership in Bulgaria results in failed strategic endeavors and huge debut (Belene NPP and NEK). In Hungary the repurchase of MOL shares, EON Foldgas transit and storage, gas distribution from RWE and now the take-over of electricity distribution obligations. These are all funded by taxpayer money, most of the endeavors in Hungary affecting end-user pricing are done by their development bank, with the potential to cover losses.

In Poland, large state ownership exists while the failure to launch a shale gas industry partially stems from the inability and the lack of experience to work with foreign investors [each of these three countries and these issues will be discussed in other blog posts, along with costs]. The financial cost of mismanagement and cancelled projects stymies efficient, secure and lower cost energy systems from developing. The once hoped flow of private capital in the region is in retreat.

My bias on the issue of state ownership is clear, I do not favor mismanaged state owned companies or overtly politically shaped utility rates. In the US government ownership exists, and there is political influence in rate setting and market structure. However, in our three countries examined, political influence prevents the system to function in both an environmentally and economically sustainable manner. Electricity and gas rates are cut across the board, benefit even those that heat their swimming pools in the summer, rather than those stuck in energy poverty. Investments into energy efficiency are neglected in favor of maintaining lower electricity and gas prices. Corruption and favoritism often floats around state ownership. From the favored gas trades with MET, in Hungary to selling yearly capacity in a no-bid sale to a private company in Bulgaria; the exclusion of transparency and competitive bidding for capacities stymies fundamental components for a market based energy system from developing.

Excluding the air of favoritism, the political view in all three countries is clear: State ownership (or deals with favored companies) protects the natural resources of the country and provides social benefits that private companies do not. This contradicts the neoliberal competitive market agenda and cross-border operation of energy companies instilled into EU institutions and treaties. The past Communist system held development of the energy infrastructure central to social acceptance. The panel house (with a lifespan of 30 year) may be badly insulated but at least the central heating is cheap. Centrally controlled pricing is still linked to income levels.

(Source: European Commission, 'Energy Prices and Costs in Europe', 2014)
(Source: European Commission, ‘Energy Prices and Costs in Europe’, 2014) Overall, the cost of electricity for households in Eastern Europe is low to average in comparison to other European Union countries.

Universal access to electricity was the last great global energy project. The goal was clear, provide access to electricity – almost at any cost. This agenda drove the development of energy systems in North America and Europe. Communism accepted the same mantra, thus we should not view some central tenets of political-economic systems as exact opposites. But there are fundamental differences in financing system expansion and operations. The Communist state, as compared to users, pays the overall bill. For example, wages, in the factories of Eastern Europe, may not have been high, but nor were daily living costs. The district heating facilities of Dunaujvaros (previously Stalin City) are connected to the town’s main employer, Dunaferr steal mill. Shutting down certain parts of the steal mill requires a new cogeneration facility – based on full market pricing. Just as universal access was an engineering and political project (hydroelectricity in America), integrated energy and socio-political systems are integrated.

The full commodification of the energy services, electricity and gas, in the household is a market mechanism. Private owners of generation and distribution facilities need to be reimbursed, and with a profit margin, to provide ‘efficiently’ managed services. The energy value chain in both Capitalist and Communist systems holds the fundamental flaw of incentivizing energy production and not demand reduction.

Despite great strides in Western Europe reducing energy intensity of economies, full commodification of energy efficiency does not exist. In Eastern Europe, energy efficiency programs are usually funded by EU funds without governments viewing efficiency as reducing gas imports or improving people’s living conditions. It is still more ‘efficient’ for politicians in Hungary and Bulgaria to sell discounts on people’s utility bills than to provide them with better living conditions in the form of insulation and new windows.

The incentives for supply side, while existing in both neoliberalism and Communism, plays out despite both sitting in contrast to each other. Neoliberalism is inherently an economic project. It was developed by the Chicago School of economists and is often linked to the privatization of energy companies in Latin America and Pinochet’s regime of oppression and rise of Neo-Marxist guerrella fighters. In general, the shift towards global capitalism took off in the 1980s and early 19990s. Neoliberalism, viewed as a project by academics focus on the inherent evil obliterating state support and jobs for three quarters of the world’s poor. Economic shock therapy, eloquently described in Naomi Klein’s ‘The Shock Doctrine’. Neoliberalism, privatization and the market economy rob the factory workers of their jobs, heat and wages.

In Eastern Europe, Communism and political suppression of free speech and religion were just a few ‘costs’ that were paid for living in a utopia – a non-market economy. Now the Communist days of low cost utilities and relatively low cost living standards are now fondly recalled in Hungary, Bulgaria and Poland. Marxist economists trained in Moscow guided the broken and inefficient economies of these countries. While the engineered infrastructure of these countries were designed with efficiency and rational engineering principles in mind, operating them created a different level of engineered and economic inefficiencies. Such as opening windows to regulate heat and an economy based on bartering.

Five year plans favored the academic discipline of engineering for developing the energy system of Eastern Europe. Markets worked according to the infrastructure, rather than the markets dictating what infrastructure would be built. The failure of the EU to integrate its energy system lies more with the market policies that must underwrite new infrastructure, with short pay back periods and avoidance of state aid rather than a lack of engineering skill to integrate the markets.

Even from a market perspective, infrastructure projects planned out over a five year time horizon (or longer) hold significant financial savings for companies supplying the energy and for consumers consuming. The failure of the Nabucco and South Stream pipelines are partially attributable to the conflicting demands of open market access and infrastructure ownership. Energy regulators are meant to create these efficiencies in a market based system. Their role is negated when decision making is politically influenced and returns on private investments are not realized. Thus Bulgaria, Hungary and Poland cannot secure long term advantages from a market based system.

Profits then losses in Hungary's utility sector. Source: Hungarian Central Statistical Office
Profits then losses in Hungary’s utility sector. Source: Hungarian Central Statistical Office, draft statistics compiled for a benchmarking report for the European Commission – not done by me.

The higher risk for investors and the inability of the state to secure long-term private financing for large infrastructure projects opens the door for Russia to have it’s way (this is less relevant for Poland). The ability for Russia to finance large pipeline projects (North Stream, South Stream, Turk Stream) and nuclear power projects (Bulgaria and Hungary) demonstrates the strength the Russian state has (paradoxically) in financing energy infrastructure in the EU. Thus while the EU’s energy market is based on economics it can’t compete on financial terms.

The market approach also can’t compete when political involvement overrides long term private investments. Political interference pushes these countries closer to Russia as the availability and interests of private companies shrinks. In an environment with politically influenced energy prices, realizing returns on investment becomes more and more challenging. In Hungary, the response has been clear. Private distribution companies, paid out high dividends thereby removing capital from the companies while slashing investments. With the rejection of a market based approach, a financing gap emerges. Russia is happy to fill this by offering its former satellites a one stop shop for finance, infrastructure, technology and the potential for politically favorable pricing.

 

The Collapse: Utility investments in Hungary
The Collapse: Utility investments in Hungary H1 = first half of year, H2 = second half of year, draft statistics compiled for a benchmarking report for the European Commission, not done by me.

It is no coincidence that the biggest supporter of Putin and Russia in the EU is Hungary’s Prime Minister, Viktor Orban. After securing a secret late night deal to expand Paks nuclear power plant with Putin, Orban now acts as Putin’s European cheerleader for building Turk Stream. The ultimate goal is political support for Orban and his 25% utility price cuts – that must be maintained.

The clash occurs in South and Central Eastern Europe between former Communist systems and the neoliberal regulatory approach to EU energy markets. The two overriding academic disciplines of engineering and economics only realize their potential with political permission. While these two approaches are reconcilable, politically, past and current adherance to one or the other approach dominants. Favoring a market orientated approach relies on trust in market forces that efficiency will be introduced to the energy market. Trust in engineering enables political involvement to set energy prices – rather than the market.

After the fall of Communism trust was placed in the neoliberal market approach, after 25 years of playing with economic markets, politicians are no longer willing to place significant trust in markets. Thus the crisis of the energy system in the region is set to escalate between the neoliberal market approach required by EU membership and a politically guided market price resting on centrally controlled and engineered large energy systems backed by Russia.

SCEE countries extend the Communist energy systems to the future

There is a delicate and blurred line between investments into the sustainable energy technologies and security of supply. Both are overreaching concepts that describe a multitude of approaches. At the core is the attempt to upgrade technologies with a low environmental impact while ensuring energy resources (primary and secondary) are secure. Creating a sustained momentum of investments through a clear trajectory is core to an efficiently managed system. The sustained trajectory towards a more secure and environmentally sustainable energy system is where countries in Central Europe fall short.

In Europe, there is a clash of how embedded energy systems contribute to energy security. There are two distinct approaches, one in older member states (UK, France, Germany) and one in newer eastern member states (e.g. Poland, Hungary, Bulgaria). Some countries transformed their energy systems in a rapid manner, like Germany and Spain, where solar and wind received a tremendous boost through feed-in tariffs. This transition is now self-sustaining due to the drop in the cost of technologies and a mature domestic service industry. While Spain cut off financing the industry became well established. In Germany, support remains and the renewable sector will continue to grow.

More broadly, the transformation boosted both countries’ energy security while moving them towards a sustainable energy system. Both environmental and commercial reasons (being leaders in energy technology) fueled this conversion. Spain reduced its oil imports while Germany reduced coal (temporarily) and nuclear power in their energy mixes. Social support existed in both countries for this transition.

Energy technologies in the SCEE region

Building a sustainable technological trajectory to transform energy systems is not occurring in South and Central Europe. Some countries, like Poland, Hungary and Bulgaria have not noticeably altered their energy systems. In fact, these countries are marked by a reassertion of their older technologies. Renewable energy technologies are kept to the minimum EU requirement which is below 20%, and little or no government financial incentives. Instead, these countries are clearly reliant on extending and expanding their current energy technologies. Poland will maintain a high mix of coal in electricity generation, currently this is near 90%. The overall 2050 energy mix is projected to have 60% from coal, 20% from gas and 20% from renewables. Thus a rough projection can see electricity generation from coal being around 70%, while boosting gas and renewables in electricity generation.

Hungary is set to increase nuclear power to over 70%, by expanding its nuclear plant. If life extensions are done for current reactors, then by 2050, this 70% ratio could remain in place. Electricity generation from coal and gas and some renewables will remain. Thus, Poland and Hungary pursue a 70% mark for their electricity systems based on previous technologies. This percentage, when combined with gas, effectively locks out renewable energy to any meaningful degree.

Poland’s Electricity Generation Mix

Source: European Commission Country Report 2014 - Poland
Source: European Commission Country Report 2014 – Poland

The energy mix of Bulgaria, from the outside, is diverse. It is a net exporter of electricity and has hydro, nuclear and renewable energy (wind and solar). However, as I will explore elsewhere on this blog, there are systemically high costs associated with Bulgaria’s solar feed-in tariffs, expensive long term contracts for coal-fired power plants, and the general overcapacity of nuclear power, which means even this ‘cheap’ source of energy either needs to be exported or (at times) taken off line due to the oversupply from solar and coal. The future of the Bulgarian energy system, while on the face of it, appears nuclear and centralized, consistent mismanagement may result in technologies with shorter payback periods dominating the energy mix, such as gas and renewable technologies.

Bulgarian Electricity Generation Mix

Source: European Commission Country Report 2014 - Bulgaria
Source: European Commission Country Report 2014 – Bulgaria

Technology and Resource Dependency

The choice of Poland and Hungary to maintain their future energy mix at 70% based on technologies from the previous energy era are directly connected to the perceived final price of electricity, gas and energy supply security. Bulgaria continues to debate and engage with reliance on Russian nuclear technology and gas pipelines – on the same level as Hungary. Bulgaria lacks the momentum to diversify away from Russian resources and technologies. All three countries are affected in their choice of energy systems by Russian control of resources and technologies. New investments fall into one or both of the categories of resource in/dependency and technology in/dependence.

The future energy systems in these countries are based on the previous Communist energy technologies and resources. This is not a trajectory that moves these energy systems towards being both sustainable and secure. Rather, ‘cheap coal’ and ‘cheap nuclear’ are perceived to provide the affordable energy that the citizens of these countries accept. The competitive advantage deriving from ‘cheap’ resources and technologies rests on the previous Communist energy complex. Today, these facilities are built under considerably different market conditions than what we have today or in the future.

It is the difference between the old political-economic regime and the one that exists in the EU that is a source of friction today. Financing of the expansion of Hungary’s Paks NPP is now provided by Russia. Russia attempts to influence the future energy choices of the region by extending the previous political-economic system of resource and technology dependency. This will be discussed in the  next blog post.

European Commission energy report identifies progress and set backs in Hungary

Giving Hungary’s energy regulatory authority greater political independence and improving investment certainty are recommendations recently published by the European Commission’s report on Hungary’s energy sector. Identified in the report are Hungary’s regional integration and consumer dissatisfaction with gas suppliers.

Contributors to the report, including analysis on Hungary, are Michael LaBelle, an Assistant Professor at Central European University, CEU Business School and Department of Environmental Sciences and Policy, and Andras Deak, Research Fellow at the Institute of World Economics of the Hungarian Academy of Sciences. Working with energy consultancy AF for the European Commission, the overall report provides a snapshot and recommendation for each EU member state.

Electricity price change by component 2008 – 2012 (source: Eurostat, energy statistics)
Electricity price change by component 2008 – 2012 (source: Eurostat, energy statistics)

The 2014 report found overall improvement in the EU’s energy infrastructure and market. Consumers in some markets have more choices for electricity and gas suppliers, cross-border trading increased and wholesale electricity prices declined by one-third and gas prices were stable between 2008 and 2012. Suggestions included more substantial regional cooperation, use of smart meters and linking more closely wholesale and retail pricing – so lower wholesale prices translate into lower retail prices.

The report on Hungary included the progress made linking Hungary’s electricity market to the Czech Republic and Slovakia. This increased the amount of electricity available on all these markets creating regional price convergence. The report also noted that Hungarian gas consumers are the least satisfied in the EU.

Deterioration in the regulatory environment and notably the powers of Hungarian Energy and Public Utility Regulatory Authority were identified as problematic areas. Actions by the Hungarian government during the reports timeline of 2012- to early 2014 noted the removal important independent functions of the energy regulatory of network tariff setting authority. These political actions resulted in the reduction of energy prices by 20% (subsequently more since the completion of the report). The appeals process against the authorities decisions was also altered removing Hungary’s courts from providing sector oversight. Overall, the report identifies actions by the Hungarian state of increasing its ownership while investor owned utilities lost money and were dissuaded from investing in the sector.

The full report can be found here, and the report on Hungary can be found here.

 

The Pull of the Communist Energy System

The role of the state in the energy system in Central Europe is fraught with historical ups and downs. Under Communism the energy system represented progress and equality with the Capitalist West. There is no doubt the energy system from gas transmission to electricity generation and transmission in all the former Soviet Union and its satellites was efficient. The energy system lends itself well to five year plans.

Last week I was in Bulgaria doing research on energy prices and the relaitons between Russia and Bulgaria (I’ll be having a lot more on this topic in future posts). I met with many renowned experts, including Bulgarian Atanas Professor Tassev, who has advised many governments and international organizations, including the World Bank. Atanas Georgiev and I sat in his office while he smoked away at his cigar. There are many old school habits that still persist the further east you go.

Professor Tassev is no doubt one of the leading experts on European energy, even if his spoken English is challenged. So I’m grateful to Professor Georgiev for translating for me. In the discussion over Russia Professor Tassev said, “When geopolitics talks, the politics shut up. And when the politics talks the economy suffers.” With this statement he gets to the heart of the energy debate between the EU and Russia.

The debate over energy is more than just everyday politics, it is about geopolitics which exist in a different realm. Our discussion was in the context of building a new nuclear power plant at Belene, Bulgaria. Russia was meant to build it, but Bulgaria backed out causing high tension between the two states.

Politicians act to influence economic development. The political strategy for the energy sector, whether in America (see my PhD thesis) or in Europe, is to provide electricity at the lowest price. Action will be taken over the choice of technology that fulfills the strongest social goals. In the case of Germany, ‘green’ goals are/were prioritized over upfront costs. In the CEE region, the price of electricity in the short term drives political decision making. Thus political interference in the regulatory pricing process.

Geopolitics is for the long-term. The long-term goals for energy technologies come in the form of nuclear reactors and gas transmission pipelines that span continents. Cheap and competitive electricity and gas today, must be preserved for those politicians that value the most energy costs. Open competitive and transparent markets, as those valued by the EU, provide no assurance on short-term or long-term price. Politicians involved in the economy fiddle with the elements necessary for economic growth. The energy sector is the backbone for any growing or declining economy, so there can be a convergence of domestic politics and international geopolitics in choosing energy technologies.

Russia posses both the technological know-how and natural resources to back up its geopolitical and political aims. These aims coincide with the domestic agenda of CEE politicians. Going forward economic growth in the CEE region is dependent on assurances and predictability in the price of energy. Price is seen by politicians in the CEE region as a competitive advantage against those EU countries with competitive and environmentally aware energy markets.

The Soviet Union modernized the energy infrastructure at a price each country could afford. Integration of these countries occurred through the energy infrastructure. A dependency built up over these years. For countries like Bulgaria and Hungary, turning away from Russia and this historical relationship becomes fraught with an inability of politicians to influence their economies. While a lack of engagement may be good for the economies, it is not good for the politicians. And this is where we have a stalemate between integrating into the EU’s interdependent energy system, and Russia’s dependent energy system.

Five ways to destroy your energy sector and your economy – a note to the Hungarian Government

I was aiming low – ‘Five ways to destroy your energy sector and your economy – a note to the Hungarian Government.’ I IM’d the title to my friend in the Hungarian energy sector – he said, “i am sure they know at least ten.” Well, most certainly they do, but I’m not as creative as the current Hungarian government. How could I even imagine that encouraging consumers to not pay their energy bills would become a government policy – and legalized. Nonetheless, I’ve written about creative tax making in the past.

To herald in the New Year and to recognize that the wise men (and women) from the EU and IMF may be gone for a few more months and as the Orban government continues to force the country into a downward economic spiral, and installing a new authoritarianism, I thought I would provide the current government a Christmas package of proposals that could bring the Hungarian energy sector more quickly to its knees. Because, as I will show, once you have destroyed your energy sector, dissuaded manufacturers from investing due to an unstable electricity sector, the only direction to go is up – and this requires foreign investment, an effective regulatory environment and strong political will that corrects the past mistakes of low/subsidized energy prices (as demonstrated in this study).

One: Encourage consumers not to pay their energy bills

The introduction of a new bill in the Hungarian Parliament would allow public institutions like schools to avoid pay their utility bills. This proposal has caused the National Development Ministry State Secretary for Climate and Energy Affairs Janos Bencsik to submit his resignation.

A proposal submitted to Parliament by Fidesz parliamentary caucus leader János Lázár last week seeks to prevent utility companies from shutting off power to certain customers who fail to pay their bills…. Industry insiders said that the proposal would allow public institutions, many of them notorious late-payers, to ignore their utility bills with no consequences, leaving power companies no recourse but lengthy and costly legal suits.

Macedonia, provides a good example as to what can happen when no penalities are imposed on late or non-payment of electricity bills. Essentially, the Hungarian proposal reverts back to the Socialist era, when non-payment was rampant in some countries.

Hungary's new energy slogan

 

In a study on the privatization process of the Macedonian electricity company (with the distribution entity being sold to EVN) I wrote, “Unpaid consumer bills, mainly from the period before privatization, are a significant issue. EVN is pursuing lawsuits against 400,000 customers for non-payment, 80% to 90% of these cases stem from the pre-privatization period. This is down from a high of 450,000.”  The draft report was read by reviewers and they came back to say that this 400,000 number must be an error. ‘Didn’t I mean 4,000?’ No – 400,000 court cases for non-payment.

The huge number of non-payment from consumers were causing significant losses to the company at the time of privatization, around 30% of the electricity transmitted in 2006 was unpaid. Of course, these losses affected the selling price at the time of privatization, as well as an indirect impact on investments and the price of electricity – and certainly a very acrimonious relationship between the government, regulatory and EVN. At the end of the day, it is the rate payer and tax payer (usually the same) who has to pay for this.

Lesson 1: to devalue a company, lower investment and create system instability encourage consumers to NOT pay their energy bills. If the company is already foreign owned, this method will be sure to create losses for the company and may encourage their withdrawal.

Two: Regulate the price of energy below the cost of providers

The case of Bulgaria’s privatization of its power plant in Varna, to the Czech power company CEZ,  demonstrates that it doesn’t have to be just the distribution companies that can be forced to eat the losses. In the same study, the decision by the Bulgarian regulator to decide on the price of electricity that would be allowed for power production from the privately owned power plant demonstrate that  it is also the generators that sell to the distribution companies in the regulated market, that must contend with the low prices.

“In the case of CEZ’s Varna Power plant the complaint centers on two issues – regulated segment market quota and the price on the regulated segment, which, according to CEZ, is set lower than production costs. CEZ Varna states that it needs over Lev 77/MWh, to be at cost, while the approved rate from SEWRC is under Lev 72/MWh.”

The development of energy regulators is something special, however, the Hungarian government views the current regulator as not knowing better than Parliament. Since June 2010, the Hungarian Energy Office lost the power to effectively and professionally regulate the price of electricity and gas.  The justification: “it is intolerable that a significant part of families’ budgets consist of utility bills.” Therefore, the regulator is the wrong unit to ensure that families can pay their bills.

The recent ‘forced’ sale of E.ON’s gas unit to the Hungarian government, and the dumping of E.ON Bulgaria by the mother company, both demonstrate what squeezing by governments does. It is still not clear how consumers benefit from government political decision making or ownership. In the case of Bulgaria, one of the main reasons, that I was able to extract from a key participant in the privatization of the distribution companies, was the fact that the government could not be trusted to ensure investments were done due to the desire to keep prices low. The same case certainly applies to Hungary – in the medium and long term, the energy sector will begin to fail if investment levels are not maintained or even increased. It takes reflective pricing of the actual costs of the energy system to ensure proper levels of investments are done to maintain and improve security of supply.

Lesson 2: to ensure that the energy system does not improve, or begins to deteriorate, make sure that companies do not have sufficient funds to cover operating and capital expenses (CAPEX and OPEX). Either removing the regulator from the decision making process or placing political pressure on the regulator can result in lower energy prices. The result can be the company is sold back to the government at a low cost. Great strategy if forced nationalization is the objective.

Three: Create a regional hegemonic energy company!

There is nothing like nationalism to fuel erratic policy making. Ideology both pro or anti-market can dent and over simplify the complex relationship between the state and private investors in the energy sector. The fact that the energy sector is a fundamental component to economic growth and a direct link to voters (through their utility bills), makes the energy sector a highly politicized (read why politicians find energy as attractive as prostitutes). It would require a book to write about all the different and constantly changing national energy strategies in Central Eastern Europe and the South East of Europe to review how almost EVERY country considers their state owned energy companies strong enough to become a regional player like CEZ. The present result is that these ambitions have only resulted in continued justification for government ownership and a lack of modernization of assets for domestic users. Hungary, Bulgaria and Romania each has these strategies, yet none of them competes regionally.

For Hungary, the government sees that MVM (the state owned former electricity behemoth that is now being used to control everything from gas to telecoms) can fulfill this regional ‘cash cow’ role. Or as 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. (see previous post on this.)

Hungary's future 'regional' cash cow - maybe a little too fat to make it out of the country

Lesson 3: To help justify why the government is so important in a country’s energy sector, just keep saying that they will be expanding regionally – and there is a lot of money to be made. This expansion still has not occurred, and if it were to occur it must be subsidized by current rate/tax payers. Nonetheless, there is still room for a first mover advantage by one of the large state owned energy companies – like MVM (see photo above to see how fast they can move).

Four: Create an erratic policy and regulatory environment

Maybe this goes without saying. Having an erratic policy and regulatory environment is usually built into the business plans of privately owned energy companies. For rate payers, this means paying more for their energy, because the risks are much greater and therefore energy companies entering and operating in a company are going to seek to have a higher rate of return. The rate of return that the electricity distribution companies received at the time of privatization in Bulgaria was 16% and 12% in Romania. While this may be great for the investors – at least on paper – as the case studies show, the risk that these companies took is partly justified based on the continued price squeeze that the companies are under. They are expected to fulfill their investment commitments, thus incurring losses, thus lowering the rate of return (in a very simple explanation). Whereas, a more predictable and stable regulatory environment can, over a few regulatory cycles can lower the rate of return, the country’s risk level and thus energy prices.

Lesson 4: erratic energy policies and regulations, can keep risk levels high and thus require companies to have a higher rate of return. This will result in higher energy prices, so instead of creating a stable predictable investment environment, keep companies guessing – this will justify the continued political intervention in the energy sector.

Five: Get free energy for government use – expropriate electricity and gas

Hungarian Prime Minister, Viktor Orban speaking in December 2020, at a primary school about the success of the free energy scheme for state institutions

 

Political control over energy prices, means that privately owned companies must accept what the government tells them to charge. The point of having an energy sector regulator is to ensure that there is sufficient incentive for privately owned companies to get a fair rate of return on their investments, while protecting consumers from monopolistic abuses. A professional regulatory staff  assesses the full costs that are incurred by privately owned companies, and ensure the costs are justified and consumers pay for an efficiently run energy system. Removing incentives or not covering the cost of operations and future investments, removes the incentives to invest and threatens security of supply.

The Hungarian government now controls the price of gas and electricity. They are also about to decide that certain consumers (state owned entities) do not have to pay their energy bills. If they allow this, the government in reviewing the costs that should be allowed in the price caps, can decided that the non-payment by these consumers cannot be viewed as losses for the company to write off – or for other consumers to cover. They will force the private electricity and gas providers to pay for the energy costs of the government.

In short, as in the Socialist era, the Hungarian government will decide that government institutions do not need to pay their energy bills, they will either make the Hungarian rate/tax payer pick up the tab through their utility bills – thus higher prices, or they will force the companies to incur losses caused by non-payment from the government.

Lesson 5: If you want to ensure that the government (through whatever entity local or national) does not pay for energy usage, simply make sure the price is set by the government and stipulate in law that there are no penalties for non-payment by government entities. This will dissuade energy efficiency improvements and drive the price of energy up for everyone else – if these losses are included in the price of electricity or gas.

 

Conclusion

The five points reviewed here represent the ways that can lead to decreased investment, less private ownership(which should be more efficient), and higher energy prices for all. The one area that I have not touched on is how creating a stable investment environment, with a well functioning and independent regulator also can create lower energy prices. Erratic policy making, expropriation of energy by the government and increased state ownership all lead to higher energy prices for consumers. In the long term, the trend will only lead to an under invested energy system that has blackouts, lacks system stability and cannot support the requirements of industry. A robust energy system is a requirement for a growing economy. Failure in the energy system represents failing every citizen. The Hungarian government is only too happy to ensure that the private ownership is diminished or eliminated while state owned energy companies with no transparency -(and a history of not justifying their costs, like private utilities), become fatter and fatter. I don’t know if fat cows produce more milk, but they certainly cost more to feed. If the cost of energy is the bottom line, then let’s have some lean beef that is healthier for the consumer.

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.

 

Exploring 10 Years of ERRA: My account of the organization’s success

Every piece of writing has its own story. The Energy Regulators Regional Association is celebrating  their 10 year anniversary in 2011. I was asked to write a publication chronicling their history and describing their success. This was an honor. The final product is a small book containing a compilation of interviews, historical research and contributions by leading regulatory thinkers.

10 Year birthdays are great!

The story behind this publication centers around working with a network of dedicated people that believe in the role and importance of independent and professional regulatory institutions.  That easily summarizes ERRA’s mission. Every person we approached for an interview was extremely kind in giving us some thoughtful and original ideas on the history and role of ERRA. As you read the publication, you can understand the difference that ERRA does make, and the support structure that it provides to national energy regulators. This widespread dedication enabled the 10 Year Anniversary publication to be that much more exciting to write. The passion that everyone expressed about ERRA’s purpose and mission, inspired me to match that passion.

This report is also special, because as so often happens when I finish writing an article or report, which can takes months or years to complete, I’m never really sure who – or whether anyone – reads it. Thus, I was pleased to hear that people were engaged with the publication at ERRA’s 10 Year Anniversary celebration. Their annual ERRA Energy Investment and Regulation conference in St. Petersburg, Russia served as the celebratory platform. It was also the location of the launch of this publication. A review of the schedule of speakers demonstrates the importance of ERRA. Just a few of these were:

  • Mr. Tony Clark, President, NARUC, USA
  • Mr. Sergey Novikov, Chairman, Federal Tariff Service of the Russian Federation
  • Mr. Robert Archer, Senior Energy Advisor, USAID, USA
  • Mr. Walter Boltz, Vice President, CEER (Council of European Energy Regulators)
  • Mr. Baohua Liu, Director-General, Power Market Regulation Department, State Electricity Regulatory Commission (SERC) of China
  • Lord John Mogg, CEER President and ACER Board of Regulators Chairman
  • Mr. Hans ten Berge, Secretary General, Eurelectric
  • Mr. Vladimir Knyaginin, Director, North-West Strategic Research Centre, Russian Federation
The geographic reach of ERRA

I conducted 35 interviews for the book. And there are two forewords, one by Tony Clark, the president of the National Association of Regulatory Utility Commissioners (NARUC), and another by Alberto Pototschnig of the Agency for the Cooperation of Energy Regulators (ACER). Some of the people interviewed include the speakers from the St. Petersburg conference, but also notable European energy experts, such as,

  • Jean-Michel Glachant -Director, Florence School of Regulation
  • Turkey representative, President Hasan Köktas: Energy Market Regulatory Authority (EMRA)
  • Konstantin Petrov, Director Markets Regulation of KEMA
  • Director, Romanian Energy Regulatory Authority (ANRE)
  • Ron Eachus -Chair of the Oregon Public Utility Commission/Former Chairman of the NARUC Committee on International Relations
  • Gabor Szorenyi, Director, Hungarian Energy Office
  • Peter Kaderjak, Director of the Regional Center for Energy Policy Research (REKK), at Corvinus University of Budapest

Inside the book, there is a wealth of information about the history and purpose of ERRA along with a description of all its activities. The rapid expansion of the organization in just 10 years, also indicates the growth in the need for regulatory knowledge in developing economies. This is where ERRA’s niche lies. It is successful in transferring the knowledge necessary to encourage professional regulatory decision making to occur.

There is an English version and a Russian version. I also have to thank everyone at ERRA and those connected with it, for working with me closely in revising and improving the drafts. The publication is based on their vision and their ideas for what makes ERRA so unique – and why it has grown so rapidly.

I’ll end this post with a word from ACER Director, Alberto Pototschnig:

The evolution of energy regulation compels regulators to work together even more. The Second Legislative Package, in 2003, required all EU Member States to establish a National Regulatory Authority for the energy sector; the Third Package is now granting these authorities greater powers and stronger independence. These are necessary factors for good regulation, but the enhancing of practices and the sharing of the best ones require much more: on the one hand, training and the dissemination of the regulatory culture and techniques; on the other hand, close cooperation among regulators at the regional level and beyond. This is where ERRA has made a key contribution over its 10 years of operation: it has an established track record of fostering cooperation between regulators and facilitating the process of market liberalisation and integration.

Energy will liberate Hungary from Neoliberal and Western Shackles

The energy sector in Eastern Europe benefited from the central planning efforts of the communist era. The oil, gas and electricity networks built during this time were robust and based on a high level of security of supply. While the oil and gas transit networks may have resulted in dependence on Russian sources, they were nonetheless robust and served to drive national economic activity. In 2004 when many countries in the region joined the EU their interconnected electricity network were more robust than most systems in Western Europe.

The days of central planning, when state owned energy companies were strong

The privatization efforts that begin in the mid-1990s and carried through the mid-2000s (see my Energy Policy article) were marked by selling electricity and gas distribution companies. This corresponded to the establishment of energy regulatory authorities to oversee the activities of these private companies, ensure the public good is fulfilled and keep prices in check while increasing reliability. This regulatory system, when allowed to function, can serve the interests of consumers and ensure private companies make investments while receiving a fair rate of return for their efforts.

Some would mark this last period as neoliberalism with the introduction of private capital and withdrawal of the state from the direct provisioning of public services in energy. A more accurate term would be the rise of ‘sectoral governance’ (Bulmer et al 2005), that is occurring globally. (But that is for another post and the basis of my next journal article). ‘Some’ (bad term to use, but I’ll do it here), consider private ownership in the energy sector, which is the driver of economic activity and has a direct impact on household budget and inflation as an essential state function. State ownership, it could be argued, is important to provide stability, long-term planning and investment to serve the national economy.

In Hungary, ‘the state’ is now in a process of reclaiming ownership rights lost during the ‘neoliberal era’. The need to reclaim ownership in the energy sector is about building up a strong industrial base for the country nation, as pointed out by Peter Szijjarto, the Hungarian Prime Minister’s Spokesman.

“We do not have a serious national industry so in order to reanimate the national industry we need to take such tough steps as for example reclaiming MOL…. In order to make Hungary strong again, we need to eliminate energy dependence, and we need to restore the national character of our strategic companies in parallel with their international operation,” Szijjarto said (Reuters, and my take on it).

Hungary enters a new era with reclaiming ownership in energy companies. The sweeping election of Fidesz, according to Prime Minister Orban allows them to finally end the communist era in the country, thus the need for a new constitution and to reshape the country according to their ‘post-communist vision. The introduction of high taxes on sectors of the economy that are privately held, like banking, energy and retail that were done to save Hungary from economic ruin, as it was explained at the time, now begin to appear as part of a broader reworking of the economic order in Hungary. Orban is leading the Fidesz-KDNP coalition in the process of not just transforming the country from a communist-socialist-private capital haven, which is represented in its own local form, but slaying the broader global order of neoliberalism. Hungary is now, according to Orban, leading the world into a post-neoliberal order.

“While we have put an end to the basic principles of a neoliberal era, we have yet to build up the non-liberal economic policy of the 21st century, in terms of planning, coordination and practices,” he said, adding that because there had been no planning in the real economy, financial planning was askew.

“The old world order is on the verge of collapsing; we have no reason to wait for the advice and opinions of opinion-shapers stuck under the rubble,” Orban said.“We say, however, calmly, politely and unflinchingly: this is none of your business; this is the business of Hungarians,” the prime minister said (MTI, my take on it).

The end of Neoliberalism and American post-war capitalism

It is this new “non-liberal economic policy”  that Hungary will be leading the region and the world in. While Romania and Poland pursue privatization of part of their energy sector, under the old way of thinking that private capital can modernize the sectors and lift some of the economic burden from the state, Hungary views the energy sector not as a burden, but as the fundamental building block of a state owned industrial complex (haven’t we seen this before?).

But what is the post-neoliberal era that Orban describes he is putting in place? Well, this is a huge question that only quoting Gramsci, Polanyi and the like can answer fully – or only partly. But essentially, don’t expect the worker or the tax payer to be better off. The 2 billion euro price tag of MOL demonstrates that it is the taxpayer/worker/citizen that will be paying for this new order, through higher taxes and services (i.e. feed through of ‘crisis’ taxes in inflation) while also having their working rights eliminated, as demonstrated by the total elimination of worker rights in Hungary over the past year. In fact, the post-neoliberal era looks like it is described in this excellent article by Elmar Altavar as presented at a conference in Venezuala in 2008.

The crisis of neo-liberal ideology does not necessarily result in a post-neoliberal order which aims at social forms beyond capitalism. In the contrary, post-neoliberalism in finance can result in new forms of capitalist hegemony which again include a stronger role of the state. Contrary to ‘old Keynesian’ state interventionism, the new interventionism – including austerity with regard to the social wage – will not be designed in favour of workers’ interest and the environment, but in an undisguised political support of financial interests.

Understanding Capitalism takes Marxism

National solutions become the way out of the current neoliberal crisis of capitalism. According to Altavar the state comes back into the economy to provide support to the faltering capitalist system. But while Altavar describes a heavy burden being placed on the taxpayer to finance capitalism to save it from drowning, Orban uses the public monies, not to save the banks and the capitalists which traditionally drive growth, but uses the cash, along with the capitalist’s money, to finance state acquisition of companies for the purpose of reintroducing the state into the market based economy. This occurs in strategic sectors to benefit the Hungarian nation – and state. In this case, the energy sector.

Under Hungary’s new post-neoliberal energy order, energy companies will be used to extend the Hungarian nation-state into domestic and foreign economies. Under this nationalist guise, this may include active participation in former Hungarian lands (Romania and Croatia). The Hungarian territorial state is only a core vessel for the economic activities of the Hungarian nation. If growth and economic prosperity, under this line of thinking, is to occur then the whole Hungarian nation throughout the Carpathian Basin needs to benefit.

The re-industrialization  of the Hungarian nation will be led and financed by the Hungarian people and companies. The logic continues, that MOL, with the help of state owned electricity provider MVM, will lead this economic revival. Along the way, Hungary will boost its energy security through diversification of energy sources (although this remains dubious if  100% of oil is from Russia). The Hungarian nation will become strong by energy, industrial and financial diversification. Those leaders and financiers in America and Europe that Orban scorns, will hold little sway over how Hungary carries out its economic and social post-neoliberal revolution.

 

Fishing for boots: My lens of change on the energy sector

The interest in the current gas market in Central Eastern Europe demonstrates the increasing knowledge about our energy sources. Over the past few weeks I have answered a lot of questions from students and journalists about the gas pipeline projects and energy security in the region. I’ve never considered myself an expert on these topics, more a student myself. The energy sector is so multidisciplinary it takes knowing (and even mastering) several topics to begin to be a true expert on the overall subject. It is important though to have a base, or a prism, that the wider changes or processes involved in the energy sector can be seen through. For me, it comes from researching and analyzing change in the policy and regulatory environment in the energy sector and how this is connected to the local. This is the basis of my approach to analysis how markets and regulations interact to diversify energy supplies by fostering investment, or more broadly improving security of supply.

The solitude of thought

The history of energy is filled with transition periods, and if you take the long view, constant change and technological evolution becomes the norm rather than the exception. But all this change occurs within systemic parameters. Due to the significant capital investments and tight legislative and regulatory conditions that are infused into every activity of the energy sector, change is gradual. Transition from one technology to another is gradual, and altering habits, industrial processes and financial regimes all takes a very long time. This is why, as described elsewhere, the transition to a low carbon economy will take a long time unless, these systemic parameters can be altered and streamlined (here is the long journal article version of this argument).

Gas and electricity diversification, or energy security, therefore does not emerge from the sudden need to alter long established trade patterns. Crises no doubt can and does play a part in this, but the constant transition that occurs is partly the result of purposeful actions by stakeholders and broader inertia of regime change. Regulatory regimes, provide the context to frame the need to create specific change, whether for market liberalization or carbon reduction. Within this regime are broader societal, governmental and scientific thoughts that make an immediate impact and hold the potential for long term impact on the energy system. An example is the reduction in car use during high gasoline prices while long term is the increase of alternative energy inputs or alternative modes of transport.

Appreciation of the political-historical context also allows a framing of today’s energy battles. A recent conversation with a reporter, had him fishing for a quote that would describe a new period of relations with the Austrians and Russians. This stemmed from the establishment of a joint company to build 50 km of South Stream in Austria by OMV and Gazprom. Do I perceive a new era in the strong historical relationship between Austria and Russia? No, not really. My Hungarian history book has a few examples of cooperation between the Austrian and Russian monarchies and the squeeze that they put on the Magyars. Should we be surprised when two state owned oil and gas companies seek to pressure the main Hungarian oil and gas company. It was only the failure of OMV and Surgetneftegaz executives to understand historical context that led to their failed attempts to storm the battlements of MOL.

Hungarian Husars - just add a suit and tie for our modern day politicans and company executives protecting energy supplies

My main contextualization of the current transition efforts to reduce carbon stem from the study of the deregulation efforts in the US and the creation of regional markets. What I discovered was the actual deregulation had nothing to do with the perceived political actions for deregulation. In two case studies, of Michigan and Wisconsin – the first deregulated and the second didn’t – it was clear that the public understanding and the technical conditions for public choice of suppliers didn’t exist. Michigan while offering choice of suppliers for consumers, did not lay an effective foundation for competitors to compete with Michigan’s existing utilities. While Wisconsin politicians made it clear there would be no deregulation. However they took strong steps to separate the Transmission System Operator from the vertically integrated utilities, and began integration into a regional market. Essentially laying the basis for competing generation companies to enter the market. This is similar to the current EU attempt in market liberalization.

Underlining these two examples is the role of the local. Local control and local attempts to position their own energy companies to remain strong in the face of competition and possible take over. The laws and new rules instituted to keep MOL Hungarian correspond with the steps in Michigan and Wisconsin. Underlining the restructuring that occurred in Michigan and Wisconsin was fueled with the idea that local manufacturing needed to have competitive electricity rates, but the electricity companies needed to be pushed into offering lower priced electricity, while also protecting them from out of state corporate take overs. It is strongly felt, and the history of electricity in the US reflects this, it is through local control or local/state ownership of electricity companies that results in the ‘best interests’ of the community being fulfilled. Companies will have vested interests in the communities and therefore will act on behalf of the local.

The lens that can be used to analyze energy policy and markets needs to account for the local. It is the local leaders and their local energy companies that will work together to ensure a locality has sufficient levels of security of supply. Within this local formula of measuring security of supply is price, local control and technologies that are used. Crises, or external knowledge, along with new regulatory regimes (i.e. thoughts on how markets and society should be organized) all influence the pace of change. Stagnation of technology or the regulatory structure will impact the ability of the system in the medium and long term to adapt to external ‘threats’. This may be shown in a single large or a series of events. It is through this prism of the historical local political-corporate interests and the role of  technology that my analysis is based. Fishing for the ‘new’ in energy will only land you with an old boot.

Hungary’s Investment Environment. Run or Play? Part 1

The idea that people and even companies are locally dependent, and not mobile assets, is now a long established academic debate. This may be at odds with some of the earlier ‘globalization literature’ which classified multinational companies as highly mobile and which seek out the cheapest labor and locations.

Hungary, and more specifically the new Fidesz Government,  is now putting this theory to the test. Interestingly, they are applying it to economic sectors that are less mobile than manufacturing. Utilities, retail chains, banks, telecoms, all sectors that require huge amounts of investment over a long period of time and that can not easily dispose of these assets – particularly in the current economic climate.

What I would like to do in this multi-part blog post is to attempt to understand the impact on the utility and energy sector that Hungary’s two extraordinary taxes (extension of the Robin Hood tax and special sectoral tax) will have on the companies and the country in the medium and long-term. And how this affects Hungary as a country that potential investors will invest in.

In this first post, my intent is to just lay down the basics of how the utility sector works with the political/regulatory sphere. This will allow a means to assesses recent changes in Hungary and the medium and long-term impact of tax changes.

Competitiveness of location

The energy, and more specifically the utility industry, is marked by embedded assets. They are stuck to their geographic location. Therefore, it is incumbent upon them to make the place they are located in, a competitive and attractive place to do business.

The role that utilities play in the US, since they are consigned by decades of regulatory oversight, is to act as economic development agencies. They help companies find suitable locations for investments and can act as go-betweens, for interested companies and local governments. They are essential players in the economic development of US states.

Utilities in Europe, while they may not play this essential go-between role (particularly in more liberalized markets, even less-so), they do play an important role as economic development agents by ensuring reliable infrastructure and acting as indicators themselves, for other investors. The utility industries close proximity to political and regulatory decisions can make it a litmus test for the broader economic environment in a country. Utilities are sensitive to the predictability of regulations and long term investment signals governments convey. In addition, utilities and other energy companies, are the economic backbone of a country – and essential for economic development, particularly for manufacturing.

There is a political and economic balance that politicians and regulators take with utilities. There is a margin of profit allowed to monopolistic utilities (and even those operating in a semi-competitive environment) in exchange for good service quality and competitive prices. When the prices become uncompetitive or perceived as too high, it can be shown, that political and regulatory efforts will be taken to reduce the profit levels. This may take the form of altering the market structure (movement from monopolistic to competitive market), imposing special taxes (a Robin Hood tax), or altering specific regulations that impact the profit levels.

These different steps can have long-term and short-term effects on how companies operate. What is essential is that investments continue in order to maintain the competitiveness of the location (upgrading lines and investments into generation and fuel supplies) and to allow a long-term predictable regulatory environment. Disruption of this path, will set back past efforts of providing sectoral stability. This can be seen in how privatizations were conducted and initial conditions agreed to. For example, if respect for these earlier agreements are not honored or acceptable alterations are not reached, then even the reason for privatization (modernization of infrastructure at a lower cost and economic growth) is lost. High market risks are reintroduced and investment decisions are delayed.

Therefore, it is essential that historical commitments are honored, or altered with mutual consent, by politicians and regulators with input from utilities. If continuity of investments is maintained in a stable regulatory environment then this sends a signal to other industries and over the long-term reduces the risk level for a country; with the knock-on effect being lower financing costs and lower prices for household and industrial consumers.

With these basic parameters laid out, in this first part, I’ll apply these to the situation in Hungary. This is particularly important as Hungary was the first country in Eastern Europe, where utilities were privatized and bought by foreign investors. Just a few years ago, a CEO of one of the largest utilities told me, the risk level his company gives for Hungary was no different than for a Western European country. However, a regional banker recently told me energy companies now see Eastern Europe as a high risk investment location with low returns. Making it an undesirable location for business.

These views will be examined in the second part. The recent imposition of extraordinary crisis taxes in Hungary may affect  investment plans and the countries investment environment – including assigned risk levels. In the next post, these new taxes will be reviewed and the impact these may have on the utility companies. The final post on this topic will address the medium and long-term impact this has on the country and other industrial sectors.