L

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Energy reform in Hungary

• László Varró Chief Economist MOL Plc

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The historical heritage 1990

• Serious macroeconomic crisis
• Very low energy efficiency
• Heavy reliance on dirty fuels (coal, fuel oil)
• Lack of faith in market based methods
• A green preception of transition

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3
Improving energy efficiency with market reforms
1980100
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The virtue of necessity drivers for change

• Budget crisis
• Looming capacity shortage
• SO2 and other environmental issues
• Need to substitute from coal

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The drivers for change

• Privatisaton a means for government objectives
• Structural reform is a prerequisite for
  privatisation

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POWER SECTOR REFORM PATH IN HUNGARY
1991/92 1995/96 2003 Restructuring Privatization
Competition
4-5 year s
6-7 years generators (8) generators (except
Nuclear) transmitter (1) distributors/suppliers
distributors/suppliers (6)
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The big regulatory trade off

• Strong investment guarantees
• Easy privatisation
• Modernisation investment bankable
• BUT Rigid commitments, lack of competitve
  incentives

• Strong competition
• Big bang structural reform
• Lower inflationary pressure
• BUT Credit rationing, lack of investment
• After Enron hangover

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The first reform of 1995/97

• Overriding priority for privatisation
• Rigid, detailed PPAs
• Privatisation in a single buyer modell
• The state owned single buyer modell acted as a
  puffer

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The single buyer model
Grid Code
Business Rules Market Rules
Business Rules
Import
Export
Power Plant Companies Electricity generation
Distribution/ Supply Companies Distribution, R
egulated Supply
Consumers
Transmission Company - Single Buyer
wholesale - Transmission, - Capacity balance -
Export, Import
Dispatcher
Operational licences
Operational licence
Operational licences
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Electricity and natural gas prices in Euro,
19901,00
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Price of normal consumption as a percentage of
disposable income
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Consequences of the first reform

• Significant investment
• Improved efficiency, technology transfer
• BIG environmental benefits
• BUT
• Cost cutting versus grid quality
• Political minefield

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Expansion of the gas network
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Employees of the distributors
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Our three most stupid mistakes

• Privatisation before tackling implicit subsidies
• No clear assignment of environmental liabilites
• Overcontarcing Failure to consider demand
  elasticity

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Price elasticity matters predicted and actual
electricity demand
predicted
actual
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Predicted and actual gas demand
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The second reform 2001-

• Driven by EU accession
• Gradual transition to a competitive market
• Regulated access to the monopoly infrastructure
• Constrains from the status quo

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Constrains from the status quo

• PPAs (stranded costs)
• Very strong lobby position of the privatised
  industry
• Weak customer representation
• Political sensitivity

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Gradual market opening

• Busienss as usual in the captive market
• No compulsory renegotiation
• Independent system operator
• Optional market opening
• OTC bilateral optional pool (if)

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Social consequences
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• Some sad facts
• Characteristics of energy demand
• Energy pricing reform in Hungary
• Experience with social tariffs

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Some sad facts 1 energy will have a high
relative price in poor countries

• Energy is very capital intensive
• Capital goods have global markets
• Power plants 40, network 60 totally independet
  of local incomes and fuel availability

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Some sad facts 2 someone will pay

• Opportunity cost of taxpayers
• Strained budgets
• Current account constrains
• The government must take a lead implicit
  subsidies to state owned institutions

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The implicit subsidy mith

• Subsidized energy benefits the poor
• Problem 1 even if it were true it would be
  highly inefficient
• Problem2 it is not even true

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Characteristics of energy demand electricity

• Difficult to subsitute, multiply application
• Perception of life necessity and luxury
  consumption
• Appliance penetration and efficiency
• Hot water?
• It does react to price

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On per capita basis electricity seems to have a
high income elasticity
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• BUT Poor families tend to have more dependents,
  on per familiy basis, income elasticity is much
  smaller
• 1 child 25 electricity demand
• Lot of noise
• Large families in the countriside
• Single pensioners

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Appliance penetration

• Usually grows with income
• Society dependent minimum group
• Energy efficiency as a luxury
• Some inferior appliances (freezer)

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Hot water complications

• Potentially 30-50 of total demand
• Legacy systems
• New housing
• Substitution to gas

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Differences between gas and electricity

• Electricification is finished in the 60s
• Very low substitution
• Luxury tresholds (air conditioning, wash up
  machine)
• Mostly domestic production, costs predictable

• Gas spread at the 90s
• Significant groups without access
• Competition with other fuels
• Correlation with flat/house size
• Mostly import, market volatility

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Gas demand characteristics

• Mainly heating
• High correlation with house size (flats versus
  houses) income-family size
• Price adjustment marginal users, better
  insulation, alternative fuels (e0,5 long term)
• Metering issues

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Proportion of families with gas network access as
a function of income
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Natural gas and unregulated fuel consumption as a
function of income
gas
unregulated
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Social and political consequences the Hungarian
experience

• Kamikaze action
• Ordinary welfare channels
• Special targeted schemes
• Social tariff schemes

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Using ordinary welfare channels

• Easy organisation
• Ready (?) institutional framework
• Can reach the elderly and large families
• Good incentive properties

• Overloaded and strained
• Some targeting problems
• Hard to communicate

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Special targeted schemes

• Can be targeted
• Excellent PR
• Tackle credit rationing

• Transaction costs
• Transparency, corruption
• Poverty trap
• Capture

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Social tariffs (Block tariffs)

• Easy organisation
• Low transaction costs
• Transparency
• Good PR

• Income elasticity
• Targeting (large families !)
• Fuel substitution
• Contrary to cost structure

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Social tariffs (Block tariffs) 2

• Low block limit
• Equivalent to a lump sum payment
• Budget transparency
• Marginal cost of consumption Good efficiency
  incentives
• Fairness problems

• High block limit
• Equivalent to price subsidy
• Marginal cost of consumption Bad efficiency
  incentives
• Fair with high income elasticity

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Some environmental aspects

• 1 increase in the effective marginal cost of
  electricity consumption saves
• 800 tons of SO2
• 70 tons of NOx
• 35000 tons of CO2
• Price subsidy type high block limit tariffs are
  environmentally detrimental

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A flat per kwh charge is already a social block
tariff
Average price/cost
Block tariff
Cost structure
consumption