Power Hungary
1. The Current Situation1.1 Privatization/Regulatory
Restructuring
A significant part of the Hungarian electricity sector was privatized in 1995 and 1996. The current regulatory structure was created pursuant to the 1994 Electricity Act. Under this Act, power generators entered into long-term power purchase agreements (?PPAs?) with the Hungarian offtaker, Magyar Villamos Mu´´vek Rt. (?MVM?), which is still owned by the Hungarian Government. Certain aspects of the regulatory regime, including price regulation, were fine-tuned in 1996. Responsibility for price regulation is currently split between the Minister of Economy (?Minister? or ?Ministry?) and the Hungarian Energy Office (?HEO?).
HEO is a state administrative body, controlled by the Government, under the supervision of the Ministry. As an administrative body, HEO does not have rulemaking authority. When HEO adjudicates specific applications for licenses, it issues its decisions in the form of resolutions. The key responsibilities of HEO are:
? Issuance, amendment and revocation of licenses.
? Providing assistance to the Minister in connection with price setting and price review.
The HEO is responsible for preparing the price regulatory decrees. The actual maximum prices and other terms and conditions of the pricing regime are fixed and promulgated by the Minister in Ministerial Decrees. Accordingly, it is the Minister who makes the final and formal decision on pricing by way of promulgating regulations in a Ministerial Decree (?Decree?). Currently two Ministerial Decrees regulate the prices of electricity. Hungarian law does not prescribe specific requirements and procedures for the repeal or modification of Ministerial Decrees. Proposed amendments to the Decrees are not published, and there is no ?comment period? for the general public. Moreover, the regulatory decrees promulgated by the Ministry are not reviewable by the ordinary courts. One could argue that this is a system where a sole public official has the authority to set electricity prices ?at the stroke of a pen?. The hard reality is that in many instances political considerations influence or even dictate pricing decisions.
1.2 Key Provisions of the Electricity Act and Decrees
Section 55(1) of the Electricity Act specified that by 1 January 1997, the price of electricity generated by the power generation companies must:
? enable generation companies to recover the costs of operating efficiently, earn a reasonable return on prudent investments and make such profits as are necessary for long-term operation;
? account for the costs related to the performance of environmental protection obligations in connection with the closing or demolition of a plant;
? account for requirements and other factors regarding economic policy, energy policy, safety of supply and environmental protection; and
? encourage the safe and minimum cost supply of electricity and the efficient use of generating capacity in accordance with the general principle of ?least costs?.
Since 1 January 1997, Decree 63/1995. (XI.24.) IKM, as amended (?Decree 63?), and Decree 55/1996. (XII.20.) IKIM, as amended (?Decree 55?), govern the principal aspects of price regulation. Decree 63 sets forth the general price regulatory principles, including price formulae and the price escalation provisions to be applied to the average electricity price of the power generation sector during the period from 1 January 1997 through 31 December 2000. Decree 55 prescribes the specific maximum prices applicable to each public power generation company. These specific prices are adjusted annually, using a combination of an inflation index and an efficiency factor.
1.3 Relationship between the Decrees and the PPAs
The specific tariff elements for each power generation company are increased periodically (currently annually) and such new tariffs are promulgated in the amendments to Decree 55. At the same time, each PPA fixes ?starting prices? and sets out price formulae for the calculation and escalation of both the Availability Fee and the Energy Fee. The formulae in the PPAs essentially track the formulae contained in Decree 55. This is because Decree 55 and Decree 63 have effectively ?suspended? the application of the price formulae in each PPA until 31 December 2000.
In practice, the annual revisions of Decree 55 govern the price increases. This practice is consistent with Hungarian law; as long as the Ministry regulates the price of the electricity generated by the power generation companies, the regulated price will supersede each PPA's pricing provisions. In other words, the parties to the PPA may not ?contract out? of the mandatory pricing provisions of the Decrees. The Decrees and the PPA will be applied together and to the extent that the Decrees leave room for the parties to regulate certain elements of the pricing structure, the PPA will be the ?gap filler?.
1.4 Pricing between 1 January 1997 and 31 December 2000
The general rule in the Electricity Act that enables generation companies to earn a reasonable rate of return and recover their costs is not subject to any time limit. As indicated above, Decree 63 nonetheless sets forth the average generation price for the 4-year period between 1 January 1997 and 31 December 2000. The Ministry can determine company-specific prices on this basis. Decree 55 does not have a specific validity period. If the Ministry were to decide not to extend the price regulatory regime under Decree 63, Decree 55 would also have to be repealed.
2. The Proposed New Electricity Act (?Proposed Act?)
With a view toward Hungary's accession to the EU as soon as possible, Hungarian policymakers decided to gradually implement open access in line with EU Directive 96/92/EC. A draft legislation, the Proposed Act, was prepared and released for public comment in June 1999. The intent was to prepare the final form of the Proposed Act before June 2000 and submit it to Parliament later this year so that it can be approved and promulgated in the second half of 2000. As planned initially, the Proposed Act would become effective on January 1, 2001. The Proposed Act will result in changes in the following areas.
2.1 Licensing
Specific licenses will be required for the following types of operations: power generation, wholesale trade, other electricity trading, transmission and distribution.
It is important to highlight that power plants with a capacity not exceeding 50 MW may be constructed, owned and operated without HEO's Generation License. This will help certain industrial users who wish to build their own power plant. In line with the very cautious opening to competition, a dispatching guarantee from MVM will no longer be a prerequisite for granting a Generation License to plants above the 50 MW threshold.
2.2 Open Access/Import-Export of Electricity
Large industrial customers with an electricity consumption of at least 100 GWh/year (?Eligible Customers?) may purchase electricity from any supplier, including power generators. This provision, which affects approximately 12 to 14 large users, would become effective in 2001. From early 2003 onwards, the 100 GWh/year threshold would be reduced and the number of Eligible Customers would increase. One of the weaknesses of the Proposed Act is that it fails to provide a timetable with specific percentages in each year for the market to be opened to Eligible Customers.
Imports will be liberalized at a slower pace. First, prior to Hungary's accession to the EU, importers will be required to obtain individual licenses for specific transactions. Second, the Eligible Customers will be required to purchase at least 50% of their electricity from Hungarian sources.
2.3 Price Regulation
Not surprisingly, one of the most difficult and controversial areas under the Proposed Act is price regulation. At the present time business users still cross-subsidize household consumption. This will be phased out gradually. Also, with the gradual introduction of open access, various access charges need to be introduced to ensure non-discriminatory and commercially sound access to the transmission network.
With respect to the price regulation of the power generation sector, in the first quarter of 2000, two proposals were considered by the regulator:
? Regulation of the average price at which MVM is required to procure its electricity demand. Accordingly, there would be no direct regulation of the power generation price and the existing PPAs would ?spring back? to govern pricing (?Proposal A?).
? Continuation of the current system of maximum prices for at least another 4-year period (?Proposal B?).
It appears that with respect to the electricity generated by existing power plants under the existing PPAs, Proposal B will prevail. The Minister will continue to set the prices for availability and electricity actually supplied under the existing PPAs with MVM. In order to monitor and influence inflation, the Government decided that Ministerial Decrees regulating electricity prices must be issued with the consent of the Minister of Finance. It is important to reiterate that Proposal B covers only the existing capacity already subject to dispatching under the PPAs. The price of the power generated by newly-developed ?merchant plants? will not be regulated. It remains to be seen, however, when the first merchant plant will become a reality. With excess capacity in Hungary, Western Europe and Central Europe, it is uncertain when these merchant plants will actually be approved, financed, constructed and commissioned. It is likely that only a limited number of merchant plants will be commissioned around 2004-2005.
2.4 Stranded Costs
As has been the case in other countries that have gone through a transition period from a regulated to a competitive environment, the issue of ?stranded costs? was raised in Hungary. Stranded costs, also known as stranded investments or stranded assets, constitute a significant potential problem in the deregulatory process. Hungarian policymakers identified stranded costs as revenue losses which would result from the difference between the PPA ?contract price? and the lower new ?market price.? Stranded costs are thus sunken costs that generators may not be able to recover if the PPAs are not honoured in accordance with their price terms. If, however, the PPAS are honored in accordance with their pricing terms, MVM would incur losses because it would be required to pay the generators a price higher than that of an alternative electricity supplier.
The key issues of stranded costs, of course, are the magnitude of these costs and the allocation of the resulting financial burden. In Hungary, there is an additional layer to the problem. At the present time, the price terms of the PPAs are superseded by the Ministerial Decrees and amendments thereto. As a result, the Minister has a fair degree of discretion in setting the ?contract price,? which will then be measured against the new market price in order to ascertain the amount of stranded costs. Presently, Hungarian policymakers and regulators are still in the process of finding solutions to the problems associated with stranded costs.
3. Another Hard Look at Pricing and Stranded Costs
The Proposed Act was not submitted to Parliament by the Government before June 2000, as anticipated. Instead, in June 2000, the Cabinet of Ministers decided to return the Proposed Act to the Ministry for another round of review and to rewrite two critical areas: stranded costs and price regulation.
There is a fair amount of uncertainly and unpredictability concerning the magnitude of stranded costs. Some observers estimate these costs to be HUF 4 billion (USD 15 million). Others argue that the amount could range between HUF 80-100 billion (USD 150-187 million).
In theory, the decision on how to allocate stranded costs is simple; they could be borne by: (i) the customers (household and industrial); (ii) the power generators; (iii) MVM, the offtaker; or (iv) any combination of the above. Solution (iv) would appear to be the most equitable outcome.
A satisfactory solution, however, will require intensive negotiations among the key players of the industry on the one hand, and the regulator, on the other. The key players and the regulator now have six months to come up with a solution.
A significant part of the Hungarian electricity sector was privatized in 1995 and 1996. The current regulatory structure was created pursuant to the 1994 Electricity Act. Under this Act, power generators entered into long-term power purchase agreements (?PPAs?) with the Hungarian offtaker, Magyar Villamos Mu´´vek Rt. (?MVM?), which is still owned by the Hungarian Government. Certain aspects of the regulatory regime, including price regulation, were fine-tuned in 1996. Responsibility for price regulation is currently split between the Minister of Economy (?Minister? or ?Ministry?) and the Hungarian Energy Office (?HEO?).
HEO is a state administrative body, controlled by the Government, under the supervision of the Ministry. As an administrative body, HEO does not have rulemaking authority. When HEO adjudicates specific applications for licenses, it issues its decisions in the form of resolutions. The key responsibilities of HEO are:
? Issuance, amendment and revocation of licenses.
? Providing assistance to the Minister in connection with price setting and price review.
The HEO is responsible for preparing the price regulatory decrees. The actual maximum prices and other terms and conditions of the pricing regime are fixed and promulgated by the Minister in Ministerial Decrees. Accordingly, it is the Minister who makes the final and formal decision on pricing by way of promulgating regulations in a Ministerial Decree (?Decree?). Currently two Ministerial Decrees regulate the prices of electricity. Hungarian law does not prescribe specific requirements and procedures for the repeal or modification of Ministerial Decrees. Proposed amendments to the Decrees are not published, and there is no ?comment period? for the general public. Moreover, the regulatory decrees promulgated by the Ministry are not reviewable by the ordinary courts. One could argue that this is a system where a sole public official has the authority to set electricity prices ?at the stroke of a pen?. The hard reality is that in many instances political considerations influence or even dictate pricing decisions.
1.2 Key Provisions of the Electricity Act and Decrees
Section 55(1) of the Electricity Act specified that by 1 January 1997, the price of electricity generated by the power generation companies must:
? enable generation companies to recover the costs of operating efficiently, earn a reasonable return on prudent investments and make such profits as are necessary for long-term operation;
? account for the costs related to the performance of environmental protection obligations in connection with the closing or demolition of a plant;
? account for requirements and other factors regarding economic policy, energy policy, safety of supply and environmental protection; and
? encourage the safe and minimum cost supply of electricity and the efficient use of generating capacity in accordance with the general principle of ?least costs?.
Since 1 January 1997, Decree 63/1995. (XI.24.) IKM, as amended (?Decree 63?), and Decree 55/1996. (XII.20.) IKIM, as amended (?Decree 55?), govern the principal aspects of price regulation. Decree 63 sets forth the general price regulatory principles, including price formulae and the price escalation provisions to be applied to the average electricity price of the power generation sector during the period from 1 January 1997 through 31 December 2000. Decree 55 prescribes the specific maximum prices applicable to each public power generation company. These specific prices are adjusted annually, using a combination of an inflation index and an efficiency factor.
1.3 Relationship between the Decrees and the PPAs
The specific tariff elements for each power generation company are increased periodically (currently annually) and such new tariffs are promulgated in the amendments to Decree 55. At the same time, each PPA fixes ?starting prices? and sets out price formulae for the calculation and escalation of both the Availability Fee and the Energy Fee. The formulae in the PPAs essentially track the formulae contained in Decree 55. This is because Decree 55 and Decree 63 have effectively ?suspended? the application of the price formulae in each PPA until 31 December 2000.
In practice, the annual revisions of Decree 55 govern the price increases. This practice is consistent with Hungarian law; as long as the Ministry regulates the price of the electricity generated by the power generation companies, the regulated price will supersede each PPA's pricing provisions. In other words, the parties to the PPA may not ?contract out? of the mandatory pricing provisions of the Decrees. The Decrees and the PPA will be applied together and to the extent that the Decrees leave room for the parties to regulate certain elements of the pricing structure, the PPA will be the ?gap filler?.
1.4 Pricing between 1 January 1997 and 31 December 2000
The general rule in the Electricity Act that enables generation companies to earn a reasonable rate of return and recover their costs is not subject to any time limit. As indicated above, Decree 63 nonetheless sets forth the average generation price for the 4-year period between 1 January 1997 and 31 December 2000. The Ministry can determine company-specific prices on this basis. Decree 55 does not have a specific validity period. If the Ministry were to decide not to extend the price regulatory regime under Decree 63, Decree 55 would also have to be repealed.
2. The Proposed New Electricity Act (?Proposed Act?)
With a view toward Hungary's accession to the EU as soon as possible, Hungarian policymakers decided to gradually implement open access in line with EU Directive 96/92/EC. A draft legislation, the Proposed Act, was prepared and released for public comment in June 1999. The intent was to prepare the final form of the Proposed Act before June 2000 and submit it to Parliament later this year so that it can be approved and promulgated in the second half of 2000. As planned initially, the Proposed Act would become effective on January 1, 2001. The Proposed Act will result in changes in the following areas.
2.1 Licensing
Specific licenses will be required for the following types of operations: power generation, wholesale trade, other electricity trading, transmission and distribution.
It is important to highlight that power plants with a capacity not exceeding 50 MW may be constructed, owned and operated without HEO's Generation License. This will help certain industrial users who wish to build their own power plant. In line with the very cautious opening to competition, a dispatching guarantee from MVM will no longer be a prerequisite for granting a Generation License to plants above the 50 MW threshold.
2.2 Open Access/Import-Export of Electricity
Large industrial customers with an electricity consumption of at least 100 GWh/year (?Eligible Customers?) may purchase electricity from any supplier, including power generators. This provision, which affects approximately 12 to 14 large users, would become effective in 2001. From early 2003 onwards, the 100 GWh/year threshold would be reduced and the number of Eligible Customers would increase. One of the weaknesses of the Proposed Act is that it fails to provide a timetable with specific percentages in each year for the market to be opened to Eligible Customers.
Imports will be liberalized at a slower pace. First, prior to Hungary's accession to the EU, importers will be required to obtain individual licenses for specific transactions. Second, the Eligible Customers will be required to purchase at least 50% of their electricity from Hungarian sources.
2.3 Price Regulation
Not surprisingly, one of the most difficult and controversial areas under the Proposed Act is price regulation. At the present time business users still cross-subsidize household consumption. This will be phased out gradually. Also, with the gradual introduction of open access, various access charges need to be introduced to ensure non-discriminatory and commercially sound access to the transmission network.
With respect to the price regulation of the power generation sector, in the first quarter of 2000, two proposals were considered by the regulator:
? Regulation of the average price at which MVM is required to procure its electricity demand. Accordingly, there would be no direct regulation of the power generation price and the existing PPAs would ?spring back? to govern pricing (?Proposal A?).
? Continuation of the current system of maximum prices for at least another 4-year period (?Proposal B?).
It appears that with respect to the electricity generated by existing power plants under the existing PPAs, Proposal B will prevail. The Minister will continue to set the prices for availability and electricity actually supplied under the existing PPAs with MVM. In order to monitor and influence inflation, the Government decided that Ministerial Decrees regulating electricity prices must be issued with the consent of the Minister of Finance. It is important to reiterate that Proposal B covers only the existing capacity already subject to dispatching under the PPAs. The price of the power generated by newly-developed ?merchant plants? will not be regulated. It remains to be seen, however, when the first merchant plant will become a reality. With excess capacity in Hungary, Western Europe and Central Europe, it is uncertain when these merchant plants will actually be approved, financed, constructed and commissioned. It is likely that only a limited number of merchant plants will be commissioned around 2004-2005.
2.4 Stranded Costs
As has been the case in other countries that have gone through a transition period from a regulated to a competitive environment, the issue of ?stranded costs? was raised in Hungary. Stranded costs, also known as stranded investments or stranded assets, constitute a significant potential problem in the deregulatory process. Hungarian policymakers identified stranded costs as revenue losses which would result from the difference between the PPA ?contract price? and the lower new ?market price.? Stranded costs are thus sunken costs that generators may not be able to recover if the PPAs are not honoured in accordance with their price terms. If, however, the PPAS are honored in accordance with their pricing terms, MVM would incur losses because it would be required to pay the generators a price higher than that of an alternative electricity supplier.
The key issues of stranded costs, of course, are the magnitude of these costs and the allocation of the resulting financial burden. In Hungary, there is an additional layer to the problem. At the present time, the price terms of the PPAs are superseded by the Ministerial Decrees and amendments thereto. As a result, the Minister has a fair degree of discretion in setting the ?contract price,? which will then be measured against the new market price in order to ascertain the amount of stranded costs. Presently, Hungarian policymakers and regulators are still in the process of finding solutions to the problems associated with stranded costs.
3. Another Hard Look at Pricing and Stranded Costs
The Proposed Act was not submitted to Parliament by the Government before June 2000, as anticipated. Instead, in June 2000, the Cabinet of Ministers decided to return the Proposed Act to the Ministry for another round of review and to rewrite two critical areas: stranded costs and price regulation.
There is a fair amount of uncertainly and unpredictability concerning the magnitude of stranded costs. Some observers estimate these costs to be HUF 4 billion (USD 15 million). Others argue that the amount could range between HUF 80-100 billion (USD 150-187 million).
In theory, the decision on how to allocate stranded costs is simple; they could be borne by: (i) the customers (household and industrial); (ii) the power generators; (iii) MVM, the offtaker; or (iv) any combination of the above. Solution (iv) would appear to be the most equitable outcome.
A satisfactory solution, however, will require intensive negotiations among the key players of the industry on the one hand, and the regulator, on the other. The key players and the regulator now have six months to come up with a solution.
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