Market power

As CEO of state-owned electricity wholesaler MVM Rt since 2002, László Pál has been a key player in the gradual liberalization of Hungary’s power sector.

Under his guidance, MVM has grabbed a large chunk of the trade realized on the liberalized market via MVM Partner Rt, a company MVM established last year to handle free market trade.

At the same time, MVM continues to act as dominant player of the power market through its control over most of the country’s power capacity – a fact heavily criticized by free market traders.

In Hungary, the first phase of the liberalization took place last January, when the country’s largest energy consumers – those using more than 6.5 GWh a year – were granted the right to purchase electricity on the deregulated market. The second phase of market opening, as of July 1, 2004, entitles all non-residential users in Hungary, meaning approximately 350,000 legal entities, to make purchases on the deregulated market. These entities account for about 70% of the country’s total electricity consumption.

Pál replaced former MVM CEO Kálmán Katona in July 2002. Pál was minister of industry and trade in 1994–1995 and was chairman of the board at oil and gas company MOL Rt from 1994 to 1998.

Pál recently spoke with reporter Judit Zegnál about MVM’s prospects on the power market, upcoming changes in the Electricity Law, and the possibility of launching regional power trade. This is a translated and edited transcription of their conversation.


Q: The second phase of energy market liberalization recently began. What position does MVM expect to achieve on the free market through MVM Partner?

A: MVM established MVM Partner last year to handle power trading on the liberalized market. In 2003, the company signed supply contracts with more than ten companies entitled to purchase electricity from the free market. It accounted for one-third of the total free market trade.
I think MVM Partner will be able to retain its approximately 30% market share on a growing market, but I do not expect the company to further increase this ratio. To handle a significantly larger volume of trading, we would have to invest a hefty amount into upgrading the company’s infrastructure. For the time being, we are not prepared for such an investment.

Q: Will the contract MVM Partner recently signed with Mátra Power Plant help?

A: MVM Partner signed a Ft 50 billion contract with Mátra Power Plant to purchase at least 70% and up to 100% of the capacity of two of its 100 MW generators for a fixed price between 2005 and the end of 2011. The capacity MVM Partner gained through this contract will enable the company to keep its market position during the second phase of the liberalization. This capacity will serve the free market.
As far as I know, it is the first contract of its kind signed between a trading firm and a power plant for the liberalized market.

Q: Free market traders often accuse MVM Rt, which has a wholesale monopoly on the regulated market, of undermining the free market. They say it blocks too much capacity for the regulated market via long-term purchase contracts with power generators. What do think?

A: Free market traders often complain that there is not enough excess capacity on the liberalized market. This is not true. There is more than 1,000 MW of free capacity in Hungary.
However, this capacity is not of the cheapest kind. That is painful for free market traders. They would like to have access to more competitive sources.

Q: Do you expect to review long-term purchase contracts with generators?

A: In line with the Electricity Law, we review the contracts every year. And every year, we find that one of the parties – either the power plants or MVM – finds the contracts advantageous and does not want to nullify them. The cost of forcefully nullifying these contracts would trigger costs in the range of Ft 1,000 billion, which nobody would be able to shoulder.
I believe these contracts are good for the country, because they give security for both generators and consumers [on the regulated market]. At the same time, MVM is obliged to sell excess capacity to free market traders via transparent auctions. So it is not these contracts that cause a shortage of cheap power.
The limited capacity of the cross-border transmission network is a real problem, because it slows down the import of cheap electricity.
Another problem is that investors have been very cautious about building new power plants, and most of those considering building one would like to have a long-term purchase contract. Banks do not provide loans for them without such contracts.

Q: Could further liberalization be harmed by the fact that consumers can move back and forth between the regulated and the free market?

A: Definitely. This is bad for all players, because it makes consumption unpredictable. I cannot tell how many consumers will come back to the regulated market tomorrow.
There have been days when actual consumption was 250 MW more on the regulated market than MVM’s prognosis. It later turned out that the difference was due to some companies unexpectedly returning to the regulated market.
In other countries, entering the free market is a one-way move, or at least it is very hard for consumers to return.
The ongoing revision of Hungary’s Electricity Law is expected to cure this problem.

Q: Will there be a new definition of the regulated market?

A: I also heard about a new definition being prepared, although I have not seen any official statements about this issue.
The European Union’s new energy directive, which was adopted last year, contains two definitions that are missing from the Hungarian law.
One is the notion of “public service obligation” (PSO), which is very close to our regulated market but not the same. Hungary’s regulated market is open to all consumers, while the PSO is available only for households and small companies.
The other notion is “last resort,” which means that the regulation guarantees a power supply for consumers whose supplier is not able to fulfill its obligations. Production, and often life, depend on power. Nobody would be able to pay the price of disrupted electricity supply.

Q: Free market traders also call for competition on the regulated market. What do you think about this?

A: I agree with the initiative to introduce competition to the regulated market.
Currently, regional power suppliers directly serving consumers on the regulated market are obliged to buy electricity from MVM. I agree that they should be able to buy from other sources.
This will require not only regulatory changes, but also the revision of several contracts. MVM is ready for such revisions.

Q: Can the current structure of the energy market handle total liberalization, scheduled for 2007?

A: The current model of the Hungarian power market, meaning the coexistence of the regulated and the free market, is unsuitable for the next phase of market opening in 2007. Under this model, traders on the free market are forced to compete with regulated prices. This distorts the market.
The regulatory framework for a new model should be adopted as soon as possible in order to give sufficient time for both traders and consumers, including the entire residential sector after July 2007, to get prepared for the new conditions. Just imagine – the entire residential sector will have to be educated about the new role of power meters and new ways of billing.

Q: According to a recent report by the European Commission, market liberalization in most member states has been slower than expected. Why?

A: One reason is the great difference between the structures of the energy sector in the member states. The EU directive stipulated a fairly uniform model for the free market, but the reality is different.
Another reason is that the EU model envisaged an active, competitive free market with lots of players. But in practice, a huge concentration of power is happening.
Seven companies control 68% of the power generating capacity in the EU. The same seven firms have over 60% of all consumers. National monopolies have diminished, while much stronger international monopolies have been created. These allow much less movement on the market.
This was not the goal of the EU directive. There is lots of discussion going on about how to tackle this issue.
The EU model also stipulated intense price competition. For some time, there was indeed competition on some markets, but due to the competition, investments aimed at creating new power generating capacities were stopped. This resulted in a power shortage, which in turn triggered a price increase. This phenomenon will also have to be addressed as the EU continuously improves its energy policy.
Hungary is in a very good position among member states, with approximately 22% liberalization after one-and-a-half years. I expect 26%–28% by the end of this year.

Q: Is the formation of a regional power market a realistic idea?

A: Most of the legal conditions exist, but this is not enough.
The Central and East European power transmission network was designed to serve relatively small traffic, mainly to overcome power shortages resulting from temporary malfunctions in national systems. This network is not able to, for example, supply a country completely from imports.
Another factor hindering the formation of a regional market is a condition set the UCTE [Union for the Coordination of Transmission of Electricity – an association of transmission system operators in continental Europe, which is responsible for setting safety standards]. It requires its members to be able to supply themselves from domestic capacities.
Yet another factor is that the EU’s energy directive makes every member state responsible for the safety of local power supply, while there is a movement for liberalizing the power markets.
Governments no longer build power plants, which is fine. Governments only buy electricity for their own institutions. This is also fine. But they are still responsible for the safety of supply, which at the same time has become a market issue. These processes are not easy to harmonize.

Q: There has been a lot of talk about the upcoming privatization of MVM. When do you think it will be possible?

A: MVM’s structure is ready for privatization. It is ready for the state to sell a stake of 50% minus one share. We can fulfill all stock exchange criteria, including a transparent corporate structure, sufficient information supply and the use of international accounting standards.
The external conditions for privatization are not favorable at the moment. The government would not receive a price for MVM shares that reflects the company’s real value.
Certain legal conditions, like the coexistence of the liberalized and regulated markets, also present an obstacle. This prevents MVM from developing predictably.
The fact that MVM is still not a profitable company would also devaluate the share price.
Under current regulations, only a minority stake can be sold, without any management rights. This makes the company uninteresting for professional investors. For financial investors, the prospect of a good yield is important. As soon as MVM can promise yields, it will be ripe for privatization.

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