200

The Electricity Industry in Hungary

Sectoral Analysis

Autumn 2005

Executive summary

International trends

The price of crude oil continued to rise throughout 2005, reaching 60

dollars a barrel by the end of summer. Despite a slight decline in autumn,

high oil prices are expected to persist in the foreseeable future

as current prices are influenced by the asymmetric growth of demand

and supply. Natural gas prices follow oil prices with a lag of around

three quarters due to pricing arrangements in long-term supply contracts.

Besides high fossil fuel costs, the rise in the price of traded

carbon-dioxide emission rights in Western Europe also exerts an upward

pressure on electricity prices. The price of emission quotes increased

by as much as 150% in the first half of 2005.

Electricity generation and foreign trade

Domestic electricity generation rose by 10% compared with 2004 with

renewables – especially biomass and the increasingly popular wind

energy - increasing their share in the generation mix.

Net electricity imports declined slightly. Import routes from Romania

and Serbia are gaining significance beside the Austrian and Slovakian

lines, which points at the increasing domestic utilisation of cheap Romanian

energy.

Evolution of the liberalised market

No new eligible consumers entered the liberalised market until the autumn

of 2005. On the other hand, the electricity consumption of this

market has been continuously increasing, reaching 1 TWh per month

in the summer. While consumption in the public utility sector decreased

by 13% in the first eight months of 2005, the electricity consumption

of eligible consumers increased by 69%.

Capacity auctions organised by MVM brought mixed results: participation

at the summer auction was low, but the autumn auction (of energy

to be delivered in 2006) was successful thanks to new products

and the good timing of the auction.

Changes in regulation

The independent system operator MAVIR has finally been merged into

MVM. This constitutes the first step towards the establishment of a

transmission system operator as required by EU regulations.

From autumn 2005 the mandatory offer price for renewable energy

increased to 23 HUF/kWh. On the other hand, producers of renewable

energy unable to deliver electricity according to their timetable are

subject to a fine. This measure was undertaken to improve system

management.

Preparatory work and public debate on the re-regulation of the electricity

market has begun with all documentation available on the

homepage of the Hungarian Energy Office. The new regulatory model

proposes an organised electricity exchange and the renegotiation of

long-term supply contracts, but contains a large number of uncertainties

yet.

1. Trends in the European Union and in the region

A marked rise of oil prices in 2005

Amongst all factors influencing the electricity industry, high fossil fuel

prices are still of primary concern. The price of crude oil reached 60

USD per barrel in September 20051 before dropping back to 53 USD by

November. However, this still constitutes a 30% rise since November

2004. In 2005 dynamic demand growth, Caribbean hurricanes and political

uncertainty in Iraq proved to be the main culprits.

The price of oil is still influenced mainly by fundamental factors such as

soaring demand and bottlenecks in extraction and refinery capacity.

These pressures are not expected to dampen even in the longer run

because oil (and gas) industries require such amounts of investment in

the coming decades which can be financed only at a higher price level.

Favourable economic outlook for 2006 is also expected to keep prices

high in the short run.

Bad signs on the gas market

According to the forecast of the International Energy Agency, global

gas consumption will grow by 2.5 to 3% per annum for the next 15

years with supply unlikely to follow the trend. The threat of a gas cartel

(based on the model of OPEC) including Russia and Middle Eastern

countries could also evolve seizing control of two-thirds of global gas

reserves.

Wholesale electricity prices in Europe

Wholesale prices stabilised around 35-45 EUR/MWh in the first half of

2005 in Western Europe. Following peak demand in the winter prices

failed to fall as a consequence of high fuel and emission-rights prices

and the relative mildness of the winter of 2004/2005. The market

price of carbon-dioxide emission quotes surged from below 7 EUR in

January 2005 to 30 EUR in July; since then it has remained in the region

of 20 to 25 EUR.

Futures prices on the German and French market stand at 45-46

EUR/MWh for 2006 and 2007, and reach 36 and 35 EUR/MWh on the

Nordpool for 2006 and 2007 respectively.

Developments in neighbouring countries

In the Slovak Republic, the Italian ENEL plans to invest 1.88 billion

euros into the Slovakian electricity system following the purchase of

electricity company Slovenské Elektrarne. Most of this sum will be

spent on the expansion of the Mochovce nuclear plant to cover the

loss of capacity after the closure of the Apátszentmihály nuclear plant

in 2008 under pressure from Brussels.

Hungarian energy industry company Transelektro signed a contract on

the 11.10.2005 to refurbish part of Tuzla power station in Bosnia. The

company had planned to enter the Bosnian market since 2004 and

won the tender over a number of competitors. The overall cost of the

two-year project amounts to 21 million EUR. In November Transelektro

signed another contract to refurbish the coal-firing Zilah (Romania)

plant and switch it to biomass; this contract is worth 36.5 million

EUR.

A tender to sell the Macedonian electricity supplier ESM was issued in

November 2005. The Macedonian government plans to sell a 90%

stake after a failed tender offer of a 50% stake in May. Upgrading the

electricity system of the country is expected to require billions of euros.

 

2. Evolution of the sector in Hungary

Electricity generation

Gross electricity consumption amounted to 25.5 TWh between January

and August of 2005, a 1.9% growth over 2004. 21.1 TWh was generated

by domestic power plants, 9.6% more than in the respective period

of 2004. The production of small (less than 50 MW) units grew by

28.2%; in 2005 these plants accounted for 8% of domestic electricity

generation. In the first half of the year 703 GWh of energy was produced

from renewable sources, constituting 4.5% of domestic generation

and 3.7% of domestic use.2 Domestic production covered 84.3%

of domestic demand between January and August.

 

Development of power plants

The contract to build a new power plant in Miskolc was signed on the

10.10.2005 between procurer MIFÛ Co. (an affiliate of MVM) and contractor

Siemens Co. This was the first time public procurement procedure

to build a power plant in Hungary. The investment, worth 14 billion

HUF, involves the construction of a combined cycle power plant of

at least 50 MW.

EMA-Power of Dunaújváros decided on the construction of a new, 200

MW gas turbine worth 32 billion HUF, after the long-term energy requirements

of Dunaferr Co. had been clarified. A further reason for

the investment is that the four furnaces currently in operation need to

be decommissioned between 2006 and 2008.

During 2005 there was great interest for small power plants and renewable

energy sources. TechCon Ltd. plans a power plant worth 6-7

billion HUF in Polgár, fuelled by junk tyres. The unit, while producing

an annual 40-45 GWh of electricity, could dispose of one-fifth of rubber

waste in Hungary. The project is currently under planning and authorisation

and the power plant could start operating early 2007.

MOL could build the first geothermal power station of the region near

Iklódbödörce in Western Hungary by 2007. The payback period of the

2-5 MW plant could be as low as 10 years according to estimations.

Should the project prove successful, MOL might be tempted to build

further power plants on its depleted oil and gas wellheads. These units

could provide the 12-15 MW geothermic capacity undertaken by Hungary

by the year 2010.

The largest wind station of Hungary was put into operation in the

mountains of Bakony near Szápár during the summer of 2005. The

610 million HUF investment was undertaken using 122 million HUF of

state and EU funds. The payback period of the investment is 8 years

while the total operating time of the station is 20 years. The 1.8 MW

power station built by the Denmark-based Vestas Wing Systems A/S

is estimated to produce 5 GWh electric energy per annum.

The city council of Bánhida said no to a biogas-firing plant because of

concerns about the air quality of the city. The investor, Biogas-Energy

Ltd. plans to build a total of 20 such units across the country.

Renewable energy in the Hungarian electricity system

According to the forecast of the system operator MAVIR, 6500 MW

new electricity generation capacity will be needed by 2015. Domestic

electricity consumption grows by 1-3% per year, therefore 2500 MW

needs to be added to the current capacity; meanwhile, 4000 MW of

old power plants need to be shut down due to obsolescence (the average

age of Hungarian power plants is 29 years).

The licenses of the blocks of Paks nuclear plant, covering 36 to 38%

of domestic electricity demand, run out between 2007 and 2012. Currently

this plant is indispensable for the safety of electricity supply;

furthermore, this plant has the lowest marginal cost of electricity generation

in Hungary. The cheapness of imported electricity is expected

to be a short-term phenomenon given the international trends of fuel

and electricity prices. As cross-border capacities are also limited, Hungarian

electricity supply should not become overly reliant on imports.

Using domestic brown coal does not pay off while coal imports from

Poland become more expensive as Polish state subsidies on coal mining

are abolished. Natural gas and renewable energy seem the most

feasible solutions to future energy shortages. As an EU member, Hungary

wowed to increase the share of renewables in electricity generation

from the current 2.5% to 3.6% by 2010.

In the first half of 2005 809 GWh of renewable energy was purchased

under the purchasing obligation; 89% of it was generated from biomass,

10.5% from water and just 0.5% from wind. Compared to the

first half of 2004 generation from biomass increased at the quickest

pace, by 150.5%; utilisation of wind energy rose by 21.4% while hydro

energy use declined by 21% due to spring tides.

Wind energy caused some controversy during 2005. The current capacity

of 7.4 MW could rise to a couple of dozen megawatts in 2006;

investors plan to build even more. On the other hand, the Hungarian

electricity system can accommodate no more than 200 MW wind energy.

The reason for this is that the average utilisation of wind wheels

is only around 25-30%, and their performance is subject to large fluctuations.

The Hungarian electricity system is very rigid even without

wind energy3; system operation would be better facilitated by power

plants firing biomass or biogas as the output of these units is more

easily controllable. The optimal solution to system management problems

would be a storage hydro plant, but such a unit exists only in

long-term plans.

External trade After a large net electricity import in 2004, energy transit gained significance

in 2005: in the first nine months net imports decreased by a

quarter on the respective period of 2004.

The most important directions of electricity trade are the lines from

Austria, Slovakia, Romania, Croatia and Serbia to Hungary and from

Hungary to Croatia and Serbia. The Slovak-Hungarian and Austrian-

Hungarian directions were valued the highest at the 2005 capacity auction

with 13.2 million and 4.9 million HUF/MW respectively.

Monthly capacity auctions in 2005 were characterised by continuous

interest towards import routes from Croatia, Serbia, Romania, and the

export line to Serbia. The price of import capacities for Romania rose

sharply during the year; this was the most expensive import direction

on average, followed by the rarely organised Slovak and Serbian import

capacity auctions. Customers showed the largest interest in the

Croatian and Serbian directions.

Network development

According to its network development strategy, the transmission network

company MVM undertook the following investments in 2005:

Establishment of a new 400 kV line between Gyõr and Szombathely;

Completion of the reconstruction of the Litér 400 kV and Dunamenti

220 kV lines;

Complete grid reconstruction (Zugló–Detk–Sajószöged–national

border 220 kV section),

Start of the complete reconstruction of the 120 kV and middle

voltage grids;

Preparations for new lines (Békéscsaba–Nagyvárad, Sajóivánka-

Rimaszombat, Pécs–Ernestinovo, Szombathely–Nagykanizsa).

 

3. Market structure

Eligible consumers Gross domestic electricity consumption rose by 1.9% in the first eight

months of 2005, in line with long-term projections of a 1-3% growth

trend. However, the structure of consumption has undergone significant

changes: free market consumption increased by 69% against

2004 and reached 1 TWh per month in the summer. Nevertheless, after

a dynamic expansion in 2004, no new eligible consumers entered

the liberalised market in the first eight months of 2005, leaving their

number unchanged at 187. The consumption of eligible consumers

hardly exhibits any seasonality since this group consists of industrial

customers. Consumption in the public utility sector fell by 13% according

to our estimation in 2005, partly due to favourable weather conditions.

In autumn 2005 17 electricity traders operated in Hungary, 11 of them

selling electricity to eligible consumers. The average buying price of

electricity traders rose by 16% between January and August 2005,

while their average selling price to eligible consumers increased by

11%. Buying prices averaged 8.5 HUF/kWh while selling prices averaged

9.3 HUF/kWh (9.8 HUF/kWh towards eligible consumers), therefore

the margin of traders relative to their buying price reached 9.1%

(15.5% towards eligible consumers).

Wholesale trade in the public utility sector

The public utility wholesaler MVM had a negative price margin

throughout 2004 as its purchasing prices exceeded selling prices by

0.5 HUF/kWh on average. In 2005 revenues broadly covered costs.

However, despite increasing market prices, traders only bought energy

from MVM at 4 HUF/kWh below its average buying price.

MVM capacity auctions

The MVM held its capacity auction for the second half of 2005 in June.

Interest in the auction was very low: the amount of energy sold fell

sharply compared to previous auctions while prices did not change.

Peak load (6:00-22:00) energy was also offered for the first time, but

no bids arrived for the new product.

The latest auction on 9. November proved much more successful. The

reasons for the success are manifold: annual products were also offered

besides the usual semi-annual ones, the auction preceded the

delivery period by a longer time, and it took place before the crossborder

capacity offering of MAVIR. A record number of 13 bidders

made offers although eligible consumers did not participate. 92.5% of

base load offers were contracted; bids for valley and peak load capacity

exceeded the original offer therefore the auctioned amount was

increased by MVM; prices surged thanks to more competition for offered

capacity. Another new product was offered: the right of capacity

use could be purchased. This deal involves a certain capacity of electricity

supply available freely at the disposal of the buyer throughout

the year. Only 3 megawatts could be sold for a 5 HUF/MW/year capacity

fee plus an energy fee of 12 HUF/kWh (payable as the capacity

is utilised); the 50% increase of gas prices and the novelty of the

product could be the explanation for such low sales.

Va

Ownership changes In October 2005 the gas company El Paso sold its 50% stake in Dunaújváros-

based EMA Power Ltd. to the other shareholder, steel company

Dunaferr Co. Since 2001 EMA Power has been in a settlement

dispute over 3 billion HUF with its main customer and co-owner, the

steel works. In autumn 2004 EMA Power launched a bankruptcy procedure

against its owner. To minimise its losses, El Paso sold its last

stake in European electricity industries for 39 million USD. The deal

requires approval from the Competition Office and the Hungarian Energy

Office, and is expected to be finalised in the first quarter of 2006.

London-based Crossroads Capital sold its 85% stake in Pannonpower

Holding Co. to RPG, an international industrial investment company.

Hungarian privatisation office ÁPV Rt. Offered its 29.26% share in Vértes

power plant to the state-owned electricity company MVM. The prospective

buyer currently owns 42.91% of the company with 18 billion

HUF own capital. The deal is in accord with the strategic objectives of

MVM.

Public utility suppliers

The largest public utility supplier remains Budapest-based ELMÛ. Buying

and selling prices of suppliers rose in 2005; their price margin increased

by 5 to 10% over 2004 (with the exception of DÉDÁSZ). The

most profitable company in 2005 was DÉMÁSZ with a 100.3% price

margin over its average buying price. Although public utility consumers

can only be supplied at higher costs, the 90.8% average margin of

public utility suppliers (compared with 9.1% of open market energy

traders) hints at the artificial protection of public utility suppliers.

4. Regulation and policy measures

Ownership change of MAVIR

The fate of the independent system operator was finally decided in

June as the Parliament approved the necessary modifications of the

Acts on Privatisation and on Electric Energy. According to these legal

changes, ownership of MAVIR falls to MVM with the exception of a

’golden share’ remaining in the hands of the Ministry of Economy and

Transportation. This constitutes a first step towards the establishment

of a transmission system operator (TSO) as required by EU regulation.

However, some analysts urged to point out that the independence of

the system operator may be harmed by this deal, threatening the

fairness of competition on the electricity market.

The modification of the Privatisation Act also laid down that the share

of MVM in the Paks nuclear plant, the transmission grid owner OVIT

and the system operator MAVIR may not fall below 99%, effectively

cementing state ownership of these assets as MVM is not for sale in

the foreseeable future.

Regulation of renewables and the obligatory purchasing system

A new regulation, in effect from the 1. September 2005, improves the

controllability of the electricity system by fining producers of electricity

unable to meet their declared supply timetable. The obligatory purchasing

system of renewable energy also changed: instead of a three-level

price system (differentiating between valley, deep valley and

peak load energy) a single tariff is in effect. Its 23 HUF/kWh level is

22.6% higher than the average of the old tariffs; this high guaranteed

price is expected to boost investments in renewable energy generation

even further.

Subsidised loans for renewables

Miklós Persányi, environmental minister announced on 26. July that

the Hungarian Development Bank (MFB) offers subsidised loans for

solar, wind and hydro energy project besides environmental and energy

efficiency investments. Loans are available until 2007; interest

rates follow the EURIBOR rate and total interest subsidies are capped

at 800 million HUF. Any company can apply to subsidies for up to

three projects and up to 240 million HUF.

New market model for the electricity system

Preparations for a new market model of the electricity system have

begun in 2005. The re-regulation of the Hungarian electricity industry

is necessitated by the new 2003/54/EC Directive of the European Union

on one hand, and recent experiences of liberalisation on the other.

Besides complying with EU regulations, the new system aims to improve

the security of energy supply (through the encouragement of

power plant and network investments), and plans to raise subsidised

retail prices to (wholesale) market prices.

The proposal of the new regulation can be found on the homepage of

the Hungarian Energy Office;4 market participants are encouraged to

make comments and suggestions.

4 http://www.eh.gov.hu

The need for reregulation

The current regulation is in conflict with the new EU Directive in the

following main points:

Regulation of eligible consumers: industrial consumers are entitled

to purchasing electricity through public utility supply; there is no

universal supplier; public utility suppliers have limited options to

purchase energy.

The state subsidises the energy sector through MVM: long-term

supply contracts guarantee that the MVM pays a non-market price

to power plants; this is compensated by switchover costs; these

may incur only until 2010 according to the new EU Directive.

The unbundling of public utility suppliers and distribution network

companies has not taken place; their regulation is not in accord

with market principles.

The preparatory study highlighted the following shortcomings of the

industrial structure:

Insufficient competition: the MVM is the dominant player of wholesale

and foreign trade, and it owns most of the generation capacities

to be offered on the liberalised market.

Investors are hesitant due to inappropriate wholesale market signals

and regulatory risks.

Excessive uncontrollable load due to the base load import of eligible

consumers, nuclear production and the obligatory purchase of

renewable energy.

Features of the proposed new model

Public utility supply would be abolished in the new system. Households

and small enterprises could purchase electricity from universal

suppliers at regulated prices; these universal suppliers would be chosen

by the Hungarian Energy Office by open tendering. This tendering

procedure is one of the key uncertainties of the new proposal: it is unclear

whether nationwide or regional universal suppliers would be chosen.

Furthermore, tendering offers a suboptimal solution since the incumbent

universal supplier enjoys special benefits (resulting from

asymmetric information and sunk costs) over potential competitors.

Sunk costs (in the magnitude of billions of HUF) arise from the establishment

of billing systems, customer service, etc. once the tender is

won. First reactions of market participants suggest that this system

would lead to the undesirable conservation of the current structure;

complete liberalisation of final supply would be a more desirable alternative.

A supplier of last resort would be appointed should a universal supplier

go bankrupt or become inoperational for any other reason. Eligible

consumers could only buy energy on the market, they could not

return to supply at regulated prices.

The transmission system operator (MAVIR/MVM) would create an organised

market (energy exchange) for hourly day-ahead trade; bilateral

over-the-counter contracts would be freely available. The organised

market would be responsible for the obligatory purchase of cogenerated

and renewable electricity. The real-time market for balancing

energy would function as a special part of the organised energy

exchange.

The position of public utility sector players would obviously change in

the new setup. The status of MVM is uncertain, depending largely on

the success of the renegotiation of its long-term contracts between

power plants and MVM. Furthermore, the proposal does not mention

the future of long-term supply agreements between MVM and the

public utility suppliers. The survival of these contracts, involving 70%

of all generated energy, could harm the energy exchange as the latter

could only operate adequately with amounts of supply and demand.

The hands of dominant market players (especially MVM) would be tied

by additional rules, for example obligatory capacity auctions, regulated

prices, and the compulsory electricity supply of universal suppliers.

Competition policy would play a more important role in the regulation

of dominant players and their performance would be assessed

in regular market analyses. This plan was understandably met by

fierce opposition from MVM.

 

5. Short term prospects

Price increases The price of natural gas for large industrial consumers rose by 7% as

of the 1. August 2005. Its impact could be felt in electricity prices

from January 2006; market participants and analysts anticipate electricity

price increases of 5 to 6%.

International prices

International electricity prices are also on the rise due to more expensive

oil, gas and carbon dioxide emission quotes, possibly leading to

higher prices for imported electricity as well. Expanding cross-border

capacities offer a larger energy import potential especially as network

development towards Romania will be finalised within a few years.

Renewable energy High obligatory purchasing prices, state-subsidised loans and EU funds

offer good opportunities for investing in renewable electricity generation.

Biomass shows exceptional potential; on the other hand, solar

and wind energy raises system operation difficulties, therefore their

expansion could be limited in the medium term. The new regulation

from September, fining producers unable to meet their timetable is

aimed at keeping solar and wind energy in control. The utilisation of

geothermic energy is still in its infancy, but a success of the pilot project

of MOL could give it a major boost.

Re-regulation The planning of the new market model of the Hungarian electricity

system has started with the involvement of regulators and market

participants. 2006 is expected to bring more debates, details and the

clarification of uncertainties in the new regulatory model.

 

6. SWOT analysis of the Hungarian electricity industry

Strengths Weaknesses

Rising electricity demand, long-term

need for new power plants

Operational regulator, high compliance

with EU regulations

Market opening under way

Long-term network development

program

Insufficient supply on the liberalised

market

Limited cross-border capacities

Difficulties in system operation

Dominant market player, strong

position of incumbents

Uncertain regulatory environment

for long-term investments

Opportunities Threats

Regional electricity trade

Spreading of market competition

Development of MVM into international

player

Energy prices detrimental to economic

competitiveness

Dependency on imports and fossil

fuel

Strengths The electricity demand of Hungary will rise in the coming decades;

additional demand and the closure of old plants will offer opportunities

for building new power plants of all sizes. The utilisation of renewables

is facilitated by the state through high obligatory offer prices and subsidised

financing. Regulation of the energy sector is adequate in an

international comparison, the regulating authority is already operational

and rules generally comply with EU directives. Market opening

has started even before the Hungarian EU accession. The transmission

and distribution network is under development according to long-term

plans.

Weaknesses Insufficient supply and import capacities limit the development of the

open market. Open market import has amplified difficulties in system

operation; the spread of renewables could aggravate these problems.

Incumbent market actors are strong lobbyists, their interests are in

conflict. 

Opportunities Network development can lead to intensified regional energy trade,

contributing to the development of the market. The new management

of MVM aims to increase the regional presence of the company;

changes in price regulations provide financial resources for a potential

expansion.

 

 


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