Just as surely winter comes every year, so does the heating season. However, if the justification from Hungary’s TSO, FGSZ is to be believed, they need to stop gas shipments to Ukraine to prepare for this winter. The Hungarian Prime Minister, Viktor Orban appears to be the grasshopper in Aesop’s fable. The Grasshopper and Ant story is about a grasshopper that plays all summer while the ants work – in preparation for winter. Well, in the cartoon version, it only takes the fall leaves to be blowing for the grasshopper to get cold and regret that he didn’t work harder. In our version today, it is the Hungarian government who didn’t work hard enough in the summer. Although on a state radio news broadcast last Friday night, Orban was credited with ensuring the country has enough gas for the winter – the announcer just didn’t mention this was at the expense of Ukraine.
If we can piece together events, on September 25th it was Naftogaz of Ukraine that suddenly found out, through an email from Hungarian TSO FGSZ, the counterpart was halting deliveries to Ukraine. Media reports imply this was after pressure from Gazprom’s head Alexei Miller met with Orban. However, I do not agree. Hungary is on too good of terms to be threatened by Russia – unlike Poland which disrupted flow for a few days after Russian pressure in September.
The reason Russia refrains from threatening Hungary is the Hungarian Prime Minister is at the forefront in Europe arguing against sanctions over Russia’s involvement in Ukraine. In addition, Orban spearheaded and flew in secret to Russia to sign a deal with Putin to expand the existing nuclear power plant. A big win for Russia to get an EU member to sign up to Russian nuclear technology. Hungary has secured a Russian loan to build the plant, despite having no discussions with the Hungarian public or any feasibility studies. Orban is in charge of Hungary’s energy policy – and representing Russia in the EU. He also pushes to restrain Ukrainian western leanings. Pushing for great autonomy for ethnic Hungarians in Ukraine matches Orban’s nationalistic zeal and his regional agenda; autonomy for ethnic Russians also matches Putin’s agenda in Ukraine. Hungary turning off the taps to Ukraine benefits both Russia and Hungary, by keeping Kiev under pressure.
Technically speaking, Hungary halted deliveries to Ukraine to receive significant quantities of western bound Gazprom gas to be stored in Hungary. The history here is on September 16th Hungary’s Development Minister Miklós Seszták received Russian deputy Energy Minister Anatoly Yanovsky. They discussed the ability for Hungary to store gas for Russia, around 500 million cubic meters. This would take 15 – 20 days to transfer into Hungary’s underground storage. In a scenario that gas flows from Russia, traversing Ukraine, are cut off then Gazprom’s gas would be available to European consumers – and to Hungary. Importantly, it helps Hungary because as of September 27th, the storage capacity was at 62%. It is, however, no accident that Hungary’s capacity is this low at the onset of autumn.
In May 2014, at an event hosted by Central European University the issue of Hungary’s ill preparedness was discussed. A now former manager at Hungary’s state owned Hungarian Gas Storage company, stated that the biggest issue facing Hungary was the low reserves and the financing of gas purchases. The reserves then were at 25% capacity. In short, money to buy gas was inhibiting Hungary’s ability to prepare for the coming winter. Therefore, the current low gas levels of 60% should not be seen in isolation. The lack of gas is a result of the lack of stable state finances for the energy sector and Orban’s energy ‘war’ waged against foreign owned energy utilities. The energy sector is now showing the stresses of heavy state ownership. The flooding of gas into the Hungarian system is at best a result of poorly managed state energy assets, at its worst, it is a calculated move against Ukraine.
Since 2010 Orban has put energy assets under state ownership and driven utility prices lower. Now, the utility sector, and particular retail gas companies, are deeply in debt, they are incurring huge losses to pay for the Fidesz government’s more than 25 percent reduction in electricity and gas bills instituted a year ago. The Orban government is now laying out a plan to have ‘non-profit’ utilities. This is hard to see how the sector can shift from horrific losses to a non-profit-chartable-status without increasing consumer costs. The cost reduction and continued nationalization of assets are set to continue.
The story of Hungary cutting off gas supplies should not be seen as Hungary bending to Russian pressure, rather Russia is helping out Hungary. Central to Orban’s grip on elections is ensuring Hungarian’s feel benefits. Whether this is in the form of retroactively changing mortgage loans between banks and their clients – forcing the banks to payback money in cash, or buying E.ON’s gas storage unit – for energy security reasons – Hungary needs to project power and responsibility over its own fate – and at the same time, deliver cash into the pockets of Hungarians. Russia can help finance and make life more comfortable for Hungarians. Ensuring the Hungarian energy system functions is now dependent on Russian short and long term investments into the country (gas and nuclear).
Hungary needs more gas in its storage in case there is an interruption between Russia and Ukraine. Russia is more than happy to store gas in Hungary, this deal does the following four things to benefit Russia and Hungary: 1) Russia stores gas in Hungary and not in its normal location in Ukraine, giving it European market access and depriving Ukraine of the chance to siphon any off; 2) Previously stored gas was ensured by E.ON Foldgaz Storage, but storage is now owned by the Hungarian state- which lacks the funds to buy large quantities of gas; 3) Hungary boosts its gas reserves with no money down, it only buys from Gazprom if there is an emergency and needs to use it; and 4) Hungary gives the elbow to Ukraine (like it has throughout the entire Ukraine-Russia conflict) but doesn’t inflict significant pain, just cuts off gas for a few weeks proclaiming its own security as more important. Nowhere in this analysis is the assumption that Russia threatened Hungary with a gas cut-off for supplying Ukraine with gas.
Hungary could have – and should have, bought sufficient amounts of gas over the summer. Instead, the country’s leadership were playing with grasshoppers. Back in the spring or early summer the Hungarian government could have struck the same storage deal with the Russians. Instead both Russia and Hungary have waited until the last minute to unroll their ‘technical’ response to Hungary’s low storage capacity. By Russia flooding Hungary’s gas system, Ukraine is deprived of valuable and necessary capacity to help mitigate their looming winter gas shortage. In a generous reading, Hungary is an unprepared neighbor. In a bad reading, Hungary is colluding with Russia to short Ukraine of gas. Let’s hope Hungary is a grasshopper.
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.
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.)
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
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.
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.
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.]
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.
An effective expansion strategy does not only depend on the willing buyer, but the selling country – and their economic and energy strategy.
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).
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.
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.
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.
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.
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.
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.
The price the Hungarian government has placed on energy security for the country is 1.9 billion Euros. The price the Hungarian government paid to the Russia’s Surgetneftegaz for buying 21.2% of MOL shares, the Hungarian oil and gas group. The move was promoted by National Development Minister Tamas Fellegi, as a radical move towards energy independence, re-balancing the countries security of supply. It would also allow the country to be more competitive and enable it to hold more economic weight in the region. These two points do not hold up when Hungary’s – and the region’s energy supply sources are examined.
First, let’s define energy security.
“Energy supply security in fact is very close to the notion of the ‘sustainability’ of the energy system. In conformity with the precautionary principle, investing in supply security implies to incur current costs in order to avoid greater future cost…. This reinforces the demand for active, forward-looking, even if costly risk management”(Directorate-General for External Policies of the Union, Policy Department 2007, 22).
Does the 2 billion Euro purchase of MOL shares improve sustainability of the energy system? No. Hungary, and the CEE region are highly dependent on oil imports from Russia. Hungary and Slovakia are 100% dependent on the oil from Russia. As the graphic below demonstrates, no where else in the world, are two countries so highly dependent on one supplier. Hungarian Prime Minister Viktor Orban and his Government are making false claims if they say that owning a quarter of MOL improves the countries security of supply.
(This shows the dependency between oil importer (down) and exporters (across). The darker the square, the more dependent an importer is of an exporter. Importing countries are listed from most dependent to one single source to least dependent. Exporting countries are listed form most likely to cause dependency to least likely. Eastern European countries depend a lot on Russia, for instance. A few countries rely on Libya, such as Ireland, Austria, Switzerland or Italy. Countries like USA, Spain or France have very diverse sources of supply.) Source
Hungary, is around 80% dependent on Russian gas. While there are plans for gas diversification (Nabucco, South Stream, etc.) there is no discussion of oil diversification from Russia. As I wrote about before, Hungary and other CEE/SEE may become more squeezed in the future as production falls off in Russia and any additional/remaining supllies are redirected to more lucrative markets.
Government ownership of a quarter of MOL shares (add in nationalized pension fund shares) does not seem to improve Hungary’s long term sustainability in energy security. When you are essentially 100% dependent on one country for your long-term oil and gas supplies, along with 50% of electricity from Russian nuclear power technology, then significantly high vulnerabilities remain in the short and long term.
The purchase of MOL shares does not improve security of supply within this assessment. In fact, it may undermine it further by politicizing the operational management and strategic focus of MOL. Further government meddling may financially weaken the company making it easier for another attempt of a hostile take-over. But then the state can step in and purchase more shares, so don’t let this fact keep you up at night..
The second argument put forward that this move will make Hungary (and the region?) more competitive falls flat. It is important to consider for a moment, the deregulation of electricity companies in the US in the 1990s. The US Midwest was one of the most active regions to deregulate their electricity markets. This was mainly prompted by the effort to reduce electricity prices by inducing competition which would offer manufacturers lower electricity prices, making them competitive against other states and regions in the US. This was the exact spark that started it in Michigan (see my PhD thesis). Hungary is claiming that the synergies between the bloated state owned electricity intermediary, MVM and MOL can create an energy powerhouse that will propel Hungary forward in the region, and no doubt, move these companies more actively into other countries in the region. MVM-MOL becomes a CEZ on state supplied steroids.
This argument is undermined again, by the fact the Hungary and the region are so heavily reliant on the raw energy commodities supplied by Russia. CEZ runs on coal and can source gas from both Eastern and Western European gas markets. Can the operational and management costs be squeezed so low as to reduce consumers costs? MOL is already the most efficient oil and gas group in Europe, while MVM is non-transparent government owned elephant and no doubt could lose a few pounds.
Finally, The idea that purchasing the MOL shares improves Hungary’s security of supply and fosters a more sustainable energy system, by reducing risks in the short and long-term, proves elusive. Essentially, if Surgutneftegaz’s voting rights, if they were ever allowed to be exercised, were capped at 10%. Over 50% of the companies stocks were held by MOL or friendly investors. MOL was not in impeding danger of becoming part of the Russian energy empire. If this was the case, then there could be some justification for spending 2 billion Euros, but it is clear that Surgutneftegaz was only a minor shareholder with limited voting rights.
Hungary has not improved its energy security of supply with this purchase. In fact, by introducing state ownership and talking about how MOL fits in with a national energy company, the independence and operational efficiency of MOL are already becoming eroded. Hungary can only improve its energy security by diversifying supplies and reducing demand for Russian sourced oil and gas. Until it develops and begins to implement a long term strategy of energy reduction and diversification, Hungarian security of supply is dependent on the decisions made by Russian companies and their government.
Supply diversification for securing energy is based on long term persistence. The recent agreement by Hungary to establish a project company to assess the viability of the LNG based Azerbaijan-Georgia-Romanian Interconnector (AGRI), may be an initial attempt. However, current gas projects cast doubt on the viability of this project.
The project company is held with a 25% stake by each of the countries. The plan is to create LNG facilities on the shores of the Black Sea, emminating from Azerbaijan, then transport the gas via upgraded pipelines to storage facilities in Hungary, or onward to points west.
The viability of this project falls flat when you consider the other pipeline and LNG projects that are at more advanced stages, and provide equal or higher supply diversification.
First, the LNG facility under development on the island of Krk, Adria LNG, which at the moment does not have a direct investment from either the Hungarian government or MOL or its Croatian subsidary INA, is a cheaper and more effective option at supply diversification. The cost of the facility is substantial, so much so, that RWE recently pulled out. Leaving a gap that Hungary/MOL/INA can fill. The high cost of one facility to construct with 4 other partners would be substantially cheaper than building two facilities with limited supply diversification.
The fact that the gas that would feed AGRI is the same gas that will be feeding Nabucco or even the Edison backed IGI (if it happens), means AGRI offers very limited supply diversification. If we consider that Turkey and Bulgaria will probably be stable transport countries. Investing in a sea based transport route literally becomes a floating white elephant – with gas.
The limited supply of Azeri gas is already a problem for Nabucco and IGI. Will Hungary and Romania (already Nabucco partners) really compete against themselves for the same Azeri gas? Although it was just stated by Turkmenistan that they have huge reserves they want to export, realization of this supply, in an efficient and timely manner, remains to be determined.
Cost is another component. Can AGRI really compete against a pipeline route? Most likely not. Nabucco will cost €8 billion for 31 bcm, while the Krk facility is planned to cost $1.5 billion for 10 bcm per year. But then use this equation (LNG terminal x 2 + #tankers = expensive). AGRI has not stated the amount the capacity. I would also assume the long term operating costs are also much lower on a pipeline operation. In addition, the facility is being designed to be expanded up to 15 bcm.
There is plenty of room just in the Adria LNG facility to off set any need in AGRI. In addition, if additional Azeri gas is what Romania and Hungary really want, this can be transported through Turkey and bottled up and shipped via LNG tanker to Krk.
The peanut for this white elephant is the Hungarian government choosing to go with MVM to be the project company. If it was a viable project MOL would become involved in it, not a generation company that already distorts market operations. But just like South Stream is a government supported project with progress now amounting to the number of intergovernmental agreements signed, but limited identification of which Russian gas fields will be used, this project will be long on talk and short on results.
It is important to try to understand why Hungary and Romania are joining this consortium if it isn’t a serious project. I still stand by my earlier assessment of why Hungary is choosing both Nabucco and South Stream. However, I’m more unsure as to the purpose of signing up to this project, maybe it is to turn up the pressure on Russia. They can both press their positions on Gazprom and see if it is serious about building South Stream.
While Gazprom dallies to sign up new partners every day, at the end of the day, it may represent a political shot across the bow towards Russia by Hungary and Romania. They may be hinting to Gazprom to get serious. Romania may be pressuring Gazprom to choose it over Bulgaria for the Black Sea landing spot, while the new Hungarian government might just like to throw off balance Russia/Gazprom. Either way, AGRI is not a serious project for supply diversification – rather a mouse used to scare the elephant.
Has the light bulb come on for MVM or has it decided to play another game on the Hungarian market? This was the question dominating the workshop organized by the new HUPX company with participation of EPEX Spot, a European power exchange company on April 7th. The day-ahead power market will be coming to Hungary by July 1, 2010. A reference price for the Hungarian market may finally be created.
First, it should be stated that a day-ahead market in Hungary meets the pent-up demand of energy traders and the market along with paving the way for a more efficient operation of the electricity market in Hungary and in the CEE/SEE region. However there does remain skepticism and many questions as to the role that MVM will play on the market and MVM’s overall strategy.
To create a liquid tradable market exchange you need sufficient buyers and sellers participating. But the problem in Hungary is there is an elephant in the country – MVM. It is the (state owned) dominant market player. It has signficant production capacity, plays a market intermediary role and owns the TSO, MAVIR and now there is a growing interest in distribution companies, in addition to all this it is the owner of HUPX; in other words it is a big fat elephant that if it decides to sit down, then no one is going anywhere.
Gabor Szorenyi director of the Hungerian Energy Office stated at the workshop, this is essentially what happenend over the past two years, politically, and to the benefit of MVM, nothing has occured that would loosen MVM’s grip on the Hungarian electricity market to promote greater market liquidity. Now the possibility exists that some liquidity will develop. But how much is the question?
And this was THE question by participants. To what extent is MVM going to participate in HUPX, since it is the main company that can create liquidity on the market? The strange thing about the workshop was that while the representatives from HUPX and EPEX were there, no one from MVM showed up to explain how they would participate. A representative from the trading arm of MVM Partners was there to explain that yes, MVM was planning to participate. While we also learned that MVM was looking at optimizing the times on its power plants so it could participate the extent of participation is unknown.
There are examples in the CEE/SEE region that can prompt skepticism about the extent that MVM has seen the benefits of an open and transparent market. The Romanian market is a good example where an active exchange operates, but due to control by the state in the generation market and the portfolio arrangement of these companies, the market remains sticky. That is cheap hydropower can be sold on an international bilateral basis, outside the exchange, while more expensive generation is kept for both the regulated consumers and for the power exchange.
This shifting of generation assets to different domestic and foreign markets is an option that MVM holds. Their current study into asset optimization should be seen as a warning signal for the regulator and other market participants that some generation assets may not be available on the power exchange. How this plays out, whether expensive generation assets are retained for the free market or the ‘regulated’ market remains to be seen – or even its daily availability. Asset optimization may just translate into profit optimization for MVM and not optimization of the market.
Another key issue is the control that MVM exerts over MAVIR. I actually have a favorite part in the presentation from the CEO of HUPX. In extolling the benefits of HUPX, the slides states,
100 % Hungarian ownership guarantees national influence
Hungary’s international influence will be strengthened
This is great. Now I buy my share of Unicum, but is there a place for “national influence” in what will develop into a regional exchange? Soon HUPX should function on an interregional basis as effectively as on a national basis. The regional role of energy traders and energy companies with their regional generation portfolios and their attempts to optimize these at the regional level leaves little room for more national interests to be asserted. The chronic under investment into Hungarian generation and transmission along with current high prices are the result of ‘national interests’ being pursued.
The role that MAVIR can play in concert with HUPX in protecting Hungary’s national interest would actually be horrible for Hungary’s true national interests. Hungary’s true national interest lies in integrating its national electricity market into the CEE and SEE regions for both security of supply benefits, meeting climate change commitments and diluting MVM’s influence in the Hungarian generation mix.
Ahh, did I just write that… regional market integration would dilute MVM’s influence on the Hungarian market? Yes, I did. Imagine, rogue traders would be buying and importing power to the detriment of MVM’s higher priced facilities – or whatever it chooses to charge. Now would that be in the national interest? Could MAVIR help the situation by restricting access to and from the Hungarian market (e.g. Bulgaria)? Will there be underinvestment into cross border infrastructure? What will the be the NTC and ATC values? How much do you trust MVM to participate in HUPX in good faith with its monopolistic control? Will it operate in Hungary’s national interest or in MVM’s own interest?
There should be more indicators that MVM is changing its ways then simply setting up HUPX. MVM needs to develop a regional growth strategy – not a Hungarian national growth strategy, there are enough private players who want into the market to begin to satisfy the generation demand. If you already dominate the market, what good does it do to seek to dominate it more? Why buy into E.ON distribution? A look around at EU and (other) national policies shows that the regionalization of energy markets is occuring, a MVM concentrated on dominating the national market demonstrates a lack of vision that will be eroded over time by endless EU directives and investigations, not to mention continual underinvestment.
If you look at the US and Europe in the 1990s, companies that have expanded beyond their national base (while it was protected) did well (my PhD and recent work has been on this topic). Merger and acquistion activity, or even organic growth at a regional level can be good business – think CEZ. MVM needs to create and act on a regional business strategy – HUPX can be the start of this (although for MVM to succeed at a regional level significant internal changes need to occur).
There remains a lot of unanswered questions as to the viability and level of power that will be available on HUPX. Before the exchange begins operations and companies spend significant amounts of money to join the exchange MVM needs to state the extent that they will participate – and how. Hopefully the day has finally arrived for Hungary to build a robust electricity exchange with multiple product offerings. This can only benefit the range of consumers in Hungary and their different types of demand. But enough questions remain that some regulatory intervention may be required to reduce MVM’s hold on the entire electricity market. Allowing it to construct a hobbled electricity exchange and expand its domestic influence should not be something it gets away with. Market participants and HEO need to step up and make their views known.
Pursuing an earlier agreement E.ON confirmed that it is in talks with the government of Hungary and MVM. The state owned electricity company is seeking to gain a minority shareholding in the distribution assets of E.ON. Talks include discussions over asset swaps, with MVM seeking to finalize the deal by the end of 2010.
MVM, just like Romanian and Bulgarian owned counterparts, once had a strategy to become a regional player like CEZ. I’m just wondering if instead of attempting to expand outside of Hungary they have decided to concentrate on consolidating their position within the country. MVM is already in a dominate position in the generation sector. The Hungarian system gives MVM a near monopoly on generation with it buying and selling a large majority of the power in the country. Even companies like E.ON or RWE that have generation assets have to sell their electricity to MVM then buy it back to sell to their generation company. Needless to say, profits were high once again last year.
The distortion that MVM causes on the Hungarian power market is really nothing short of scandalous. It is a middleman that does not need to exist. In fact (if I can deviate) it reminds me of the system set up at the Hungarian Academy of Sciences library. If you want to use the library you have to do the following: Go to the coat check, get your coat check number, go to the library, say hello to the ‘library nani’ who, after looking at your library card and taking your coat check tag, gives you a seat number on a green card, then you go to the librarian to give the same number and your card, after which the librarian gives you a red card with the same number on it. I won’t even get to the point that it all should be electronic and you can sit anywhere…but the existence of the library nani is equivalent to MVM.
While I prefer my tax money going to the library nani who plays solitaire all day, MVM, by acting as the middleman sucks money from my pocket to enrich itself and the state. The profits it makes both in its market dominant position and role as a middleman causes all consumers in Hungary to pay more for a service that does not even exist in surrounding countries. This is one reason why Hungary has the highest electricity rates in the region. In addition, MVM has played an important role in the perpetual underinvestment in generation in the country – leading again to higher electricity rates. Plus with its total control of the transmission system operator MAVIR, thus limiting exports and imports, it strangles the Hungarian market through a state approved monopolist – despite EU efforts foster a competitive electricity market.
Now, that MVM is interested in buying into the distribution assets, whether a swap or not, it will essentially recreate a vertical monopolist on the Hungarian market. Through some of my research in the past I have examined why a government would maintain a vertically integrated monopoly (Michigan has essentially done this). The reason for it is to ensure long term power investments that will result in lower prices. I fail to see how the track record of MVM or its strategy milking consumers for unnecessary services contributes to a competitive Hungarian energy sector.
The alternative to a government owned power milking machine is effective regulation with stipulated rates of return and regulated prices (for providers of last resort). Really, life can be that simple.
But just like consumers don’t think of where their milk or meat comes from, they don’t understand the complex financial transactions involved in the energy sector. This enables governments to use the sector as a taxpayer milking machine – essentially adding another tax layer to utility bills. Maybe it is time for Hungary to become power vegetarians.