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Burning concerns about state’s foray into energy

The Hungarian government says it is pushing out foreign firms to keep utility bills affordable and ensure a secure energy supply, but critics say their interference does more harm than good.

Proclaiming a goal of keeping prices low and ensuring energy security, the current Hungarian government is reshaping the country’s gas and electricity markets by pushing out foreign firms so that the state can take control of utility companies.

The European Commission and other critics have said the government’s interference in the market could lead to a situation where state aid is used to subsidize below-market energy prices, something that is against European Union law. Opponents of the effort also maintain that, in their aim to reduce prices, state-backed utilities could be forced to cut services and maintenance, eventually leading to a situation where the local energy infrastructure will become unreliable in serving the country’s needs.

In effect, critics have said, the government’s approach could set back the developments in infrastructure that have been made since privatization of the energy system began in the 1990s.

The government has countered these critiques with the claim that its strategy is necessary to undo injustices caused by privatization, when the country, eager for foreign investment, sold utilities to private buyers for less than market value.

But according to Attila Holoda, a former state secretary and current managing director of local consultancy Aurora Energy Ltd., the utilities were sold cheaply in the 1990s because they involved some risk and needed a lot of work.

“The state did not have money to modernize these companies,” Holoda explained. “The privatization agreements were not based on the proper valuation of these companies, as purchase prices were discounted by the unreasonably high risk factor. Furthermore, buyers were obligated to modernize the companies they purchased.”

Whether or not its actions are fair, the government is going ahead with a strategy to make it unprofitable for foreign investors to stay in the market, and these firms have been forced to sell to the state. In the latest such deal, closed on September 29, state gas company Főgáz acquired the universal service arm of GDF SUEZ Magyarország, including its related technical systems and infrastructure.

The First National Utilities Company (ENKSZ), the main state company involved in buying utilities, told the Budapest Business Journal that it cannot say if there will be any more such purchases, but added that it will assess whether new acquisitions are needed to achieve its goals – namely keeping utility prices low and becoming more cost effective.

Ultimately, market intervention by ENKSZ could create a vertically integrated utilities system that would tend to reduce the country’s dependence on foreign resources.

Squeezing private utilities

In its effort to dominate the market, the government has been squeezing private utilities by increasing the special taxes on utility providers while reducing the fees they are allowed to charge.

In 2013, the government required 20% cuts in consumer prices for gas, electricity and district heating, and further cuts in 2014 of 6.5% for gas and 5.7% for electricity.

“The yield on energy was first cut back to 4% and today it is less than 1%, which is less than capital costs,” said an expert in the energy sector who asked not to be named.

In 2008, the previous, Socialist government passed an 8% tax on the utilities sector. In 2012, in the first term of the current Fidesz government, that tax was increased to 31%. Currently, taxes levied on energy companies can amount to as much as 50% of a company’s revenue, including a crisis tax, a utilities tax and a corporate tax, the expert told the BBJ.

“The crisis tax, which was 1.05%, was based on turnover and companies had to pay that tax even if they were in a loss-making position,” the source said.

On March 31, Parliament passed a bill providing loss-making utilities with an opportunity to get out of their predicaments. The law allows universal service providers, utilities that are licensed to sell gas or electricity to the public, to walk away from their contracts and give up their licenses.

Having made it so companies would want to sell, the government made it easier for them to do so, and then started buying.

The government had been buying parts of utilities for state ownership for the last couple of years, but early this year, the effort was given a formal mechanism. The Hungarian government launched ENKSZ, with share capital of HUF 1 billion and capital reserves of HUF 14 bln, in February. ENKSZ, the government said, would act as an efficient, predictable and cheap utilities provider for Hungarian households. By April, 300 ENKSZ customer service points had begun operation across the country.

A representative of ENKSZ told the BBJ that the company’s aim is to “guarantee a high level of service and maintain low fees based on utilities price cuts, as well as to provide unified billing for gas, electricity and district heating services”.

Forced to leave

Years before the state-mandated cuts in utility fees, universal service providers had already been recording losses due to high taxes. When fee cuts came, these firms knew that their days were numbered and they began planning accordingly.

France’s GDF SUEZ (now ENGIE) was already looking for an exit strategy following the introduction of utility fee cuts in 2013, according to the expert we interviewed. GDF was in the process of separating its universal and free market activity into GDF SUEZ Energia Hungary and GDF SUEZ Energia Holding Hungary, respectively, the expert added. At the time, GDF SUEZ Energia Holding Hungary was a major player with 11-12% of market share and a valuable client portfolio.

Now, no longer able to take advantage of a broad vertical reach in the market, the company’s position in Hungary is tenuous. “In the case of these so-called vertically integrated companies, if one or two legs are eliminated, it doesn’t make much sense for them to stay in the region,” the expert explained. The firm may soon leave the country, but when GDF first entered the market, it had a very different vision. “Their massive investment in infrastructure was a sign of their long-term plans in Hungary,” the expert said.

GDF SUEZ and Germany’s E.ON handed over their universal service provider licenses to supply gas in June, followed shortly after by Tigáz. These firms had invested heavily in infrastructure to deliver their gas, but their only option was to sell, and the only buyer was the government.

The state distributor of public utilities, MVM, finalized the acquisition of Főgáz, which was owned by Germany-based RWE, in July of last year for a reported $187 million. During negotiations, RWE reportedly felt that they were being strong-armed into handing over their assets. RWE East Chairman Martin Herrmann was quoted as complaining that the Hungarian government was engaging in “expropriation”.

By the summer of 2015, Főgáz, now state owned, was winning tenders with ease, and taking over the clients of both E.ON and GDF SUEZ, making Főgáz the sole universal service provider of gas in Hungary. The company currently supplies gas to approximately 3.3 million households in the country.

With much of the foreign-owned universal gas providers having been bought by the state, the acquisition of universal electricity providers is the next step for ENKSZ, which says it hopes to enter the electricity market by the beginning of 2016.

Public vs. private ownership

In a country were the net wages are among the lowest in the EU, the price argument has the strength to win many battles. “Utility bills are a daily issue for households in Hungary, so price volatility affects most households significantly,” Holoda explained.

According to statistics compiled by the Hungarian Energy and Public Utility Regulatory Authority (MEKH), Hungarian households spend 4.7% of their income on electricity and gas, one of the highest levels in Europe, while Luxembourg is the lowest at 1.3%.

By buying up universal service providers and pushing their free market affiliates out of Hungary, the state is paving the way for a vertically integrated utilities system, but the government’s motivation is different from the firms it is replacing. In private enterprise, vertically integrated systems are designed to disperse the risk of market presence. In the case of the government, its aim is control. “ENKSZ has an interest in every level of the energy value chain and this plays an important role in its representation of national interests within the energy policy,” ENKSZ told the BBJ.

“Hungary’s logic is in line with Eastern European logic, in that domestic supply shall be used to satisfy much of domestic demand,” Holoda said. “In contrast, European thinking supposes that a free and unlimited market must be established.”

ENKSZ also said that “its primary goal is to guarantee reliable service and stable prices”, but critics argue that the two are not mutually compatible. In the event of global energy price increases, ENKSZ would be put in a loss-making position, at which point it would likely have to compromise service, such as maintenance, or dip into state subsidies to cover losses. “State subsidies are strictly monitored and the EC will not allow these to be disbursed,” said Holoda, though he acknowledged that the EC’s enforcement of these regulations might take years if the Hungarian government decides to bend the rules.

Hungary is not the first government to get involved in the energy business, according to Attila Chikán, of energy services company Alteo Group. “The state taking part in securing the population’s energy needs via ownership in a company, is not unprecedented; several providers, with partial or total state ownership, work around Europe to serve customer’s needs successfully and with high standards,” he said.

The bigger issue, according to Chikán, is that the government, as regulator, faces conflicting interests: It must create a strong and predictable legal environment, even while it is focusing on its primary strategic goals of reducing the cost of energy.

A private, for-profit company has a tendency to be leaner, more efficient and more competitive than its state-run counterpart. Consumers tend to have more rights in a competitive market because they have more choice.

“Consumers are not aware of their rights and of what they can expect and demand from their utility company,” according to Holoda.

Given that the process of amalgamation has already begun, critics are doubtful that a strong regulator will be established, and according to our unnamed source, energy authorities do not appear to be intervening in the process, least of all in defending consumer rights.

Critics fear that, if prices are kept artificially low and ENKSZ begins moving toward a loss-making position, elements of service will be compromised. Hungary may become less dependent on foreign resources but that does not mean that taxpayers will be spared the expense in the long term – even if that expense shows up in the form of poorer service.