IEA Commends Hungary for its Determined Effort to Liberalise Energy Markets, but Warns of Challenges Ahead

"Hungary is fully compliant with its commitments regarding strategic oil stocks, and has made remarkable progress in liberalising its energy markets", said Claude Mandil, Executive Director of the International Energy Agency (IEA), at the launch today in Budapest of the "Hungary 2003 Review". "But the country must address a number of challenges," he added. These include improving competition and security of supply in the gas and electricity sectors, introducing cost-reflective prices and putting more emphasis on energy efficiency.

Achieving greater competition and security in the gas and electricity sectors
Security of natural gas supply is vital for Hungary. The Report commends the country's efforts to diversify the sources of the imported gas. It is also opening the domestic upstream market, in order to increase indigenous gas production and facilitate competition. The final adoption of the Gas Act will help to stimulate domestic gas production by reducing uncertainties over future regulation of the sector.

However, limited gas-to-gas competition, due to the strong dominance of Russian gas, the uncertainty as to future gas demand - which depends on electricity demand - and the oligopolistic structure of gas distribution companies are fundamental constraints to the development of strong and healthy competition in the Hungarian natural gas market. The appropriate authorities, including the Hungarian Energy Office (MEH), should carefully monitor the development of the gas market, notably the impact of current take-or-pay contracts, the limited sources of supply and the fairness of access to transmission network and storage as the market evolves.

From 2003 onwards, the Hungarian electricity market is being progressively opened. Several challenges remain however. Hungary must ensure that the state electricity generation and grid company (MVM) does not cause market distortions given its importance in the market. The authority vested in the newly-established independent system operator (MAVIR) should also be further strengthened. Given that Hungary is likely to encounter capacity constraints around 2005, the role of MEH and MAVIR in monitoring generation, transmission and interconnection capacities will become crucial.

Increasing the Hungarian Energy Office's power to regulate prices
The policy aiming at keeping energy prices low for certain categories of consumers for social reasons has detrimental effects. In spite of recent efforts to allow prices to better reflect costs, this policy still adversely affects choice between fuels, artificially boosting natural gas demand by households, for example. This additional demand is already causing seasonal congestion of the gas transmission network. Low prices also discourage energy saving and act as a disincentive to investment by energy firms since they produce less financial return. This policy has serious implications for energy security. The Report recommends that the government should provide a clear timetable with milestones for price increases to market levels, mainly for gas. To avoid a possible conflict of interest, it should give full authority to the Hungarian Energy Office not only to calculate prices, but also to set them for the regulated part of the market.

Reducing energy consumption and boosting energy efficiency
As in many other transition countries, Hungary's energy policy has traditionally focused on expanding energy supply, while paying little attention to costs and economic efficiency. In the past decade, the government has placed greater emphasis on the demand side. The implementation of the Energy Conservation and Energy Efficiency Improvement Action Programme, begun in 2000, is encouraging. However, the primary focus of Hungarian energy policy remains largely on the supply side. A weaker emphasis on the demand side could be problematic in the future.

Final energy consumption has been fairly stable in recent years, but this is largely due to the phase of economic restructuring, during which several energy intensive industries shrank and less energy intensive industries emerged. But the pace of economic restructuring is likely to slow down, which will lead to the growth of final energy consumption, following the gradual growth of GDP per capita. Some specific sectors of the Hungarian economy must work to increase energy efficiency, notably the construction industry, small-medium enterprises and the transport sector. The Energy Centre should be granted long-term funding and be doted with the appropriate executive powers.

Exploiting near-cost effective domestic renewable resources
Hungary's renewable energy potential, though limited, is currently underdeveloped. Some sources could be exploited as Joint Implementation projects. Significant near-term renewable energy potential lies in exploiting bioenergy resources, renewable municipal wastes for electricity and heat production, and geothermal energy for heat. However, the currently available grants and funds might be used to support technologies that have little economic relevance in Hungary, unless clear technology or market priority is given. Similarly, the use of a single feed-in tariff may end up promoting too few renewable energy options. The current policy framework for renewables should be improved to better reflect cost effectiveness.