Changing direction: Reform of energy utility sectors in Central and Eastern Europe

Transcription

1 Changing direction: Reform of energy utility sectors in Central and Eastern Europe A report from the Economist Intelligence Unit Sponsored by

2 Contents Preface 3 Executive summary 5 Introduction 8 Part One: Analysis of trends 10 Regional trends: Putting customers first 10 Facilitators of liberalisation 11 Impediments to liberalisation 12 Ranking the countries 12 Outlook for further liberalisation 15 Winners and losers 17 Part Two: Country profiles 18 Czech Republic 18 Hungary 21 Slovakia 24 Romania 27 Poland 31 Russia 35 Conclusion 39 Appendix I: Methodology for the EIU Market Openness Ranking 40 Appendix II: European Commission data on market openness in gas and electricity 42 Appendix III: Participants in in-depth interviews 46 Appendix IV: Economist Intelligence Unit data on utility sectors in six CEE countries 48 The Economist Intelligence Unit Limited

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4 Preface C hanging direction: is an Economist Intelligence Unit white paper, sponsored by Oracle. Like a predecessor study sponsored by Oracle, A painful road forward: Utilities in Central Europe (2004), this study considers the progress of countries in Central and Eastern Europe (CEE) in transforming their electricity and gas utilities from monolithic monopolies to unbundled, competitive and consumer-oriented firms. The study takes an in-depth look at energy utilities in six countries: Czech Republic, Hungary, Slovakia, Romania, Poland and Russia. The study is based on interviews with utility executives, regulators and other industry experts, as well as desk research that included analysis of industry and market data. Our sincere thanks go to the interviewees who are listed in Appendix III to this report for sharing their insights and views. The Economist Intelligence Unit bears sole responsibility for this report; the findings do not necessarily reflect the views of the sponsor. The authors of the country profiles are Andrew Langley (Russia), Janos Hidi (Hungary), Vladimir Dohnal (Czech Republic and Slovakia) and Paulius Kuncinas (Romania and Poland). Nicholas Redman wrote the analysis of trends and developed the methodology for the Economist Intelligence Unit Market Openness Ranking, a data-based comparison of utility sector openness in the six countries. Aviva Freudmann directed the project and edited the report. September 2010 The Economist Intelligence Unit Limited

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6 Executive summary After two decades of post-communist transition, CEE countries are moving towards de facto opening of their energy utility markets. There is widespread inward investment into the sector by West European utilities, considerable entry of new players and systematic compliance with requirements to separate transmission networks from energy production assets. However, as with any complex process, progress towards liberalising the region s energy utility markets has been inconsistent across countries. While the region has made progress towards transforming the legacy of state control of utilities, it still has a long way to go. For example, despite the presence of privatisation laws and policies, state ownership is surprisingly resilient. In some countries, governments retain majority ownership of supply firms as well as transmission assets. In others, state control takes the form of regulating key fuel sources, or regulating the prices that utilities pay for fuel and/or that end-users pay for energy. Nonetheless, utilities show signs that they are aware of looming competition, and have taken steps to upgrade customer-facing functions. For example, online customer services are becoming more widespread, as are improved in-person and call-centre services. Utilities are also taking steps to improve their public image and are diversifying into alternative and green energy initiatives. To assess the degree of progress that the region s utility sectors have made in this direction, the Economist Intelligence Unit interviewed utility executives, regulators and industrial energy users, and combined their views with desk research and analysis of data on market opening. The main findings of the research are highlighted below. A major driver of liberalisation is the need to upgrade plant, and attract capital to do so. This has opened the way for strategic investors to enter the market, bringing advanced management practices and technological know-how along with capital. Competition appears to be more advanced in electricity markets than in gas markets. This is mainly because the power sector has more varied sources of fuel and greater access to required feedstocks. In the case of gas, there are only two options for obtaining the fuel access to domestic production or to imports and both tend to be dominated by governments or monopoly, government-backed incumbents. The Economist Intelligence Unit Limited

7 The concentration of gas supply sources (mainly in Russia, via Gazprom) hinders competition in the gas sector by giving suppliers pricing power. When importers of gas must all pay the same prices for fuel, because they are buying from the same source, this leaves comparatively little room for pricebased competition at the retail or end-user level. Across the region, competition is more advanced in industrial market sectors than among households as is also the case in other regions. In most of the six states, household prices are still regulated as governments try to protect citizens against rate increases. Governments are more likely to leave large industrial users to their own devices, allowing them to choose their own suppliers and negotiate their own prices. EU policies on competition, customer protection and environmental protection are drivers of competitive markets in five of the six countries reviewed. This may be one reason that the sole non-eu nation in the group, Russia, is far behind the others in liberalising its energy markets. Politics plays a distinct role in the process of reforming utility markets. In particular, government unwillingness to expose electorates to higher, unregulated prices for gas or power is a factor in prosperous times, and even more so in economically difficult times. Unlike most Western countries, the six CEE countries do not have interest groups dedicated to protecting consumers interests. This weakens consumers voices, making it more difficult to establish a customer focus in both utility regulation and in utilities management practices. Market openness rankings: two approaches The Economist Intelligence Unit s qualitative research produced the following ranking of market openness in the six countries surveyed: Rank Country 1 Czech Republic 2 Hungary 3 Slovakia 4 Romania 5 Poland 6 Russia This ranking tracks approximately the EU s data for supplier switching among customers in the various countries, although those data are limited. In addition to the qualitative assessment of market openness, the Economist Intelligence Unit conducted a broader quantitative analysis of the degree to which the six countries met certain benchmarks of competitiveness as of This analysis yielded the following rankings for electricity and for gas: Electricity Gas Rank Country Score Rank Country Score 1 Poland 25 1 Czech Republic 25 2 Czech Republic 22 2 Romania 19 3 Romania Hungary Russia Poland 16 5 Slovakia 20 5 Slovakia Hungary 16 6 Russia 9.5 The Economist Intelligence Unit Limited 2010

8 The outlook for liberalisation of the gas utility sector depends largely on the prospects for ending the near-monopoly that Russian gas currently enjoys in CEE. The prospects for this are good, in view of new sources of domestic production and new routes for importing gas. The prospects for further liberalising the electric utility sector are also positive, in view of the ongoing need to attract inward investment. But these prospects also depend on the success of the EU s effort to liberalise national markets and encourage crossborder trading. Further progress is likely to come first in electricity markets, which are already more advanced than gas markets, mainly because the structural preconditions for competition are already in place. In general, liberalisation of utility markets is a two-stage process. The first stage is for prices to rise from their artificially low (regulated) levels, in order to reflect the full costs of production and transmission. At this stage end-users are the losers and producers/generators are the winners. In the second stage, when prices have risen to a level that enables producers and distributors to cover all their costs and to make a profit, the benefits in a competitive market accrue to end-users in the form of lower tariffs owing to competition. The Economist Intelligence Unit Limited

9 Introduction O n June 25th 2009, the European Commission made a surprising announcement: it was taking legal action against 25 member states virtually the entire EU for violating rules in the electricity sector. The Commission also said it was suing 21 states for violating rules on gas. Many of the complaints concerned impeding crossborder energy trading across the bloc, a long-elusive EU goal. But a lot of them also dealt with how states regulate their electricity and gas sectors, especially concerning competition. For example, the Commission accused Poland and Romania, among others, of maintaining a system of regulated prices in violation of the EU directives on electricity and gas. The surprising thing about the announcement was not that states are tardy about implementing EU rules, but that the tardiness is so widespread, encompassing developed and emerging economies alike. Italy and France, for example, are among those facing EU infringement cases related to regulated prices. This suggests that, when it comes to promoting competition in sectors that have long been heavily state-controlled, the EU as a whole still has a long way to go. Against this background, the Economist Intelligence Unit undertook research on the progress made by six Central and East European countries along the road to open and competitive utility markets. The countries studied are the Czech Republic, Hungary, Slovakia, Romania, Poland and Russia. These were selected as examples of former communist countries that are leading economies in the region. Five of the countries are now members of the EU. The sixth, Russia, is by far the region s largest economy. All six countries have had large odds to overcome, including a legacy of under-investment in plant and equipment, unfamiliarity with utility market risks, and a dearth of experience in operating competitive, customer-focused businesses. This study looks at the progress these six countries have made in the last two decades in leaving that legacy behind and modernising their energy utility sectors. The focus is on how far the countries have come in introducing competition de facto rather than only de jure. To determine the degree of liberalisation, the research considered such indicators of competition as the actual ability of customers to switch suppliers, the possibility for new competitors to enter the market, the absence of excessive concentration of asset ownership, the decoupling of ownership of production and transmission facilities, the full or partial privatisation of production assets, and evidence of price competition and other aspects of customer-oriented practices on the part of industry players. 8 The Economist Intelligence Unit Limited 2010

10 Although the main focus is the progress made by each country and the trends common to all six the study also includes a comparative ranking of the countries. There are two types of rankings, each using a different methodology. The main one is qualitative, combining both the electricity and the gas sectors, and is based on the current situation. This ranking relies on desk research and on in-depth interviews with customers, regulators and market participants. Under this analysis, the most competitive energy utility sectors are in the Czech Republic, followed by Hungary, Slovakia, Romania, Poland and Russia. This ranking is reflected in the ordering of the country chapters. The second ranking is quantitative, and considers electricity and gas separately. The quantitative rankings are based on regulatory and market data for 2008, mostly from the European Commission. This analysis evaluates the countries based on the presence of certain quantitative indicators of competition, such as the proportion of production open to competition, the combined market shares of the three biggest players, and the proportion of transmission capacity that is separate from production. Under the quantitative analysis, the ranking for openness in electricity is led by Poland, followed by the Czech Republic, Romania, Russia, Slovakia and Hungary. The ranking for gas is led by the Czech Republic, followed by Romania, Hungary, Poland, Slovakia and Russia. The methodology used for the quantitative rankings is presented in Appendix I, and the underlying EU data are in Appendix II. The rankings differ because they are based on different methodologies and reflect different time periods. The qualitative ranking is based on wide-ranging expert interviews and considers up-tothe-minute conditions. The quantitative ranking is based on a model that is, on selecting certain indicators and drawing conclusions based on performance in those indicators and relies on data reflecting market openness as of While the quantitative ranking may be more methodologically rigorous, the qualitative ranking probably comes closer to describing the current situation in the sixcountry group. The Economist Intelligence Unit Limited

11 Part One: Analysis of trends Companies become customer-facing when they operate in competitive markets and wish to remain there because they can expect a reasonable rate of return. The challenge in the energy utility sector in Central and Eastern Europe (CEE) has been to create those conditions, including the introduction of competition in generation (electricity) or production and import (gas); introduction of competition in distribution and sales; separation of monopoly transmission facilities from these competitive activities; and lifting of price controls to allow freer competition based on price. After two decades of post-communist transition, CEE countries are starting to fulfil these conditions. But, as with any complex process, progress towards liberalising markets has been uneven within countries, as well as inconsistent across them. Part One of this report examines the trends common to all six countries, considers the reasons for progress or lack thereof, and evaluates the outlook for further liberalisation. Part Two looks individually at six major CEE economies the Czech Republic, Hungary, Slovakia, Romania, Poland and Russia and assesses each country s progress towards creating competitive, consumer-oriented energy utility sectors. Regional trends: Putting customers first Although the CEE region has made progress towards ridding itself of the legacy of state control of utilities, it still has a long way to go. Competition has progressed farthest among the EU member states in Central and Eastern Europe, but even in this region it is not always fully in force. State ownership is still much in evidence. The former monopolists are in many cases still the dominant players in their markets, even if they no longer enjoy official monopoly status and are no longer 100% state-owned. In all six countries, the first formal steps towards liberalising markets have been taken. These include allowing private investment in particular, by strategic investors from the West European utility industry in production (and, to a lesser extent, transmission and distribution) assets; unbundling previously monolithic companies into separate production and transmission/distribution entities; passing reform laws allowing new players to compete in the market; and creating a regulatory apparatus to ensure fair conditions for competitors and customers alike. The dismantling of vertically integrated production and transmission companies was particularly important, since transmission and distribution networks are natural monopolies unlike production and generation assets. 10 The Economist Intelligence Unit Limited 2010

12 In practice, however, the liberalisation of these markets is still a work in progress, For example, despite the presence of privatisation policies, state ownership is surprisingly resilient in the countries reviewed. There is wide variation among the countries in terms of the extent to which the state has actually withdrawn from the supply side of the market. In some countries, states maintain control by keeping majority ownership of supply firms. In others, state control takes the form of regulating or owning the fuel sources that utilities use for production of energy, or regulating the prices that utilities pay for fuel and/or that end-users pay for energy. Such measures can render privatisation moot at best. On the plus side, utilities in the six countries show signs that they are aware competition is coming, and have taken steps to upgrade customer-facing functions. For example, online access is becoming more widespread, and in-person and telephone-based customer services are becoming more userfriendly. Better-trained marketing departments, with a focus on targeted key-account management, are becoming the norm. Various green initiatives intended to conserve energy or reduce environmental impact are also becoming widespread. Most notably, utilities are focusing on pricing their services for industrial users with an eye towards keeping customers from migrating to existing or potential competitors. Facilitators of liberalisation A major driver of liberalisation is a region-wide need to upgrade plant, and attract capital to do so. This has opened the CEE utilities market to players from outside the region, in particular to large West European utilities including Enel (Italy), Gaz de France, Électricité de France (EdF), E.ON, RWE and EWE (Germany). There are looming capacity shortages (both gas and electricity) in some countries as economies start growing again following the slowdown of While this may accelerate the drive to attract inward investment, in the short term capacity shortages shift the balance of power to suppliers; customers are in a poor position to shop around for better prices and services under conditions of shortage. Generally speaking, competition is more advanced in electricity markets than in gas markets. This is mainly because the power sector has more varied sources of fuel and greater access to required feedstocks (coal, uranium, wind, waves, biomass). In the case of gas, there are only two options for obtaining the fuel: access to domestic production or import volumes. Because national production in all countries (except Russia) is relatively small scale and tends to be dominated by the former state monopoly, there is little competition. Similarly, because nearly all of the states (again except Russia) rely on gas imports from Russia, there is little scope for competition and governments often prefer to have their former monopoly as the sole negotiator with Russia s monopolist, Gazprom. As in other regions, in the CEE competition is more advanced in industrial market segments than in the household segment. In most of the six states, the household market is still subject to price regulation by governments, for electoral reasons and to ensure that lower-income groups do not fall into fuel poverty. Large industrial users are given wider latitude to shop for supplies and negotiate their own deals, which implies that they also take on more risk regarding prices. Industrial users tend to be far better informed than households about the options available to them. As such, they are at the vanguard of competitive markets: if their experience with freer choices proves successful, governments The Economist Intelligence Unit Limited

13 may loosen the controls that hold back competition in the household segment. Finally, EU policies concerning competition, customer protection and environmental protection tend to promote development of competitive markets in five of the six countries reviewed. This may be one of the reasons that the sole non-eu nation in the group surveyed, Russia, is far behind the others in liberalising its energy utility markets. Russia s focus is on creating conditions to ensure that the sector modernises its facilities and remains viable. Market competition issues are not yet high on the agenda. Impediments to liberalisation Politics plays a distinct role in the process of reforming utility markets. In particular, government unwillingness to expose electorates to higher, unregulated prices for gas or power is a factor in prosperous times, and even more so in economically difficult times. For example, Hungary s recent reregulation of consumer prices for electricity is expected to curtail competition in the household sector. Such measures protect consumers in the short run, but tend also to discourage inward investment required for modernisation. Ultimately, the customer has to pay for modern, reliable, clean and sufficient generating capacity. The concentration of gas supply sources (mainly in Russia, via Gazprom) further hinders competition in the gas sector by giving suppliers pricing power. When importers of gas must pay the same prices for fuel, because they are buying from the same source, this leaves comparatively little room for pricebased competition at the retail or end-user level. Even in the most liberalised CEE countries, the political and legal framework for the utility industry is not as reliable as in Western Europe. National regulators require time to develop laws, practices and expertise to ensure competitive markets. Moreover, unlike most Western countries, the six CEE countries do not have interest groups dedicated to protecting the interests of utility consumers. Instead, this function is performed informally by regulators, alongside their other functions as neutral market referees. This means that utility consumers have a weaker voice in CEE than in Western Europe, putting them in a poorer position to advocate for their interests in regulation and in utilities management practices. Ranking the countries A qualitative analysis While rank ordering was not the primary purpose of this study, the research on individual countries (see Part Two) allowed us to generate a comparative ranking of the countries in terms of the openness of their energy utility markets. That ranking is shown overleaf. The most open utility sectors are in the Czech Republic and Hungary. In the Czech Republic, three major players compete for business in the electricity sector and large new entrants into the gas sector are making inroads into the incumbent s dominant position; in Hungary, where the dominant electric utility has had to make room for newcomers, as many as eight significant players compete for the industrial gas market. 12 The Economist Intelligence Unit Limited 2010

14 Rank Country 1 Czech Republic 2 Hungary 3 Slovakia 4 Romania 5 Poland 6 Russia At the bottom end of the qualitative ranking are Poland and Russia. In Poland, supplier switching is negligible despite the presence of several strong competitors, as customers apparently are unaware of the options available to them, and gas is still very much dominated by a government-controlled incumbent; in Russia, competition is hardly on the agenda, as utilities and policymakers struggle just to keep up with energy demand. This assessment is based on a wide range of factors: whether competing suppliers of electricity and gas are present in the market, whether market concentration among suppliers is kept to a minimum and/or is on the decline, whether customers can choose among suppliers and the degree to which they exercise this freedom, whether utilities compete on price and on service, whether strategic investors have been able to introduce modern management techniques, and whether utilities are showing signs of greater customer focus, for example through improved customer services. The ranking based on these considerations tends to track the available EU data on the incidence of customers switching suppliers. While data on supplier switching by electricity customers are patchy at best, an approximate rank ordering of the switching rates based on EU data by eligible metering point puts the Czech Republic first, followed by Romania and Slovakia. (Comparable data on electricity supplier switching by eligible point in Poland and Hungary are not available. According to the EU, however, when switching rates by volume rather than metering point are considered, rates of more than 10% were reported for large industrial users in Poland and Romania.) What persuades most customers to switch is, of course, the chance to save money through lower bills. The Czech Republic does best on this measure since it allows markets to determine the price of gas and electricity for both households and businesses. Thus EU data show that in the large-industrial segment in the Czech Republic, 33% of customers by eligible point switched supplier in That proportion rose to 45% in By any standard, these are very high levels of switching. Moving between suppliers was also prevalent in the medium-industrial segment in the Czech Republic, reaching rates of 15% and 18% respectively in 2007 and By contrast, neighbouring Slovakia continues to regulate gas and electricity prices, which limits the ability of suppliers to compete on price. This is reflected in switching rates of only 2-3% in the large-industry segment of Slovakia s electricity market in 2007 and 2008, and negligible switching rates in other market segments. One indicator of the newness of competition in the region s utility markets is the dearth of data on customer switching. In electricity, an EU report on the industry published in March 2010 had no data on switching by electricity customers in Poland or Hungary. In the gas industry, the EU report included The Economist Intelligence Unit Limited

15 data on supplier switching by metering point in the Czech Republic (5.3% and 6.7% among largeindustrial users in 2007 and 2008 respectively), but none for Hungary, Poland, Romania or Slovakia. A quantitative analysis In addition to a qualitative assessment of market openness, the Economist Intelligence Unit conducted a broader quantitative survey of the degree to which the six countries had fulfilled certain preconditions for competitiveness as of 2008, the most recent year for which EU market-openness data are available. Using EU data for the five EU member states in the sample, and national data for Russia, this analysis rates the progress of these six states against EU best-practice and the EU s competitive benchmarks. This analysis yielded the rankings in the following tables, which present the full scores for each country on each of six indicators, as well as each country s total score. The scoring of market openness was done on a 1-5 scale, where 5=fully open, 4=mostly open, 3=somewhat open, 2=mostly closed, and 1=fully closed. The full methodology behind the scoring and ranking is explained in Appendix I. The EU source data used for the scoring appear in Appendix II. ELECTRIC POWER Market open? Production sector competitive? Economist Intelligence Unit Market Openness Ranking Distribution sector competitive? Transmission unbundled from production? Industrial prices set freely? Household prices set freely? Poland Czech Romania Russia Slovakia Hungary GAS Market open? Production sector competitive? Distribution sector competitive? Transmission unbundled from production? Industrial prices set freely? Household prices set freely? Czech Romania Hungary Poland Slovakia Russia COUNTRY TOTALS COUNTRY TOTALS In electricity, Poland leads the ranking based on strong data showing lack of concentration in both the generating and distribution sectors, and based also on 2008 data showing that prices for industrial consumers were freely set and were lower than an EU benchmark. Poland was followed closely by the Czech Republic, where the market was similarly open to competition, but where market concentration in the power sector was greater than in Poland. Hungary, surprisingly, appears at the bottom of this ranking, based on 2008 data showing concentration in both the production and the distribution 14 The Economist Intelligence Unit Limited 2010

16 markets, and also based on data saying that the Transmission System Operator had not unbundled transmission and production assets at that time. In gas, the Czech Republic leads the quantitative ranking, based on strong scores for competition in its distribution market, and strong scores on free-market determination of both industrial and household prices. Romania also scored well on competition measures in the distribution market, and on legal unbundling of its distribution sector. Russia is at the bottom of this ranking, owing to a variety of factors: a market dominated by Gazprom with scant competition to speak of, bundled transmission and production ownership, and tightly controlled prices. Outlook for further liberalisation Gas The outlook for liberalisation of the region s gas utility sector depends largely on the prospects for ending the near-monopoly that Russian gas currently enjoys in Central and Eastern Europe. Among the five CEE states, only Romania has sizeable domestic production, and only the Czech Republic imports a significant proportion of gas from a non-russian source. So-called Central Asian gas is actually Russian in origin, although it is supplied by traders rather than Gazprom. In any case, since 2009 this source of gas has dried up and there is little reason to believe that it will re-emerge. The good news for liberalising gas markets in future is an increased possibility of domestic production. Foreign investors are currently developing conventional gasfields in Hungary. Across the region, and particularly in Poland, it might be possible over a year period to develop significant production of unconventional gas, using advanced extraction techniques pioneered in the US, where unconventional gas has become a major source of domestic production. In nearly all cases in CEE, new sources of domestic production will be managed by new entrants and so will increase competition in production. This could increase national self-sufficiency, as well as breaking the hold of former monopolies. The addition of new gas import sources made possible by new pipeline infrastructure is likely to help as well. The gas dispute in January 2009 between Ukraine and Russia exposed the overdependence of the EU s eastern members on Russian gas delivered via a single route. However, plans are under way to remedy this. There are several planned import pipelines, including Nord Stream, South Stream, Nabucco and ITGI, some of which will bring new suppliers to the EU market and hence increase competition. There are also plans for new north-south interconnection lines, to complement existing and planned east-west ones, which will allow the CEE region to tap gas entering Europe from other points, such as North African or Middle Eastern liquefied natural gas (LNG) coming in through France, Spain, Poland and perhaps Croatia. All this will boost competition in gas import markets, for example by introducing Azerbaijani or perhaps Turkmen gas into Europe. Moreover, planned LNG terminals in Poland and Croatia hold out the possibility of CEE states obtaining gas from a range of producers in the Middle East and North Africa, including Qatar and Algeria. Because these cargoes are unlikely to be priced according to the oil-indexed formula that governs Russian exports to Europe, it has the potential to increase price The Economist Intelligence Unit Limited

17 competition significantly. A case in point: in 2009, the increased availability of non-european LNG in continental Europe stoked an unprecedented level of price competition, in some cases forcing Gazprom to cut its prices by amending the oil-indexed formula. The position within the Russian gas market is different from that of the other states, because Russia is self-sufficient in gas and is a huge exporter. The key to development of competition in the Russian market lies with the government in two respects. First, it has the ability to force Gazprom to give independent gas producers and oil companies non-discriminatory access to its pipeline system; this will increase competition among producers. Second, the government plans to either liberalise prices or else raise the fixed tariff by a considerable margin, by the middle of this decade; either decision would raise incentives for producers to operate in the domestic market, creating more scope for price competition. The driving force for Russia to make both these changes could be the need to secure investment in new fields and also to make domestic consumption more efficient. Whereas in most cases liberalisation largely benefits end-users, in Russia it will benefit producers, since the regulated prices for households and industry are very low. The main losers will be households, which will have to pay more for gas. Electricity The prospects for the further liberalisation of the region s electric utility sector are positive, in view of the continued need among the region s utilities to attract inward investment to upgrade ageing production capacity. For example, the need to attract investment was the main driver of the complete overhaul of Russia s power sector, which today is much more liberalised and competitive than the gas sector (although the state still plays an important role in power production and transmission, as well as regulating end-user tariffs). A further boost to competition will come from the EU s ongoing efforts to liberalise national markets and encourage crossborder trading. The main barriers to liberalisation, as noted above, have been the efforts of governments to shield voters from free-market pricing for power. The development of competition in generation has also been stymied by governments determined to retain a controlling minority stake in former state monopolies. This applies particularly to Slovakia, although in different ways the government remains an influential player in all of the other CEE states as well. Furthermore, the existence of complex and opaque contracts, tacit renewal clauses, unclear pricing and switching fees are deterring consumers from changing supplier. Despite these barriers, further progress on liberalisation is likely to be seen in electricity markets, which are already more advanced than gas markets. This is mainly because the structural preconditions for competition are already in place. Competition in power generation will increase as privatisation proceeds (for example, in Poland) and new energy projects come online. The need to cut budget deficits will also impel governments to rethink whether they can afford to subsidise end-user tariffs. Finally, pressure from the European Commission should remove more of the impediments to competition at the retail level, such as administrative barriers to switching supplier. Liberalisation in gas markets is more dependent on external developments, such as the lengthy process of building of new pipelines, and the equally long-term process of increasing domestic 16 The Economist Intelligence Unit Limited 2010

18 production through new projects. But despite the delays, these projects are likely to contribute to a liberalising trend in gas markets as well. Winners and losers Who wins from the ongoing process of liberalisation, and who loses? As a general matter, there is a two-stage process. The first stage is for prices to rise from their artificially low levels, in order to reflect the full costs of production and transmission. At this stage end-users are the losers and producers/generators are the winners. In the second stage, when prices have risen to a level that enables producers and distributors to cover all their costs and to make a profit, the benefits in a competitive market accrue to end-users in the form of lower tariffs. There is also a universal benefit for the countries concerned, in that the introduction of competition to energy markets tends to raise the efficiency of energy use, and along with this stimulates innovation. At a more basic level, utility customers stand to benefit from an increased customer orientation on the part of utilities, driven by competition. Some of the changes in utilities management practices, as noted in the country profiles that follow, include upgrading the quality of customer service and encouraging energy conservation and environmental improvement projects. An example of a customer services measure is an effort by some utilities in the region to streamline their tariff structures and provide customers with simple, clear and informative bills for gas and electricity. The Economist Intelligence Unit Limited

19 Part Two: Country profiles Czech Republic Electricity: Power to the people Competitive overview On paper, and to a growing extent in practice, the Czech power sector is fully liberalised, with customers free to choose among competing power companies. The old days under the communist regime, in which the industry was dominated by the then state-owned integrated utility, ČEZ (Ceske Energeticke Zavody), are long gone. The industry today is unbundled, and several large private players are involved in both production and distribution. These providers compete with each other for both industrial and household customers. The opening of the Czech power market has evolved over two decades. The first step occurred in 1990, when the government split ČEZ into separate generation, transmission and distribution entities. The distribution part was subdivided into eight regional companies. The unbundling was an important forerunner to partially privatising generating plants and distribution networks. Then, ahead of EU accession in May 2004, the government passed legislation opening the electricity market to competition. Transmission and distribution companies were required to open their networks to competing suppliers. By 2002, large industrial and commercial users were free to choose among competing suppliers. Households acquired the same privilege in Customers interests are looked after by two regulatory bodies: the Energetický Regulační Úřad (ERÚ), which regulates prices for power distribution services; and the OTE, which ensures that customers wishing to switch suppliers can do so without hindrance. While all this represents a considerable market opening, in one sense the liberalisation of the Czech power market is still a work in progress. New players are free to enter the market, but in practice the market and in particular the power generating market is still fairly concentrated in the hands of a few companies: ČEZ, E.ON and Prazska Energetika. The eight regional distribution companies are 18 The Economist Intelligence Unit Limited 2010

20 controlled by the same three companies. This market dominance by the Big Three is being challenged, albeit slowly, by new entrants. Interestingly, given a choice between the incumbent, ČEZ Central Europe s biggest utility and other providers, more than one-half of customers stayed with tried-and-true ČEZ. According to 2008 figures from Mintel International Group, a research consultancy, 56% chose ČEZ as their power supplier, 22% opted for E.ON, 10% chose Prazska Energetika and 12% chose others. By 2009, according to ERU, ČEZ s market share had fallen to 45%, E.ON held steady with 21%, Prazska Energetika climbed to 12%, and newcomers Lumius (4%), Czech Karbon (3%) and Czech Coal (2%) made good initial showings. When looked at from the perspective of installed capacity, a similar picture emerges: ČEZ is well ahead of the pack. The former monopoly, which is still 70% state-owned, accounted for 74% of power production in Its installed capacity is 12,405 mw. Other players are much smaller: Sokolovska uhelna has installed capacity of 590 mw, Energeticky a prumyslovy has 330 mw, J&T-owned International Power Opatovice has 363 mw, Dalkia CR has 550 mw, Pražská teplárenská has 484 mw and Alpiq Generation has 415 mw. Power distributors are free to choose among any of these generating companies, as well as to buy power on the Czech or foreign energy exchanges. The customer s view Paradoxically, the economic crisis of was good for competition, first because reduced demand forced distributors to fight for every customer, and second because lower prices on the spot market helped alternative suppliers to gain a foothold in the market, as they were relatively less likely than the incumbents to be locked into long-term purchase contracts at high prices. The ultimate beneficiaries of both factors were electricity customers, who were able to negotiate lower and more flexible tariffs. One example is offered by Formplast Purkert, a small manufacturer of plastic car components with annual sales of 15m. Zdeněk Purkert, the company s owner, says he was able to cut his electricity bills by 5-10% when he switched power supplier. He notes approvingly that his new supplier, Lumius, is also quick to step in and help a customer, as for example when he had a problem connecting an expanded manufacturing plant to the power grid in He adds that when he notified ČEZ that he was switching to Lumius, the large incumbent did not make a counter-offer to keep his business. The incumbent, however, says that it is indeed courting customers, in various ways. One example is CEZ s Zelená energie (Green energy) programme, which provides grants that match customers investments in environmental projects. These projects can include anything from developing renewable fuel sources, to implementing energy conservation measures or planting trees to improve the environment. The idea is to link the ČEZ brand with environmental awareness, and to contribute towards more economical and environmentally sound operations of industrial facilities. Gas: Transgas battles other titans Competitive overview Liberalisation of the Czech gas market lags behind that of the electricity market, both in terms of chronology liberalisation began only in 2005 and in terms of degree of market opening. On paper, The Economist Intelligence Unit Limited

21 the market was fully open to competition by 2007, and competition is gradually being introduced. But as is the case with electricity the market is still dominated by the formerly state-owned incumbent. The former monopolist, Transgas, is now owned by RWE and controls about 67% of the gas market. In recent years, alternative players have made inroads into Transgas s market. The biggest competitor is Pražská plynárenská, which had a 12.4% market share in 2009, followed by Vemex (majority owned by Russia s state-owned Gazprom) with 9%, and E.ON Energie with 4.3%. There are signs that competition is gathering pace. The former Slovak gas monopoly, SPP, entered the Czech market in 2008 and has already acquired a 6% market share. Then in June 2010, ČEZ entered the retail gas market, offering cheaper gas acquired on the spot market. The utility believes it has an advantage over the incumbent, which it says is more likely to be committed to long-term take-or-pay contracts. ČEZ entered the industrial market in late 2009, and claims to have already signed contracts representing 5% of that market segment. The customer s view Although the gas market is officially open to competition, provider-switching by customers has made a fairly modest start. Between January 2008 and November 2009, only about 18,000 customers changed their gas supplier. the figure THEN jumped by 10,000 customers in December 2009 alone, and the totals have been on an upward trend ever since. Transgas is taking steps to stem the outflow. Its owner, RWE, has brought in Western management practices, including segmenting the customer base and appointing account managers for key customers. In 2008 Transgas established an internet portal that provides customer services online. Czech Republic: In Brief * 2015* GDP per head (US$ at PPP) 20, , ,610.0 Real GDP (% change pa) Population (millions) Industrial production (2005=100; av) Gross Electricity Generation (Gwh) 81, , ,778.9 Gross domestic electricity consumption (GWh) 64, , ,363.9 Electricity: Gross domestic energy consumption (% change y/y) Natural Gas Production (ktoe) Natural gas: Total imports (ktoe) 7, Natural Gas: Gross domestic energy consumption (ktoe) 7, , ,028.2 * EIU forecast ktoe= kilotonnes of oil equivalent Source: EIU CountryData 20 The Economist Intelligence Unit Limited 2010

22 Hungary Electricity: MVM makes room for newcomers Competitive overview Hungary s electricity market was fully liberalised under a reform law in early 2008, which widened the scope for competition among generating and distribution companies. This law built upon the breakup and privatisation in the late 1990s of the state-owned incumbent, MVM (Magyar Villamos Muvek), which saw the transfer of many of the monopolist s generating and distribution assets to private companies. Many of the buyers were foreign utilities, including E.ON and RWE of Germany and EdF of France. The result has been enhanced competition for certain market segments, but in practice MVM retains a dominant position, particularly in power generation. MVM still controls 55-60% of Hungary s power production through its full or partial ownership of power plants, and through power purchase agreements. Through MVM and its ongoing hold on power supplies, the government is able to continue ensuring that low-cost power is allocated to households. In addition, the government moved earlier this year to ensure that it has a direct tool to let households benefit from regulated energy prices. In June 2010, parliament reinstated the old system of government-set electricity and gas prices for households, in effect potentially making this market segment unattractive for would-be competitors. The upshot is that Hungary s power market is mixed, with competition developing in the industrial and commercial segment, but virtually non-existent in the household segment. On paper, 11 regional universal service providers and some other traders compete for household business based on price and service; households are technically free to choose among any one of the universal providers as well as any other supplier on the open market. In practice, however, households have little reason to switch suppliers, since prices for households nationwide are set by regulators. And, in fact, nearly all households in Hungary are served by the universal service provider in their own regions. Even before the latest move to re-regulate household prices, households were hesitant about switching suppliers. Since 2008, households and small businesses typically have stayed with their current suppliers even if a competitor offered small businesses as much as 5% lower electricity bills. According to industry estimates, only 8-10% of small businesses switched suppliers. Price competition is more evident in the industrial segment. Large energy users are free to shop for power anywhere at unregulated prices and in fact do so. The law refers to the large-user segment as the open market. Major companies compete actively for this segment. In 2008, the most recent year for which market share figures are available, E.ON and RWE were in the lead, with market shares of 29% and 28% respectively. MVM and EdF followed, with 14% and 13% market shares respectively. The remainder of the market was shared by 13 other companies. The opening of the industrial and commercial market to competition, which began in 2004, has put power producers and distributors as well as consumers on a steep learning curve. Industrial customers The Economist Intelligence Unit Limited

23 have had to learn to manage the risks that came along with their new-found freedom of choice, and in particular how to shop for the best deals. Producers and distributors have had to learn how to access a market that previously dealt with only one supplier, and how to manage the risks of ramping up capacity only to see demand fall, as it did during the recession of The customer s view There are signs that this learning process has been successful. Suppliers have improved their customerfacing functions, with more attractive websites and online services available in many cases. Customerfacing offices have been refurbished, and anecdotal evidence suggests that waiting times have been reduced. A customer satisfaction index produced by Hungary s Office of Energy shows a steady improvement over the past two to three years, according to Dr Gábor Szörényi, director of that office s Directorate of Energy Supply and Consumer Protection. In addition to enhancing customer services, some power suppliers have started to offer energy consultancy services usually for a fee as well as a wider range of tariffs. Some market observers say that power companies have also become more tolerant about late payments, to avoid alienating customers. Another sign that competition is heating up is the recent appearance of a new market entrant, Magyar Telekom. This firm, a Deutsche Telekom subsidiary, is piloting market entry as an electricity and natural gas trader. Above all, many large customers report a drop in their electricity bills both because of a fall in market prices following the economic slowdown and because of competition among power producers. For many end-users, however, price declines occurred only after a one-year delay, with the benefit of lower wholesale prices accruing mainly to energy traders during that period. Gas: Turning up the competitive heat Competitive overview The re-regulation of household prices announced by parliament in mid-june applies to household purchases of gas as well as electricity. On paper, households may still choose among 11 universal service providers as well as open-market providers. But as long as households benefit from price regulation, they are unlikely to exercise this right. Indeed, according to Zsombor Szilágyi, head of industrial relations at EMFESZ Natural Gas Trading and Service Provider LLC, a natural gas distribution company, the regulated gas price in the universal service segment does not even cover suppliers costs. The universal service market segment (consisting mainly of households) has existed under law since July 1st 2009 and is mainly served by E.ON, RWE, GdF Suez (France) and ENI (Italy), as well as some further smaller service providers. These companies face a squeeze from two directions: the price they can charge households is regulated, and the price they must pay for their gas purchases is kept high by the fact that the wholesale supply is fairly concentrated. About 70% of Hungary s gas comes from Russia (mainly Gazprom), another 20% from domestic sources, and the rest from the West, mainly Austria. The gas suppliers in the wholesale segment are E.ON, with 55% of the market in the second half of 2009, MOL with 16%, ENI with 15%, and RWE with 7%. The rest of the market is supplied by smaller 22 The Economist Intelligence Unit Limited 2010