Analysis: Market anxious over new state utility

Deals

The following story is from the October 3-16 print edition of the Budapest Business Journal.

While anaysts say a certain amount of state participation in the utility sector is necessary, some private companies fear that a government-owned, not-for-profit energy company could push them out of the market.

A national utility provider in the form of a state-run non-profit company will be launched in March, the government has announced. As the deadline for making the necessary regulations is October 30, the details are unknown yet. Market players are watching anxiously, because whether the new company will be a state-owned giant, as is typical in Eastern Europe, or an effectively operated business depends on those details.

The government set up a working group with the participation of the justice, development, and interior ministers as well as the president of the Hungarian Energy and Utilities Regulation Office (MEKH) to prepare for the establishment of the state company through two earlier resolutions published in August. According to the decrees, the government will seek to ensure cheap and sustainable public utility services.

Market players agree that this will be a major milestone in the process of strengthening the state’s hold on the energy sector. The establishment of a huge state-owned non-profit holding company would permanently restructure the whole market. Initially, the company would distribute electricity, gas, and heating. Later it would add water supply, sewage, and garbage collection.

The new state company will operate on a multi-level structure, however, the exact details are not clear yet, Máté Tóth, an attorney-at-law at Faludi Wolf Theiss, told the Budapest Business Journal. The most probable candidates for the organization at the top are the state-owned Hungarian energy group MVM and the Hungarian Development Bank (MFB).

By making the new company non-profit, the government aims to restrict profit making on the provision of its services, said Tóth. One option is making profit realization impossible by regulating energy prices. Another is reinvesting potential profits. “If we look at the foreign examples, such as the U.S. public utility companies and the German Stadtwerke, any profits they make must be reinvested in network development,” Tóth pointed out. He cited the example of the Stadtwerke of Cologne, which cross-finances the local loss-making transport company from its profits made on electricity prices.


What happens to private players? 

In the long-term, two things could happen to those private firms in the sector directly affected by the envisaged state holding company, explained Tóth. One possibility is that the state would acquire their market presence and their infrastructure; the question is: at what price? This is a major trap, as too high a price might not be compatible with EU state aid rules, while too low a price could break investor protection rules. The other option is to directly or indirectly pressurize these companies into withdrawing from the market, he said, adding that this would probably not happen. Trading companies and competition among them should not be affected.

With a suitable development strategy, state participation in the energy sector is necessary to some extent, Attila Chikán, CEO of energy supplier and trader Alteo Nyrt., said. But it is acceptable only so long as the government does not use non-market and regulatory pressure to improve its position at the expense of private businesses. There are sectors where state involvement can be stronger, such as on the market of universal service providers. However, in the segment of small power plants with a generating capacity of 50MW or less, he sees no reason for increasing the state’s role. Hungarian SMEs have a good chance to successfully operate in this segment, as these plants need only around €1-20 million investment. In addition, unlike the state, smaller, more flexible private companies have the ability to keep up with the rapid technological changes.

Chikán presumed that certain foreign companies, which had acquired utility firms in 1995, had reaped excessive profits at certain periods due to regulatory flaws. However, he warned that “we cannot undo that now and we should not move from one extreme to another”. He does not feel threatened by attempts to force out his business, and he believes that in the case of certain energy companies there were internal reasons behind the decision to leave the Hungarian market. He pointed out that the state has paid a fair price for the assets it has acquired so far.

“As the district heating market is already 100% regulated, we do not expect any major surprise or shock from the new developments,” Ferenc Fernezely, commercial director of Dalkia Energia Zrt., said. “This activity is often loss-making, we are allowed to make only a maximum 2% return on assets, which does not even include all the costs.” He pointed out that district heating providers are already practically non-profit organizations, adding that this is not sustainable in the long run.

One possible advantage of the entry of a national provider could be increased safety through more effective account management and collection, and the launch of the necessary reconstruction and developments, according to Fernezelyi. “As an effectively operated private firm, we hope that we can successfully compete with municipality-owned providers,” he stressed. Indeed, the majority of district heating providers are municipality-owned, with Dalkia the only international player in this segment. The company recently agreed with E.On Hungária Zrt. on the sale of heating plants in Debrecen and Nyíregyháza. With the acquisition, Dalkia Energia will supply nearly 110,000 residential consumers and tens of thousands of public institutions with heat in Hungary.

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