Unbundling experiences in Hungary

László VarróChief Economist

EPP-ED Public Hearing, 13 February, 2008

New Europe: inefficient markets due to supply dominance and inadequate infrastructure

►Excessive reliance on one single source

►Lack of interconnections

►Insufficient storages

►No LNG

►High prices due to lack of competition

►Bad energy efficiency

►Resulting a much higher economic and social cost of gas supply security problems

The bad case: New Europe

2

Composition of gas sources

Meshed networks vs. parallel East-West transit routes

►Share of gas in primary energy

►Prevalence of gas in heating

►Reliance of the electricity system on gas

►Lack of significant transit flows

►The strongest national interest for developing infrastructure and enhancing infrastructure

The worst case: Hungary

13%

19%

15%

19%

21%13%Russia

Norway

Holland

UK

Algeria

other

64%

36%

Russia

other

Efficient markets reinforce supply security

► Prices as signals: demand reaction

► Reorientation of trading flows

► The value of peak, market based storage investment

► The big lesson: the January 2006 „almost crisis”

Unbundling: a key of efficient markets

► Access to infrastructure

► Incentives for infrastructure developoment

► Barriers to entry, cross subsidies

► Facilitating the emergence of new gas sources

► Capacity utilization, incentives for market liquidity

► Avoiding conflicts of interests

Legal unbundling is an illusion

Legal unbundling

► Network operation and trading interests still in collusion with respect to network investment and capacity allocation

► High monitoring and enforcement costs

► Fails to deliver non-discriminatory TPA

Ownership unbundling

► Deep, serious remedy BUT

► Long lasting structural improvement for the market

► Welfare benefits

‘Proper regulation’

► Information asymmetry between regulator and regulated entity is too deep

► High costs of the regulatory regime

Non-structural solutions cannot create fair competition

Legal or „Bundled” unbundling: techniques in the practice

► Cash pool between the trading and the network company.

► Pledging the network assets as collateral for the trading positions.

► Joint outsourcing of key operations to the holding company which is not under regulatory oversight.

► Inadequate Chinese walls, linked IT system

Timeline of the liberalization of the Hungarian gas market

► MOL has been vertically integrated dominant player on the Hungarian market

► January 1, 2004 Market opening: New Gas Act entered into force, but very little competition. Market split into regulated and competitive markets until July, 2007 (formally)

► 2005 MOL-E.ON Ruhrgas transaction

► Originally MOL retained 25 % of supply, 75% of transmission network

► DG Competition’s condition for transaction approval was full unbundling: E.ON purchased 100 % of supply, MOL retained 100 % of transmission

► 2008 Residential sector is also free for competition

Structure of the Hungarian gas market changed due to the sale of MOL’s certain gas assets to E.On Ruhrgas International

► Gas market before the gas transaction ► Gas market today

Import gas

source Regula-ted

market Gas transmi-

ssion

Gas storage

Gas distribu-

tion, consum-

ption

Import gas

sourceRegula-

ted market

Gas transmi-

ssion

Gas storage

Gas distribu-

tion, consum-

ption

Compe-titive market

Domestic gas source

MOL’s presence Other market participant(s)

Compe-titive market

MOL’s re-entering in progress

Domestic gas source

Competitive gas market has grown significantly since the market opening in January 2004

0

50

100

150

200

250

300

Competitive market gas volume (mcm)

mcm

/ m

on

th

MOL’s experience: Ownership unbundling: a nice idea that works

Regulatory aspects

► Better investment incentives

► Truly independent TSO behavior

► TSO objectives now aligned with the regulator

► Lower compliance burden

► More market based balancing

Management aspects

► Clear incentive structure

► More transparent management structure

► Focus on core competences

► Positive effect on corporate culture of the TSO

► Better reputation among stakeholders

185 - 220

100 - 120

Norway

Wes

t-A

fric

a

Russia

25 - 60 Middle East

Libya15 - 40 Central Asia

+ Caspian

85 - 115

16 - 35

12 - 25

5 - 10

15 -

20

Egypt

Algeria

Source: IEA, OME 2004

With proper infrastructure, Europe could have an efficient diversified market

Indigenous

Production

145-160

Carib.

11

Estimated natural gas supply structure of the EU in 2010-2020 (billion m³/year)

Estimated natural gas supply structure of the EU in 2010-2020 (billion m³/year)

* EU-27, Switzerland and Balkan states

NETS: An unbundled infrastructure platform

► Proposal to unite Central and South-Eastern Europe’s gas pipeline networks within a new and independent regional natural gas transmission company

► Significantly higher value for shareholders than operating separate systems

► Would be well positioned to leverage international capital markets to finance major projects

► Consumers would also enjoy the benefits of an integrated platform for natural gas supply and a greater overall security of supply

Austria

Czech Republic

Italy

Hungary

Slovakia

Greece

Romania

Bulgaria

Turkey

Bosnia

Germany Ukraine

Moldova

Croatia

Slovenia

Serbia

Albania

Montenegro

Poland

Macedonia

Source Company Information

NET, as an unbundled transmission company would be a natural ally for the required massive infrastructural investments

New infrastructure investments through NET

Main planned new investments in the region

Nabucco pipeline project and Adria LNG providing the entire region with new source

Interconnectors between the national gas transmission systems

Capacity de-bottlenecking optimizing regional balance system

Establishment of a regional hub(s)

NET as a platform for new investments

The united gas transmission company would be much more capable of carrying out infrastructure investments, which would be further enhanced through a possible IPO

Most of the planned projects in the region affect the countries in question

NET as a growth story

NET would provide a tremendous growth opportunity on several counts

Based on its sound financial background, NET could easily become an active player of the regional (and European) privatizations and other transactions

The expected total European ownership unbundling would lead to a high volume infrastructure transactions wave only available for independent operators like NET

After a possible IPO, NET shares would represent the growth opportunity of planned international projects with already diversified country risk

The establishment of gas hubs facilitates the development of secondary trading

Thank you

Harmonization of regulatory systems enhances NETS and further contributes to market efficiency

Enhancement of the operation of existing gas transmission infrastructure

Unified grid codeAn entry-exit tariff system

Current

system of

Transpor-

tation tariffs

Clear and

easy to

understand

tariff system

Reflection of

location

differences

Establishing a new regional entry-exit tariff system

A clear regional tariff system enabling investors to understand the expected position of the infrastructure company

Reflecting location differences in marginal costs Providing price signals for congestion managementMitigating excess capacity demands

The bulk of the revenue would come from relatively short

period capacity reservation fees and volume related fees

Reservation period should not exceed one year

NET would encourage secondary trading of booked

capacity

Enhancing the development of an efficient market

Facilitating spot trading

Medium term capacity utilization risk

Could be socialized within NET countries

NET, as an entity, should assume this risk due to its

superior knowledge of the system and its strong

balance sheet

NETS is gathering momentum

► A dialogue of TSO’s is under way

► Policy framework build on existing regulatory cooperation

► Strong interest from national energy policymakers

► Preliminary work on several issues: structure, governance, business model