Utilities, state monopoly or liberalization?

After World War II, a very new perception of the electricity industry spread around Europe; namely, that the whole sector should be regarded as a natural monopoly. Former companies were merged to form one national or a few regional entities. In Europe, most countries felt that the monopolistic corporate entity could be controlled most effectively when it is owned by the state. A prominent example of the process, Electricite de France (EdF) was founded in 1946, as a result of the nationalization of around 1,700 smaller energy producers, transporters and distributors by the Ministry of Industrial Production.

State monopoly

However, critique of the regulatory systems had already started in the 1960s, and by the ’80s the development of the technology and basic state budgetary needs established a good environment for privatization. But many difficulties slowed the way towards liberalization, like the natural monopoly status of network operators, distribution challenges or so-called ‘stranded costs’. These arise from the fact that before the reform of industry, a company might have planned investments, the costs of which were covered by its monopoly position.

These stranded costs may include the establishment of certain power plants that are no longer sufficiently profitable in a competitive environment, or the losses that a trader sustains because the long-term contracts it signed for large amounts of energy from some power plants were at higher prices than it could reach on an open market.

As a recent example, national energy group, MVM re-negotiated its long-term supply agreement with Mátrai Erőmű power plant to get lower electricity prices. MVM is also reviewing its agreements with Alpiq Group’s Csepeli Erőmű and EdF’s Budapesti Erőmá for the same reason.

Liberalization

While security of supply and access for those most in need are the main reasons behind state monopolies, a more effective industry was behind the market opening and liberalization – and this applies to the European Union’s energy policy as well. But even if the effective functioning of the sector was a goal before the utility reforms, that goal wasn’t realized flawlessly, with large and persistent price differences between countries.

The first (96/92/EC) directive of the European Union imposed at least a mandatory unbundling in accounting for vertically integrated electricity companies. The first experience of market opening soon revealed that this was not enough: the owners of the networks did not attempt to provide network access that was transparent and non-discriminatory, and preserved the possibility that, by using their monopoly profit from the network access fee, they could cross-subsidize other activities that gave them an unfair competitive advantage. Therefore, the new EU directive (2003/54/EC) makes unbundling of management regarding the transmission and distribution networks mandatory.

Customer’s choice

Even a few years ago, utilities didn’t much worry about customer loyalty, because their customers had little or no choice in who was their power supplier. Liberalization has changed all that. Now that consumers can switch from one utility company to another in many European countries, executives in the industry pay more attention to customer loyalty. In fact, customer retention has become critical for utilities at a time when margins are under pressure and customer acquisition costs and churn rates are rising.

According to the findings of ‘European Utilities: New Rules for Keeping Customers Plugged In’, a study of more than 40 utilities and 8,500 utility customers in Western Europe by Bain & Company, the only consistently high levels of customer advocacy in utilities are typically among two categories of “new entrants and discounters” and “local brands”.  Otherwise, it finds that utilities in Europe have the lowest overall level of customer advocacy, even lagging behind industries such as banking, mobile telecom, and insurance by as much as 35% on average.  The churn caused by this low engagement has been chipping away at overall profits, via higher customer service and acquisition costs—brand “detractors” generate less than half the profits for providers on average than do brand “promoters”.

The Hungarian way

While state intervention in many cases serves the purpose of helping the poor by providing cheap energy, in Hungary it serves political goals as well. The current government wants to keep energy prices artificially low to win votes, and to use it for other purposes (e.g., to drive down inflation).

In parallel, to keep up sympathy for ruling party Fidesz, Viktor Orbán’s government started to accuse private (often foreign-owned) utility companies of being too greedy. In accordance with that, it lowered domestic energy prices by 10% and has sought to gain influence in Hungary’s energy sector.

Hungary bought back a 21% stake of national oil and gas company MOL from Russia’s Surgutneftegaz, citing strategic concerns over the ownership of Hungary’s energy supply in 2011, the price tag being HUF 505 billion – or almost €2 billion. The latest instance of the Orbán administration’s efforts to consolidate control over the country’s energy and utilities sector, MVM signed an agreement with Germany’s E.ON to buy its natural gas business for €870 ​million. The acquisition includes 100% of the shares in E.ON Földgáz Storage Zrt and E.ON Földgáz Trade Zrt, thus all of the companies’ assets will be transferred to MVM Group.

Orbán announced at a press conference following an EU summit in Brussels earlier in July that Hungary would reduce household gas and electricity prices by another 10% in October. The decision will cause much havoc on Hungary’s energy market. In the case of a second decrease in prices, Elmű-Émász should close its business as it couldn’t afford to pay its bills, Marie-Theres Thiell said in an interview given to business daily Népszabadság.

Or maybe it’s just another step by the prime minister to force utility companies to sell their business at below market price to the re-nationalizing Hungarian government.