At the end of last year AES of the US and Tractebel of Belgium separately concluded legal cases involving the Hungarian government. Both cases threatened to undermine the government's image as a good place for foreign power investors.

AES made the legal claim for more than $300 million ? against the government, the privatization agency APV and Magyar Villamos Muvek (MVM), the state-owned electricity company ? over assets the company had acquired as part of the privatization of the sector in 1996.

At issue were differing interpretations of contracts connected with AES's construction of the new Borsod CFB plant and the retrofit of its AES Tisza II plant.

A compromise deal was finally reached just before year-end. Under the terms of the deal AES Tisza II Eromu and MVM signed a new 15-year power purchase agreement under which all of the output of the station will be purchased by MVM. AES Tisza II is also able to make certain investments into the power station. AES Borsod Energetikai and MVM also agreed to increase the amount of generation purchased by MVM from the two coal plants over the next few years. AES owns a 99% interest in the Tisza II, an 860MW oil- and gas-fired power station, AES Borsod, a 171MW coal-fired power plant, AES Tiszapalkonya, a 250MW power station and AES Lyukobanya, a coal mine in North East Hungary.

The resolution came just a few weeks after Tractebel, the Belgian power group, concluded a similar dispute.

But critics claim these disputes merely highlight how successive governments have failed to liberalise fast enough. Critics also claim this could be alienating foreign investors and undermining credibility in the Budapest stock exchange.

So far it seems as though companies such as AES and Tractebel are keen to stay, but there are signs elsewhere that the government needs to move more swiftly.

The Electricity Distributors Association says that MVM's failure to privatise or restructure has caused part of the problem and that its unwillingness to relinquish its monopoly may provide short-term benefits but could lead to long-term problems when the market liberalises in 2003.

Margaret Dezse at PricewaterhouseCoopers Corporate Finance believes that Hungary is still well ahead of many of its neighbours. ?As to whether or not the government has done enough to encourage investment in the sector, one only has to compare the percentage of privatization in Hungary's energy sector to that of Western European countries,? she says. ?Hungary has one of the highest privatization rates of all Western and Eastern European countries, and all energy concerns except the electricity company MVM (which includes nuclear facilities) have been privatised.?

New electricity act

Furthermore, liberalisation of the electricity sector follows the passing of a new electricity law on 18 December 2001. The law, which took several years of discussion, a new minister and lots of deliberating will open up Hungary's electricity market to competition beginning with a 33% stake in 2003 and concluding seven years later.

The act is some way removed from what was first envisaged but it does fulfil the basic requirements needed under European law.

Marcell Nemeth, senior associate at Allen & Overy in London, says: ?The key word is transition. Hungary has adopted new legislation which is intended to be in line with EU directives.?

However, the law heavily favours the interests of the state electricity company. In particular it protects MVM's interests in Paks, its nuclear power plant which still produces some of the cheapest electricity in the country. Plus the government decides how and when MVM can be compensated for losses on stranded costs.

Says Nemeth: ?During the time it took to pass the new law, the situation has become better and better for MVM. Now the law has achieved the most important element for MVM, it remains as the monopoly supplier for the public sector and it won't be privatized.?

PwC's Dezse says that those who have already invested in the region are maintaining their interests in Hungary. ?We also expect to see new players enter the region, as liberalisation opens up a wider market for things like the transport and distribution of gas and electricity,? she says.

But what does this mean for investors? The reality is that the new law is unlikely to attract single-asset players. However, it could mean some strategic movements by some of the well-established European companies.

György Dallos, manager at the Boston Consulting Group in Budapest, says there are clear differences in the types of players coming into Hungary's energy sector. Companies such as Eon and RWE look upon Hungary as an extension of their wider regional strategy. Meanwhile companies such as AES are cherry picking deals and with only one or two deals on the book, financed as non-recourse transactions, it is more difficult to find synergies. Then there are existing local players who may themselves become targets for partnerships of takeovers.

Dallos says that while the November report by European Commission noted Hungary's lack of progress in preparing for the internal energy market last year, ?the new Electricity Act adopted by the Hungarian parliament on 18 December means that 2002 will at least see some progress, if only in legislative terms?.

Industry participants seem to agree that the new act is good news for the sector but it is unlikely to encourage an influx of greenfield power projects. Hungary has a relatively small customer base of about 5 million and already has sufficient capacity ? the biggest producer is still MVM's Paks plant.

Says Nemeth: ?For the next couple of years it will be a matter of ?wait and see'. Strictly speaking there is no need to add capacity. But there has been a huge amount of interest for new green ticket waste-to-energy plants. Old power stations could be transformed into waste-to-energy plants.?

Mol - ified?

But for many the next big question for Hungary is ? what will Mol do? The Hungarian oil and gas conglomerate, which is still 25% owned by the government, has faced mounting losses. Responding to this, Mol announced at the end of last year that it would be selling off its downstream gas assets in an effort of shore up its ailing finances.

Ruhrgas and Gaz de France were among a number of companies who expressed an interest in buying up to 50% of Mol's gas pipeline and trading business. But at the beginning of January Gaz de France said it was still waiting for a response for its proposals and declined to give further details of its offer.

Says Nemeth: ?The company's new management says it wants to divide and concentrate on oil. They have serious plans but whether they can do it and at what price is the question. However, it is unlikely that any private investor will take up the offer with such low gas prices. Now the government seems to be a serious candidate as the purchaser of Mol's gas business through its development bank.?

At the end of January the Hungarian government said it had made a generous offer to buy the entire gas assets of Mol. This was followed just two weeks later by an announcement by MFB, the Hungarian Development Bank, that it was ready to start exclusive negotiations on the sale of Mol.

Perhaps the result is unsurprising. Most consumers in Hungary have heating systems based on gas, a legacy of the communist era, which makes the price of gas a deeply sensitive political issue. As a result successive governments have capped the price of gas, meaning that Hungarian consumers are paying well below the European average.

For Mol the combination of price caps and the high cost of importing gas has been disasterous. It is expected to make a loss on its gas business in 2001 of the equivalent of about $400 million.

Whatever the outcome, the government's renationalisation of a partially privatized industry could prove a serious blow to investor confidence in the region, providing proof the government is still very cautious about handing over the reins of its power and energy business to foreign investors.

Says Nemeth: ?There are unlikely to be too many new players coming into Hungary. On the other hand those already in the country are not about to move out. The next stage is unlikely to take place before EU accession, when the balance of power will shift.?