Tag Archives: Finance

Putin-Orban Politburo Meeting: Cash and energy co-dependency

The global fall in oil prices and the shaking foundation of Russia’s economy has analysts and the media questioning Russia’s commitment to financing and  building Hungary’s expanded Paks II nuclear plant. On February 17, Hungary’s Prime Minister will be in Moscow for a meeting with Putin – almost a year to the date Putin visited Hungary. Top of the agenda is energy. In this short analysis, I’ll simply be stating the importance of energy projects and the historical commitment both Russia and Hungary hold to supply side economics of energy resources. Their common energy policy is: Immediate cash is more important than long-term energy reduction methods. This is in contrast to more advanced countries which are moving to tackle demand side inefficiencies and rolling out low cost distributed generation technologies.

The autocratic habits of Putin and Orban make them susceptible to stick with supply side economics. Pushing out natural resources and producing more and more energy to grow an economy is straight from the Politburo playbook. Or more accurately, Gosplan’s book.

To frame my discussion on supply side history of energy resources let’s go back to the 1980s, when the Soviet Union’s organization of Gosplan set the five-year plans. And let’s frame this discussion within the general economic difficulties the Soviet Union found itself in the 1980s. Energy investments were planned to increase 50% between 1981 and 1985. More broadly, this “implied that energy was to absorb fully two-thirds of all new Soviet investment during the coming five-year plan…. [With] the share of energy in the planned increment of industrial investment came to a whopping 85.6 percent.” This means, almost all of the money meant to build the Soviet economy was going towards energy projects. Much of this was down to the increasing costs of extraction and expanding the energy network from Siberia (Gustafeson 1989, 36). We can also insert gas pipelines to Eastern and Western Europe. In short, the energy sector was the primary recipient of financial resources for the Soviet Union. The sector held both domestic and foreign political-economic dimensions.

Just to bring us back to the era of Soviet energy policy and the Politburo

Wrapped in the Soviet energy strategy was rolling out nuclear reactors across the Eastern bloc. Hungary was a recipient of this push with the building of Paks in the 1970 and early 1980s. But Hungary pursued Paks only after it became clear that oil was going to be very expensive over the long term for producing electricity. Paks II represents the continued economic investment abroad for political-economic influence, and this supply side ideology.

There was a moment of rationality, by 1983, Gorbachev recognized the need to re-orientate, at a significant scale, capital onto energy conservation measures. Nonetheless, by 1985, global oil prices plummeted along with the dollars fall against other currencies. Oil profits were wiped out in the Soviet Union (Gustafeson 1989, 36, 46 -48).

It is important to pause here, I’m spending time on this, as it reflects our world today – in 2016, low oil prices and external conflicts (even down the the Syria/Afghanistan comparison).  The push for conservation was a watered down for the five-year plan starting in 1985, investment into energy supply would continue at a high pace – the money was needed, while energy conservation was given lip-service (Gustafeson 1989, 36, 46 -48).

An energy conservationist?

Russia is built on an export hand-to-mouth energy system. Political influence and immediate cash needs supersede long-term planning for efficiency and effectiveness of energy resources. Putin is lucky to find a friend like Hungary’s Orban who also understands the benefits of supply side energy for political and economic purposes. Cash generated from consumers helps to finance government expenses.

Hungary holds no ambition to reduce its raw energy needs. The solution of the Orban government since 2010 is to take money from foreign and domestic energy companies to reduce household’s energy bills by 25 percent. I’ve outlined how unsustainable this is before. The drop in oil and gas prices over the past few months, has seen households in Bulgaria pay less for their gas, but the same has not happened to Hungarian households. Essentially, either the financial losses in the system are being paid off, or the money goes into the ether.

Under the Orban government, over the long-term, Hungarian households are no better off than the foreign energy companies. The dramatic reduction in investments into the energy sector means fixing things as they break will cost more money. In addition, there is almost no money to invest into energy efficiency. If a large number of Hungarian households have trouble paying their energy bills – and this is the rational used for nationalization and reducing bills 25 percent – then they don’t have money to invest in energy efficiency which will reduce their bills more than 25 percent. Thus over the long term, Hungarian households will  pay more for an energy system with spot repairs and for leaky windows and walls.

Demonstrating the common perception in Hungary of corruption at the highest levels, the government is reallocating EU funds of HUF 309 billion meant for energy efficiency measures in 50,000 homes. The money will now be used only in public buildings. In my opinion this is an attempt to satisfy the EU’s energy efficiency directive. This stipulates that governments must renovate three percent of the buildings they own per year. Just like other large scale projects in Hungary (notably LED street lighting by Orban’s son-in-law), these government controlled projects are susceptible to corrupt tendering practices. Or in the eyes of the government, they can meet the EU energy efficiency directive while also channeling money to selected companies. They also do not need to finance this three percent goal from the state budget.

Just like the government of the Soviet Union, both Russia and Hungary place supply side energy economics ahead of demand side efficiency measures. Even if these measures cripple and stunt the economic growth of each country. Supply side measures are only short term building projects pumping out more and more natural and financial resources. Only the companies and individuals vested into building the infrastructure and selling energy resources make money. The financial resources of households are degraded over the long term because they must pay more for emergency repairs and inefficient homes.

Hungarian gas bills represent a simple wealth transfer to Gazprom and both the Russian and Hungarian governments: Twenty-percent of every gas bills goes to pay Hungarian VAT (this is higher than in 2008 – and even higher than Norway’s VAT), around 70% of householders bill payments go to the (mostly) Russian entities that sell the gas, including Gazprom Export. Thus, Hungarian households do a wealth transfer to Russia and to Hungarian government approved entities involved in the gas business. Only a small percentage of the bill actually covers the network costs – which the government waged the war against foreign utilities over. The increase in corruption in Hungary and the endemic corruption levels in Russia means Hungarian households are forced to pay for energy services that may also be involved in corruption. The costly expansion of Paks II, also fits into this narrative. If investments into energy efficiency (both electricity and gas) were carried out households could reduce this wealth transfer to Russia and the Hungarian government.

Source: European Commission, 'Energy prices and costs in Europe' 2014, https://ec.europa.eu/energy/en/publications/energy-prices-and-costs-europe
Source: European Commission, ‘Energy prices and costs in Europe’ 2014, https://ec.europa.eu/energy/en/publications/energy-prices-and-costs-europe

The original push for energy conservation by Gorbachev in the mid-1980’s was also a push for increase resources to benefit consumer goods and the lifestyles of Soviet citizens.  In the end, the financial resources went into expanding the energy sector to underpin an inefficient industrial sector. Immediate cash was the main concern. This is the same concern that underpins the operations of Hungary and Russia – thus they maintain a supply side energy system with high taxes. It would be useful if Putin and Orban spoke together about improving the lives of their citizens through energy efficiency efforts – and not expanding the profits of Gazprom and intermediaries involved in the gas business or large government projects meant expand energy production (Paks) or steering energy efficiency contracts to approved companies.  Hungarian household should not subsidize the supply side energy interests in Russia and Hungary. It would also help if Putin and Orban stopped acting like members of the Politburo in 1985.

Additional sources:

European Commission. “Energy Prices and Costs in Europe,” 2014. https://ec.europa.eu/energy/en/publications/energy-prices-and-costs-europe.
Gustafson, Thane. Crisis amid Plenty: The Politics of Soviet Energy under Brezhnev and Gorbachev. A Rand Corporation Research Study. Princeton, N.J: Princeton University Press, 1989.

The Day Hungary Cleaved from Europe: The true cost of Russian gas

The visit of Russian President Vladimir Putin to Budapest on February 17th, 2015 marks the day the Hungarian government voluntarily returned to the Russian sphere.

The outcome is three-fold: First, Hungary’s Prime Minister Viktor Orban openly rejected the EU path of energy market transparency and integration. Second, Hungary accepted ‘cheap’ Russian gas in exchange for a Ukraine-like gas arrangements which depend on Orban’s political fortunes at home. Third, Hungary operates its gas network for the benefit Russian geopolitical aims.  This arrangement threatens both Europe’s  and Hungary’s drive for energy independence, system stability, and European energy security underpinned by interconnection between countries.

A great friendship

The Cost of Cheap Gas

The Hungarian movement into Russia’s embrace was done in the name of ‘cheap’ gas. Reportedly, the price dropped from the oil-indexed price of $440 per thousand cubic meters (tcm) to $260 tcm, against a European gas-on-gas average price of $270 tcm. Bingo! Nonetheless, the drop is significant when you consider this post listing previous 2013 prices in the EU (before our recent oil and gas price decline). Importantly, the deal renegotiated Hungary’s previous long-term contract with Gazprom enabling it to utilize its previous unused gas on the take-or-pay scheme. Although, this supply extension (from a trusted source I’m told) was already agreed to back in 2008 when E.ON owned the import rights. Thus in short, Hungary received very little from Russia for all the political and economic favoritism listed below.

But first let’s put these numbers into a regional perspective. The new price is based on non-oil based pricing, thus hub price. Bulgaria, for example in 2012, renegotiated its long-term contract between Bulgargaz and Gazprom increasing the gas hub based pricing to 20% from 10% previously.  While OMV in January of this year, shifted to hub based pricing with Gazprom. Thus Hungary simply follows on this regional shift that began in 2008 and gets a somewhat lower price for being a good customer.

This temporary arrangement, rather than going with a new long-term contract, was done under the reasoning that current volatile gas and oil prices means Hungary may see further price drops in the future (er, or Russia might increase the price?). It is also enough time for Hungary and Russia lay plans for a gas link to Turkey. Importantly, for this article, election years in Hungary may occur in 2018 and 2022. Any change in government after 2018 will need to deal with the Russians at that point. Cooperation on gas and nuclear will need to continue.

Nonetheless, let’s not think in terms of only open market pricing – which Gazprom is not noted for. Particularly, when Putin shows up on your door. Rather let’s consider that Hungary’s European Union membership was openly sold for gas necessary to prop up artificial utility price cuts and for a trip wire gas deal – any shift in the governing party will result in more expensive gas. Cheap gas and political trip wires are key reasons for the past political instability in Ukraine, in other measures Orban is also shifting Hungary to the Ukrainian gas model.

The overall actions of the Hungarian government during Putin’s visit demonstrate Hungarian historical values are neither respected nor honored. Rather, shameful Hungarian historical political tendencies bared themselves by Putin and Orban’s negation of the living memories of Hungarians break from the Soviet sphere in 1956 and 1989.  But Hungarian society, the one that I know, is waking up. The Hungarian people reacted to Orban’s governing style, and no doubt Putin’s visit, by taking away his two-thirds majority in Parliament in a local by-election this week, February 23rd.  There is no social return to Russia’s barracks.

The Hungarian populace is firmly in the EU. In contrast Orban openly embraces Russia in the pursuit of cheap energy sources, in the form of gas shipments and new nuclear power plant agreement. This pursuit belies a more efficient scenario where Hungary’s EU membership serves as a basis for a more secure  and interconnected system that provides sustainable priced electricity and gas. EU presence in negotiations can also boost Hungarian gas deals. Following the EU path both honors Hungary’s European membership and advances national and EU energy independence.

Political reasons are behind Orban’s friendship with Putin. Hungary has cut electricity and gas prices more than 25% since 2012. During the 2014 local elections advertisements existed across the country proclaiming the energy price cuts; in 2013 there was an open government funded PR war against foreign owned utilities – even a petition drive! The price cuts, while good for households in the short term, have significant impacts on the energy system.

These prices are resulting in private gas and electricity companies hemorrhaging cash for residential customers. Eni, the Italian gas and oil company Hungarian gas subsidiary, TIGAZ, is accumulating financial debts nearing its capitalization.  The Hungarian government is racing to set up its own for profit service provider in 2015 (although they say it is non-profit, it is registered as for-profit). This is necessary to take over the universal consumer obligation. The private distribution companies, owned by ENI, RWE, E.ON do not need to file again to be universal service providers to supply electricity and gas at a loss on the regulated market to households. Nonetheless, to be fair to the Hungarian government, these and other companies did have years to foster a competitive market for households and they never did. The question though is how to foster a  fair market price without bankrupting companies.

The losses on the regulated market can be taken over by the Hungarian state, which has conveniently placed the ‘non-profit’ entity in the Hungarian Development Bank. However, the placement of many energy entities – such as a gas trading entity, into the bank raises red flags.  The potential exists for capital injections into the bank, by the government  to result in cross-subsidized losses. The bank incurs losses, through its ownership of the service provider, but the government makes up for these losses by capital infusions into the bank. However, under the gas agreement the current 25% cut likely be maintained without losses, thus Putin delivered Orban a golden egg – with Putin keeping the goose.

(In the past few months I have submitted questions on this topic to the Hungarian government and state owned companies but my requests for interviews were all declined. The Hungarian energy regulator did speak to me about the technical reasons for cutting gas off to Ukraine in September 2014 – a contract from Naftogaz was never returned).

The Hungarian energy system now operates under the same politically driven concerns as the bankrupt Bulgarian energy system. As a starter, under Orban and the Fidesz super majority in Parliament, the operating profits of the Hungarian utility sector as a whole flipped from a profit of HUF 224 billion in 2009 to HUF 119 billion loss in 2012.   Bulgaria is at least attempting to dig itself out of these past practices, which has placed the Bulgarian state owned energy company, NEK in debt of €767 million in the past four years. (well, it now recognizes these losses, so maybe it will act). Hungary is just lowering the ladder to go down this hole.^ Orban is right, he does need Russian gas to have cheap energy for consumers. The significant losses by utilities and the re-organization of the Hungarian energy market demonstrates this.[For more on information on the similarities of Hungarian and Bulgarian energy systems see this (draft) co-authored article].

Putin’s Pipelines

Driving further dependence on Russia is Hungary’s reduction of interconnector capacity between Hungary – Austria (HAG), and Hungary – Slovakia. The HAG has 3 bcm, but Hungarian state owned MVM holds a monopoly on the capacity granted by the Hungarian Parliament in 2011 citing energy supply security as justification. Capacity is extremely limited and widespread media coverage given to a partially Russian owned firm, MET, holding a special arrangement with MVM on importing and reselling gas into Hungary through HAG. The other owners are reported in the Hungarian media as being politically connected in Hungary.

The story of the Hungarian-Slovak interconnector is short. Meant to open in January 2015, ‘technical reasons’ keep this 5 BCM pipe closed. In addition,  operating rules are delayed while they are being modified. The importance of the SK-HU pipeline is viewed by the fact that German Chancellor Merkel in her February visit with Orban, brought up the use of this interconnector by RWE. As is clear, Putin has Orban’s ear, not Merkel. It remains unknown when this pipe will open.

Constraining Hungarian import and export capacity also constrains volume and price liquidity on the Hungarian market. This would erode MVM’s and Gazprom’s lock on the Hungarian gas market and even allow export to Ukraine. Evidence of this can already be seen in the relatively huge profits booked by MET through its deal with MVM shipping gas from Austria. In 2010, MET had HUF 44 billion revenue in 2010, by 2012, the company had  HUF 280 billion in revenue and “paid 60 billion in dividends to its owners, 2.5 times more than the overall dividends paid by the whole group of foreign incumbents in the same year.”* Or as mentioned above, the utility sector as a whole experienced a  HUF 119 billion loss in 2012. Other market players receive no such treatment, instead they are burdened by both special sectoral taxes and regulated utility rates. The losses in Hungary may only be comparable to Bulgaria – not a model energy system, plagued by riots and constant court battles between utilities and governments.

In terms of the SK-HU interconnector, RWE would benefit by both exporting to Ukraine and servicing Hungary’s industrial sector, which are stuck with Russian gas. In addition, Orban promised Putin not to re-export Russian gas to Ukraine, further restricting gas that could flow to Ukraine.

Market liquidity enables Hungarian industry to build managed gas portfolios enabling them to leverage a variety of gas trading mechanisms to hedge and play with market pricing. These should be done on a liquid Hungarian gas exchange which is operated by MVM’s CEEGEX. Instead, western European gas is limited in Hungary.

Under current rules, Hungary operates a ‘free trade zone’ for gas in its state owned gas storage facilities. Gas traded between entities is confidentially reported to the Hungarian energy regulator.  No tax is paid until withdrawal happens. Thus, Gazprom is able to ship gas to Hungary, the gas can be traded multiple times, and only once it is withdrawn from storage does the price become known. Non-transparency is a friend of Gazprom. Just as huge profits are booked from imports from Austria by the selected MET, who buys and trades with MVM, the stored gas remains opaque. Bi-lateral contracts while legal, should be pushed towards the exchange. Hungary already has CEEGEX  where all free-trade zone gas should be openly traded and would serve Hungary and the region well. Orban has a vision to develop Hungary as a gas trading hub. Restricting imports and exports reduces Hungary’s regional potential.

The necessity to increase Russia’s gas storage in Hungary was prevalent last fall when Hungary needed Gazprom to store gas in Hungary  because it did not purchase enough over the summer months. After Hungary purchased the storage company from E.ON in 2013, the new owners in their first year were waiting for market participants to fill up the storage. With the Hungarian energy system already running a huge deficit, and the Hungarian government slapping taxes on everything from coffee beans to maintaining its 27% VAT,  the country is hard pressed to pay for gas.

One of the key outcomes of the recent Putin-Orban deal was Hungary now only pays for stored Russian gas once it is used. This means Hungary does not need to pay for gas sitting unused in its storage facilities. Security of its gas supply is now handled by the Russians. This is important, as was the case this past year, where Hungary had expensive Russian gas sitting in its storage while the hub price next door in Austria was significantly lower. This may be one reason, the HAG interconnector has a stuffy nose.

This agreement for storage between Putin and Orban also validates my previous argument explaining why Hungary stopped gas shipments to Ukraine and was not able to fill-up its storage during summer. By September 2014, it was clear the Hungarian government needed Moscow’s help. Thus the gas storage deal was struck in September and shipments to Ukraine blocked to make way for the deluge of Russian gas into the Hungarian gas system – or so the official explanation goes. (Coincidentally shipments stopped after Orban met with Gazprom CEU Alexei Miller in September 2014, previously I gave Orban the benefit of the doubt, no longer).

The agreement over flexible storage amounts and timing of payments is also reminiscent of Ukrainian dependency on Russian gas. In the past, Ukraine’s inability to pay for gas placed it under the thumb of Moscow. When Ukrainian political leadership changed, it also meant a significant price increase  for the European friendly government. The new flexible agreement with Putin and Orban further opens the way for any post-Orban political era – which the Hungarian people are beginning to contemplate. Future gas negotiations will need to occur in 2019-2020, time enough to check in on Hungary to see how well Paks is progressing (the start of construction), gas price shifts, Hungary’s stance on EU energy integration, and after the 2018 elections.

The impact that Orban’s embrace of Russia is already apparent. Neighboring Slovakia is planning EuStream which seeks to build an interconnector with Romania and routing the gas via Bulgaria to the Southeast market. This avoidance of Hungary goes against Hungary’s historical attempts to unify both the CEE and SEE region into a tightly integrated gas market. In 2007, Hungary’s MOL took the initiative in its New European Transmission System (NETS) to lead the way. I personally sat in one of the first meetings and it was clear while MOL was taking the lead, it was political resistance in the other countries that held back the concept.  Now we see Hungary attempting to maintain its political control and influence over the region, with neighboring states planning to avoid Hungary.

The pipelines leading into Hungary from Austria, Slovakia and Ukraine, under current operations, should be viewed as strongly influenced from the strong friendship that exists between Orban and Putin. It is apparent from many of Orban’s public statements that he views Hungary being under the tutelage of Russia. Despite calls that Hungary’s energy sovereignty must be protected at all costs. The cost is a battle with the EU over Hungary’s low energy prices, not with Russian energy dependency.

Quixotically, the result is reliance on Russian gas and nuclear technology. The definition of ‘sovereignty’ in recent history holds its place in the last great international relations era when the Soviet Union existed. Thus for this argument of energy sovereignty to even make sense, it must be defined as energy dependence with political and economic sovereignty at home. Unfortunately, if we look at Ukraine, not only have they lost territorial sovereignty, political sovereignty was violated when Russia increased their gas price as retribution for being EU leaning.

When Orban speaks of sovereignty he speaks of his own political sovereignty – retribution will come for new political leadership not aligned to Russia. Putin’s pipeline’s are no longer just transit pipelines.  Hungary maintains energy security restrictions on the HAG, flips on and off the tap to Ukraine, and has technical difficulties with getting its interconnector up and running with Slovakia. All these align with Russia’s aim of restricting regional gas flows. In the past I have usually given Hungarian authorities the benefit of the doubt on these technical matters. Sometimes, it is good to question authority.

The Message: Orban left Europe

The stern and cold messages sent by both Chancellor Merkel (before Putin’s visit), who didn’t know what to make of Orban’s admiration of ‘illiberal democracy’, Polish Prime Minister Ewa Kopacz who held, “honest and difficult talks” with Orban (after Putin’s visit), Slovakia routing neighboring pipelines around Hungary, Romania’s intelligence chief considers Hungary untrustworthy, and Ukraine invites the regional heads of state for a commemoration, but not Hungarian, these all send a clear message: Orban cleaved Hungary from Europe.

The European project founded on energy security and dependency is firmly rejected by the current Hungarian government. All European energy systems are nationally focused, but only those systems most open to corruption and voter manipulation, like the case of Bulgaria or Ukraine, firmly reject integration, transparency, and cooperation with neighboring countries. The European energy system pushes market transparency and integration in the pursuit of prices that sustain and develop the energy system.

In contrast, secret middle of the night nuclear deals, opaque financing of energy utilities, state controlled pricing, coincidental limitations on imported gas,  all underpinned by a hotline friendship – with a leader of a country that formerly occupied your own country, and  just invaded your neighbor, but who gave you some ‘cheap’ gas, to help your politically controlled energy system, reads like a Russian novel, with things never ending well for the main characters.

On top of our Russian novel,  none of Orban’s actions can be labelled as energy sovereignty. Rather, as we can see from Ukraine, energy dependency creates political instability, under investment in the energy system, corruption and the maintenance of a political distance from Europe. Stepping out of Russia’s line results in swift reprisals.

February 17th, 2015, Orban was the lone man out in Europe for opening Hungary to Putin.  The pursuit of cheap gas, the rejection of Europe’s new Energy Union and embrace of a former occupier signals Hungary’s political, economic and energy dependence on Russia. This new relation is dependent on Hungary’s nuclear power deal withstanding EU scrutiny, sustained ‘cheap’ Russian gas and Hungary threatening to block EU diversification efforts  through the Energy Union.  Hungary stands with the opaque political governance model of Russia, not the transparent governance model of the EU.

Nonetheless, as Hungary’s long history shows, the Hungarian people do kick the Russians out. The price Orban got for gas is already too much for most Hungarians.

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References:

^LaBelle, Michael, and Atanas Georgiev. “The Socio-Political Capture of Utilities: The Expense of Low Energy Prices in Bulgaria and Hungary.” University of Eastern Finland, Joensuu, Finland, 2015.
 *Felsmann, Balazs. “Winners and Losers on the Liberalized Energy Sector in Hungary: A Co-Evolutionary Approach.” Budapest, 2014.

Euro Energy Czar: Does West Europe finally get it?

The apparent creation of an energy czar for the European Union signals a harder line against Russia. A move from the days when Germany’s Chancellor, Gerhard Schroder moved from the chancellor’s chair to a Gazprom chair – represented the ‘tight’ relationship between Germany and Russia. Akin to marriages  between European monarchies. (I’ll leave it to you to develop the image of Schroder marrying into a Russian oligarch family.)

The revitalization of the eastern European countries is now represented by the appointment of Prime Minister Donald Tusk of Poland to lead the other European leaders in the EU Council of Europe. Tusk earlier this year championed a call for an EU gas union that was widely acceptable as a great idea – and has pushed forward the long simmering discussion of a closer EU energy union.  In 2010 former European Commission President Jacques Delors and Polish MEP Jerzy Buzek, floated the idea to build an EU energy community – drawing from the founding structure in the European Coal and Steel Community.

It is now the Polish contingent that is pushing for a ‘high official’ to coordinate all external energy policy.  The EU Parliament’s Foreign Affairs Committee overwhelming adopted the proposal to create an energy czar to represent a common EU energy position in the foreign policy realm. Adopting a common energy foreign energy strategy and representation – no matter how muddled by diplomatic niceties, is stepping in the right direction to address the tremendous energy security gulf between ‘old’ member states and the states joining since 2004.

As I’ve written before, there is a huge gap between the development of the energy systems in the west and east. Both financially the western EU members are able to invest and upgrade their energy systems, while the east are stuck attempting to keep prices extremely low, with limited upgrades throughout the system. This applies to rolling-out more energy efficiency measures and renewable energy. The east becomes stuck in this pipeline dependency. Unable  – and in some cases – unwilling to finance their way to a new energy system.

Independence from Russia is a nice dream, but energy is the way Russia projects its power. For some politicians, like Hungary’s Prime Minister Orban, staying within the Russian sphere of influence holds financial and political benefits. For the Poles, they gain politically moving away but are so wedded to the Russian gas system, and reject significant upgrading to their energy system, such as getting off the carbon road, that they remain tied.

An EU energy Czar able to counter the Czar of Russia (Putin) must be given legitimacy from EU members.This means both the Germans and the Hungarians – much line up with the Poles and seek greater independence from Russia. However, as the building of the South Stream pipelines shows, Hungary and Bulgaria are willing to move forward with Russia on the pipeline despite strong resistance from Brussels. Unilateral agreements and development projects – at the expense of the overall long term EU energy security – will fail to elevate the Czar to a meaningful position.  European countries must line up, and even lend some sovereignty to an EU high representative for energy. The foundation of the EU is based on coordination of energy and industry, let’s ensure this remains central to keeping Europe strong.

 

 

EU Needs to Protect Founding Principles: Threats from Russia & Hungary

The time has come for the European Union to morph into a strong international force representing democratic rights and international stability.  Acting softly does not work. The confluence of aggressive Russian tactics to take more territory from Ukraine and Hungary’s rose-tinted glasses on the authoritarian political-economic model of Russia and China – and rejection of EU liberal values, threatens Europe’s founding principles and its territorial integrity.

Peace is threatened on Europe’s edges. It’s time to reach back to the values and wisdom for the founding of the European Union, when it was the joining of the European coal and steel industries, with Germany and France uniting for lasting peace in 1951. Economic dependence would unify the continent and prevent war.

The annexation of Crimea by Russia is now an accepted territorial change.  Russia got it for free because the international community didn’t stand up for Ukraine. Now Russia is expropriating more territory to serve Russian President Putin’s political and nationalistic ambitions. Continual instability on Russia’s fringes can help keep not just his popularity up, but keep Russians together rallying for another war. At this point a victory is necessary for Putin. If annexation of eastern Ukraine is not the ultimate end, then instability and projection of an independent Russian enclave inside Russia will do. Control of Russia’s political system, state apparatus, the media, and clamp down on NGO’s all serve to ensure Putin’s power remains unchallenged, ultimately serving his aggressive foreign and military policy. Manufactured crisis ensures domestic support and keeps institutions and the populace toeing Putin’s line.

Hungary's political-economic model, as perceived by a street artist.
Hungary’s political-economic model, as perceived by a street artist.

In Hungary, the parallels are apparent. Orban has waged his own one-sided war against the EU, IMF, US, NGOs and almost every foreign government. The Orban government is actively inciting irredentism  in Romania.  Instability, created by Hungary, provides the government a platform to ‘represent’ Hungarian interests internationally. The ‘rational’ goes, sins between 1989 and 2010 of liberal economics and communist political maneuvering must be wiped out. However, for most people, this was the democratic period that Hungary had. Nonetheless, democracy, as stated by Orban, doesn’t really work well; now we can watch as Orban consolidates his personal power further by rejigging the whole state institutional structure, and improving upon his (essentially) unlimited authority. In two to three years time we will soon have President Orban to call the leader of the country. Echoing Putin’s back-and-forth between prime minister and president.

Fidesz and Orban have a false mandate. No government can be claimed legitimate when election rules are changed and when the OECD finds the elections unfair. The current two-thirds control in Parliament would not have happened if the elections were fair. Currently, the current local elections are under way, Fidesz wasn’t going to win (or by much), so the rules were changed at the last minute. In a few weeks, they can claim a ‘democratic’ mandate to continue their illiberal and illogical policies of modeling Russia, China and India – and not European countries.

Autocratic leaders are challenging the values and the founding principles for the European Union. For these autocratic leaders nationalism can replace economic growth along with illogical economic and foreign policies. The ‘nation’ also also replaces liberal democratic institutions and individual rights.

The 2008 economic crisis resulted in a delayed and inept EU handling by failing to foster economic cooperation between members states. The current democracy and territorial crisis caused by Putin and Orban, pose a deeper threat to the stability of the EU. Orban and Putin both disparage and dishonor the democratic principles and right for economic freedom: they both reject international stability done through common economic and political values. The expression of the nation is more important than economic growth or individual rights. Instability and security concerns are necessary to project an ‘us’ or ‘other’ mindset. Components needed to maintain unlimited power.

It is now time for the EU to solidify and project its unified strength against aggressive rulers with territorial ambitions and authoritarian power. Not standing up for the founding principles of the EU threatens unleashing the same violent forces the charter was established to contain. The EU must now escalate the cost for Russia to maintain its outpost on Ukrainian territory. Through both economic means, and in human life, through increased military aid to Ukraine to maintain eastern Ukraine. Russia won’t know the EU is serious about territorial integrity until it actively works to keep it. In addition, Hungary may be Russia’s outpost in the EU, but that does not mean the EU must accept or maintain the outpost. Appeasement for authoritarian leaders threatens the political, social and economic founding principles of the EU, and its territorial integrity. The EU needs to act.

 

Hungary’s Viktator crashes against the new global order

The crash of the Hungarian forint had us all on edge this week. The ripples went out to neighboring countries and the Eurozone as a whole. The Hungarian Prime Minister, Viktor Orban became globally known by his local name, ‘Viktator.’ With these economic waves, the international press woke up to the disappearance of democracy and failed economic policies in Hungary.

The currency collapse and the removal of checks and balances between government institutions, along with the high speed erratic-drunken-like policy making that marks the Orban regime, is nothing new to us locals. But what is so great about Orban taking Hungary over the cliff of rationality is what it exposes for the modern state system: Erratic dictators are controlled by an international regulatory regime that requires stability, predictability and fairness. Orban went against every tenet of this system in his nationalistic power grab. Foreign companies and Hungarians themselves are all paying more for Orban’s ‘rebirth’ as Hungary’s nationalistic savior.

The politicization of key government and regulatory institutions (judiciary, finance, energy, media, etc.) and the removal – or simple lack of professional knowledge, erodes these key tenets and forces the country into a downward spiral of economic and political demise. In short order Orban himself caused the currency to collapse. He failed to restructure the state to meet modern economic challenges – instead restructuring it to meet his vision of a nationalistic ‘independent’ state. He did this through the  politicization of economic and social policy, and the cementing of these failures into the country’s constitutions. Collectively, these changes doom the country for generations to come. Regardless of what international institutions can force Hungary to change under the pressure of complete economic collapse – a collapse Orban may even accept with his North Korean style nationalistic ideology.

Orban drives the Hungarian economy off the road.

Others will point to the Eurozone crisis as playing a part for Hungary’s economic collapse. If a drunk driver hits a person crossing the street, is it the pedestrian’s fault – or the drunk driver’s? A sober driver may be the  most boring person at a party, but at least they will get you safely home. And that is why we need professional regulators sitting in independent regulatory institutions. The key players in the Eurozone are financial regulators and central banks – each a professionally managed and independent institutions buffered in various forms from political interference. These are the ‘guys’ you want to drive you home.

More broadly the European Union and global modern governance is based on independent regulatory institutions. There independence is secured through how directors are removed or term length, there mandate is to serve the people. Because of this mission, their appointment process should be as depoliticized as possible. They should also reflect local characteristics of each country’s political and historical system (appointments by monarchs are possible). But since Orban is not officially yet the King of Hungary, we can view him as a political actor.

Theory

The global regulatory regime, or ‘regulatory capitalism,’ for David Levi-Faur, holds distinctive characteristics separating it from previous regulatory eras:  stronger autonomous agencies, new technologies of regulation, new national and international regulatory layers. The “hegemony of neoliberal ideology” is more discursive, as capital is constrained through a regulatory regime (Levi-Faur 2005, 27). While Levi-Faur looks at the role of capital we can use Hungary to help us make the link to the political actions of the state.

The charts below demonstrate the rise of regulatory institutions in the EU. These were created to provide a professional policy environment in increasing complex fields that require complex understanding of each sector. This also corresponds with the integration of the EU (or previously the European Community). Globally, the rise of regulatory institutions is mirrored – therefore we can can describe the rise of a global regulatory system.

Can Orban go against the rise of the European regulator? (source: Gilardi 2005)

Regulatory regime saves democracy

The Viktator of Hungary has decided to stand up against these international and national regulatory institutions and politicize the depoliticized technocratic regulatory institutions (i.e. serving the bankers alcohol). He is taking the rug out from under global regulatory capitalism, and forcing it to operate within an unpredictable policy and regulatory environment. The leaked conditions that the IMF has proposed Hungary follow to secure a new financial agreement represent not just  good economic practices but re-enforcing and re-institutionalizing a more stable regulatory order.

– restoring the central bank’s independence;
– reinforcing the Fiscal Council;
– stricter fiscal policy, especially on the expenditure side;
– considerable reduction to crisis taxes and their eventual phasing out;
– putting a stop to implementing ad-hoc economic policy measures;
– seeing through the previously announced reform measures;
– overhaul of the system of social transfers;
– restructuring of public transport companies;
– introducing the institution of consumer bankruptcy

The IMF conditions in blue represent the conditions necessary for global regulatory regime to operate. (As a daily rider of Budapest’s public transport company, BKV, and as such a consumer of carbon monoxide inside the bus, I welcome a long-term vision of financial stability and investment in public transport too.) These conditions lay bare the role that independent financial institutions play in overseeing a country’s economy. They also indicate the areas where the Orban regime has failed to provide professional leadership.

Reinforcing the failure of abiding by the rules of the regulatory regime – in the social sphere is Hungary’s year old media law,  completing Orban’s control over public discourse. Even here, in an in-depth comparative  report on Hungary’s media law done by Central European University, shows the new media regulator fails in every respect to uphold the public good and emerges as a political tool of the Orban regime – and is not an independent regulator.

The former PM Viktor Orban puts out an engine fire on his bus. After being ousted as PM in 2012, Orban became a bus driver at BKV.

In an article that I’m writing on the diffusion of regulatory practices in the energy sector, I emphasize how international best practices that guide regulatory making are localized within social, institutional and political arrangements within each country. This must occur in order for these institutions to be effective and to reflect the needs of citizens. There is a strong debate that these regulatory institutions are anti-democratic and remove democracy from key social and economic actors.

What is clear in the case of Hungary, it is this global regulatory regime, and even international capital, are saving Hungary’s democracy. Or at least attempting to save it. For as much as the IMF can impose financial conditions necessary for Hungary to be bailed out, it is the political support and demands of the EU that will serve the citizens of Hungary in supporting to have democracy partly restored. Maybe the laws on media, judiciary and finance will be amended in the short-term. However, Hungarians will still need to remove the Viktator and his regime from power and re-institute the broader system of checks and balances. Hungarian voters themselves must re-establish democracy in the country. No global or international coalition of institutions and governments can provide the localized and contextualized institutional and social arrangements that a national civil society can develop. So while Orban has given the finger to the international regulatory regime, it is the actors in this regime and the Hungarian people that will have the last word.

 

A picture of Orban running from a BKV Kontroller -Not even the Viktator can ride for free

 

Why Hungary’s revisionist energy strategy will fail

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

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

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

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

Examples from elsewhere

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

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

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

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

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

Squeezing the gas from the foreigners

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

"Any advice on dealing with foreign energy investors?"

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

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

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

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

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

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

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

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

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

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

Regional expansion

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

Foreign ownership in privatized electricity distribution companies

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

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

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

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

 

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

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

Conclusion

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

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

 

Bulgaria: Oh – I have to pay for the pipeline?

Will that be cash, credit or debit?

Bulgaria appears to be ahead of most countries signing up for gas projects. Probably only for the fact that they are the only ones that might be able to squeeze a little extra money out of others. Sofia now wants a little extra help from the EU to finance its pipeline construction to connect to Nabucco. I guess a transit pipeline is not much help if you can’t get the gas out of it. Seriously, though this raises two flags.

One, Bulgarian finances are tight, but so are the other CEE countries – Romania, Hungary, how will these countries be paying, not only to build the actual Nabucco pipeline but the connections for the off-take? Will MOL and Transgaz be able to self finance these portions? For me, this is a significant point as it indicates that the other countries will be coming out with similar requests for financial help or maybe even a reduction in their share of financing portions of the project. If things are financially tight now, for companies and governments alike how will they raise the needed capital in time to begin construction in the next few years?

Point, 1.1 For Bulgaria, Serbia and Hungary it also must be asked:

– What about financing of South Stream connections?

– What about financing for South Stream pipeline portions that are more directly connected to state participation?

Two, we have a on Trend.az, of Bulgaria getting ready to join AGRI. Georgia is keen to export Azeri gas via tanker to Bulgaria. However, while the whole AGRI project remains speculative, it becomes even more unsure when it appears that Bulgaria can’t finance key aspects of the Nabucco project. Security of supply can be increased for each country, but participation in every new gas pipeline project that is announced seems dubious.

And three, what will also appeal to Hungary and Romania, is Bulgaria request to shift Nabucco costs out of national budgets – i.e. debt levels will not be seen.

Overall, the financial crunch is emerging for these projects. While countries continue to sign up and support all alternative routes – the deeper questions of who is going to pay for this still needs to be asked. In addition, if these pipelines/LNG facilities are built how much will gas cost for consumers? Will the cost be so high, as to reduce demand making these projects over ambitious?