Market Overview


The Hungarian electricity supply industry consists of 12 generating companies and six distribution and supply companies. The high-voltage transmission network is owned by MVM Rt., the country's state-owned incumbent monopoly power supplier. MVM also owns Hungary's nuclear power plant Paks which accounts for almost 40% of domestic power generation, 34% of the shares of the Vértes coal plant, as well as stakes in two generating companies (Mátra and Dunamenti). Generation is on average 50% foreign (mainly privately) -owned; the remainder is owned by Hungarian private owners, the Hungarian Republic, MVM, municipalities, and other state-owned institutions. Distribution is owned to 70% by foreign, in all but two cases private, investors. Much of the existing generating capacity is very old, and, due to high air pollutant emissions and tightening environmental standards, about 30% will need to be retrofitted with environmental control technology or be replaced in the next decade. Hungary uses twice as much natural gas than the IEA Europe, most of which is imported from Russia.

At present, the Hungarian power market is not competitive. Generators sell power to MVM under long-term contracts, and distributors buy it from MVM under long-terms contracts. Under the current legislative framework, the main regulatory responsibility lies with the Minister of Economic Affairs who regulates end-user prices. The Minster's decisions are prepared by an energy regulator (the Hungarian Energy Office) and the competition authorities. The Hungarian Energy Office also controls major ownership, and capital transactions. A draft Bill aiming to introduce competition according to the provisions of the EU Electricity Directive is currently under discussion.

Historical Overview

The Hungarian electricity supply industry has undergone dramatic change over the last five years. The industry had been nationalised after the Second World War. The nationalised system, which consisted of a multitude of individual entities, had been combined into the government-owned Magyar Villamos M´u´vek Tröszt (MVM T., Hungarian Electricity Board), which was formed in 1963. MVM T. had 22 subsidiary companies. Of these, 11 were power stations and one a repair company, six were regional distribution companies, one was responsible for the high-voltage electricity grid (OVIT), and the remaining three were responsible for investment, construction and installation.

After the collapse of the Soviet Union, MVM Tröszt was corporatised. Based on proposals developed by the Ministry of Economic Affairs and submitted to the Government in April 1991, it was to be reorganised into a two-tier structure. In the upper tier, a central organisation was to be responsible for technical and economic management and overall co-ordination. This organisation was to function as a financial holding company owning and managing the second tier, the generation and network companies, which would become independent corporations. The objectives of this reform were to render transparent the economic situation of MVM T.'s individual corporate parts, to attract foreign capital for new investment, to separate ownership and operation, and to "loosen" the monopolistic structure of generation and supply. Control over the new structure was also to be given to Parliament and regional and local governments.

The proposal was accepted by the Government, and on 1 January 1992, MVM T. became Magyar Villamos M´u´vek Részvénytársaság (MVM Rt., Hungarian Electricity Companies Ltd.). The subsidiaries responsible for generation, transmission and distribution/supply of electricity were formed into independent joint stock companies, but they continued to be owned by MVM Rt. and by the Government.

The next step was taken in 1994, when the 1994 Electricity Act (Act XLVIII of 6 April 1994 on the Production, Transport and Supply of Electric Energy) came into force. This Act describes the tasks and responsibilities of the Hungarian Energy Office (Magyar Energia Hivatal, MEH) (important legal provisions for the establishment of the Hungarian Energy Office were also established earlier through the 1994 Natural Gas Act). MVM's generation side was reorganised into eight different generating companies, the Vértes, Mátra, Tisza, Bakony, Budapest, Dunamenti, Paks, and Pécs power companies. Except for the Mátra, Dunamenti and Paks companies, all power companies comprise several power plants. Paks Power Co. owns and operates Hungary's 1 840 MW nuclear power plant.

Operation and construction of the transmission grid and system operation, including dispatch of power plants, are the responsibility of Országos Villamostávvezeték Részvénytársaság (OVIT Rt., National Power Line Co.), which is a fully-owned subsidiary of MVM. The distribution and supply side was organised into six different companies with exclusive supply areas: Édász Rt. (Észak-dunántúli Aramszolgáltató Rt. (Northwest Hungary Electricity Supply Co.)), Elm´u´ Rt. (Budapesti Elektromos M´u´vek Rt. (Budapest Electric Co.)), Émász Rt. (Észak-magyarországi Aramszolgáltató Rt. (Northern Hungary Electricity Supply Co.)), Titász Rt. (Tiszántúli Aramszolgáltató Rt. (Eastern Hungary Electricity Supply Co.)), Démász Rt. (Dél-magyarországi Aramszolgáltató Rt. (Southern Hungary Electricity Supply Co.)), Dédász Rt. (Dél-dunántúli Aramszolgáltató Rt. (Southwest Hungary Electricity Supply Co.)). Figure 34 shows the supply areas of these companies.

Figure 34 Electricity Distributors and Retailers in Hungary
Source: MVM Rt.

In December 1994, it was decided that all generating companies except Paks (Paksi Atomer´o´m´u´ Rt.) and all six distribution and supply companies should be privatised. MVM was to retain the Paks plant and the grid company OVIT. MVM would also continue to be responsible for import and export of electricity, wholesale trading, reliable power supply, system development and investment in generation, and the operation and development of the transmission grid. All of these functions are to be carried out at minimum cost.

By early 1998, all distribution and supply companies and all generating companies except Paks and Vértes (Vértesi Er´o´m´u´ Rt.) were at least partly privatised. According to the draft energy programme of the Government in office since spring 1998, MVM and Paks are to remain in state ownership, but no official decision has been taken yet.


The Hungarian electricity supply industry comprises 45 power plants for public electricity supply, amounting to 7 352 MW of capacity. In addition, there are 182 MW of industrial autoproduction; these comprise two power plants owned by foreign investors, the Csepel plant (owned by PowerGen) and the Dunaújváros (owned by EMA Power). The size of the power plants, their age and geographical location, and the fuel they use reflect the pattern of past investment in generating capacity which occurred in distinctive waves in Hungary.

Plants burning brown coal were mostly commissioned in the 1950s and 1960s, although some date back to the 1930s and 1940s. They are generally very small and located near the coal mines. Their thermal efficiency is very low. Figure 35 shows the average thermal efficiency of the Hungarian power supply system between 1951 and 1997.

Figure 35 Average Thermal Efficiency in Hungary's Power System Public Supply, in %
Source: MVM.

The next wave concurred with the development of Hungary's lignite deposits, situated in the northeast of the country. This fuel was used in the Mátra (formerly Gagarín) power plant, which has generating units of 100 and 200 MW. Around the same time, larger "hydrocarbon" (oil and gas dual-fired) boiler plants were built, e.g. the Dunamenti and Tisza II plants, each with larger block sizes of above 200 MW.

Hungary's nuclear power station at Paks was commissioned between 1981 and 1987 and consists of four double blocks of 2 × 230 MW each, yielding 1 840 MW total capacity. The reactors are of the Soviet VVER-440 design. Originally there were plans to build two more nuclear units of 1 000 MW each at Paks in the early 1990s, but the plans did not materialise due to the political events. Table 7 shows the size distribution of power plants in Hungary (the Paks plant and the matter of nuclear energy in Hungary are treated in greater detail in Chapter 10).

Table 7 Size Distribution of Generating Units in Hungary All Input Fuels, Public Supply

< 20 MW 20-49 MW 50-99 MW 100-200 MW > 200 MW
Number of Units 41 16 12 12 18
In Number of Power Plants* 8 7 4 5 3
Capacity (MW) 334 451 740 1 787 3 990

* Note that this table does not list very small power plants below a capacity of 3 MW.
Source: IEA estimate based on MVM statistics.

It is important to note that electricity demand, which had stood at a maximum of 40.7 TWh in 1989, collapsed after 1990 as a consequence of the breakdown of the centrally-planned economy. Although demand started growing again in mid-1992, consumption had not yet reached its 1989 level in 1997: gross consumption amounted to 35.6 TWh, 7.7% less than in 1989. Despite these rather drastic demand swings, net domestic generation continued its growth trend almost unbroken, and rose from 27.0 TWh in 1989 to 32.4 TWh in 1997. This is because imports from the Soviet Union (Ukraine) fell to about 10% of their previous amount during the same time and had to be replaced by domestic generation to a large degree (these issues are described in more detail in the following section, Transmission, Interconnection and International Trade). Total imports now stand at about 20% of their values in 1990. Figures 36 and 37 illustrate the development of power demand and supply over the last 21/2 decades.

Figure 36 Electricity Demand by Consuming Sector, 1973 to 2010
Source: Energy Balances of OECD Countries, IEA/OECD Paris, 1998, and country submission.

Figure 37 Electricity Generation by Fuel, 1973 to 2010
Source: Energy Balances of OECD Countries, IEA/OECD Paris, 1998, and country submission.

Figure 38 The Hungarian Transmission Network and Main Power Plants
Source: MVM.

Figure 36 highlights the collapse of industrial electricity demand after 1990. Residential and commercial demand continued its growth unabated; electricity demand for transport stayed flat.

Figure 37 shows electricity generated by input fuel. The growing importance of the Paks nuclear plant is clearly discernible. It accounted for some 39.5% or 13.97 TWh of generation in 1997. The second most important fuel was coal, with 26.5% or 9.73 TWh. Oil and gas were at a par, with 16.6% (9.59 TWh) each. Renewables played a very minor role: hydro generation, almost all run-of-the-river, accounted for 0.6% (0.179 TWh) and combustible renewables accounted for only 0.3% (0.3 TWh).

Transmission, Interconnection and International Trade

The Hungarian transmission system also underwent dramatic changes during the last nine years. Figure 38 shows the current state of the transmission system and the main power plants connected to it.

The map shows one high voltage alternating current (AC) power line of 750 kV and about 2 000 MW capacity, entering Hungary from Ukraine and ending at the Albertirsa substation. Long-distance transport of electricity over this type of transmission line is economic only for very large amounts of electricity. There are only a few other cases elsewhere in the IEA (it is generally cheaper to transport the input energy and convert it into electricity closer to the demand centres than to transport electricity over long distances - provided the input is mobile. This is obviously not the case for hydro power, and some of the existing very high voltage power lines are consequently used to transport hydro-electricity). The power line is typical of the trade relationships prevailing in the former UPS/IPS (United Power System/Integrated Power System), which connected the Former Soviet Union and its neighbouring States within the framework of the Council of Mutual Economic Assistance (COMECON). This power line, which came into service in the late 1970s, is part of a whole 750 kV network that linked Hungary, Poland and Bulgaria to the large-scale power plants of the Former Soviet Union, including the Chernobyl power plant in Ukraine (there are two distinct ways of transporting electricity over long distances: along alternating current (AC) lines, or along direct current (DC) lines. The average cost of DC transmission falls significantly with distance, which makes this method cheapest for moderate amounts of power transported over long distances (above 1 000 km). The average cost of AC transmission falls with the amount of power transported, but this decline is much steeper than the distance-related decline for DC. For this reason, even very long-distance power transmission is cheapest via AC lines, provided the amount of power carried is high enough. The 750 kV AC network linking the countries of Central and Eastern Europe and the Former Soviet Union was well adapted to the power flows it supported: 1 000 to 2 000 MW transported over several thousand kilometres). Hungary had contributed financially to the construction of this line and some of the power stations it connects. There are two other power lines, one 400 kV line and one 220 kV line along a parallel corridor, terminating at the Sajószöged substation in eastern Hungary.

The total import capacity of these lines was 4 000 MW, amounting to more than twice the capacity of the biggest Hungarian power plant, the Paks nuclear plant, and over 60% of peak load in 1990. At the apex of electricity imports in the same year, 12.2 TWh of electricity were imported (net imports) from the Soviet Union (Ukraine) over these lines, amounting to exactly one-third of gross electricity consumption in Hungary. In comparison, electricity imports account for less than 10% of electricity consumption in the countries of IEA Europe, and less than 2% in IEA North America. The net imports of Italy, the largest electricity importer in the IEA, amounted to only 13% of its power consumption in 1997.

In addition to power trade with the Soviet Union, Hungary also traded comparatively small amounts of electricity with Czechoslovakia, Romania, Yugoslavia and Austria. It was a net importer only from Austria, and to a very minor extent (17 GWh in 1990).

These imports from the Soviet Union occurred under long-term contracts which were originally to expire in 2004. After 1990, and most markedly in 1992, imports from the Soviet Union were reduced because of increasingly unattractive prices and unfavourable terms but also because of unreliable supply. One year later, Ukraine suspended all exports to Hungary due to domestic shortages. Shortly afterwards, the Ukrainian power system was isolated from the UPS/IPS system. As a consequence, Hungary's annual imports from Ukraine fell further and today stand at 1.37 TWh (net imports). As imports from the East were reduced, Hungary increasingly imported Slovakian electricity, part of which originates in Polish power plants.

At the beginning of the 1990s, Hungary sought to leave the UPS/IPS power system and connect itself to the Western European UCPTE (Union pour la coordination de la production et de la transmission de l'énergie électrique) system. Poland, the Czech Republic and Slovakia had the same objective, and together these countries founded CENTREL, the Association for the co-ordination of Polish, Czech, Slovak and Hungarian electric power companies. The objective of CENTREL was to improve those countries' power systems quickly to reach the much more exacting UCPTE standards, to synchronise (synchronisation refers to power systems using alternating current (AC). All parts of such systems must run synchronously, i.e. the electrons in all interconnected AC wires must move backward and forward in lockstep. This issue does not arise for direct current (DC), as it only flows in one direction) their networks with them, and to become members of UCPTE as soon as possible.

Synchronisation with the UCPTE meant first and foremost disconnecting the CENTREL system from the UPS/IPS system. The CENTREL countries achieved this in 1993, after which their possibilities for trading with electricity suppliers outside CENTREL were greatly reduced. Trade could still take place across direct current (DC) lines and the appropriate converter stations; Hungary's trade with Austria could continue over the DC line connecting Gy´o´r and Vienna and the respective converter station in the south of Vienna which came into service in December 1992. Another possibility for imports was from power plants which were isolated from their own system and synchronised with the CENTREL system. This is the method that allowed, and still allows, continued - though greatly reduced - imports from Ukraine although the Ukrainian system and the CENTREL system have not been synchronised since 1993.

Subsequently, Hungary had to improve certain aspects of its power system. AC interconnection requires the systems of member utilities to be "in phase". This means that the flow direction of electrons in the wires must change synchronously. In Europe, the frequency of these oscillations is 50 cycles/second or 50 Hertz (Hz). The UCPTE system requires frequency control in a narrow band of ± 0.1 Hz; greater frequency variations can cause problems ranging from breakdown of computer systems to brownouts and blackouts in large areas of the system. Compliance with these technical requirements generally means that additional power plant capacity has to be installed. This capacity delivers so-called ancillary services, e.g. it generates only to maintain frequency or voltage at the required levels, and therefore has to be able to start generation very quickly. For Hungary, this meant that the objective was to be able to increase power generation by 8-10 MW per minute per unit, whereas its best performance was 5 MW per minute and per unit. In response to these requirements, several gas turbines were installed - Hungary does not have mountainous areas suitable for hydro plants with storage capacity. MVM is at present building two more gas turbines as secondary reserve in Sajószöged and Litér.

After several encouraging test runs, the CENTREL and UCPTE systems were synchronised in October 1995 and continue to run in parallel. Utilities from the CENTREL countries are associated members of UCPTE, but their objective is to become full legal members in the near future. Figure 39 shows Hungary's and CENTREL's interconnections at the end of 1997. The converter station to the south of Vienna is out of operation today.

Figure 39 Hungary's International Interconnections
Source: MVM.

Figure 40 Hungary's Transboundary Electricity Trade, 1997
Source: MVM.

In 1997, net annual imports from Slovakia stood at 1.79 TWh. Power exchanges with Austria are balanced. Total net imports were drastically reduced: in 1998, they amounted to 0.74 TWh per annum, representing less than 1/5 of their amount on 1990 and less than 6% of today's total gross consumption, which can be considered very normal. Nevertheless, the Minister of Economic Affairs and the Minister of International Economic Relations still retain the powers, attributed to them under the 1994 Electricity Act as a precautionary measure against renewed import dependency, to control the amount of electricity imports and exports. Figure 40 shows the gross trade flows in 1997.

Aside from the 750 kV line, the Hungarian transmission network consists of a 400 kV network, begun in 1967, which connects most of the large power plants. Some power plants such as one block of the Dunamenti plant feed into a 220 kV network, begun in 1960 but not added to since 1970. Some power plants, including Pécs and Borsod, are connected to the 120 kV network. This network is almost twice as long as the 400 and 220 kV grid, but most of it is used for distribution and was transferred from MVM (OVIT) to the distributors in 1992. MVM continues to operate the segments that are linked to power plants and function as low-voltage transmission lines.

This grid layout reflects the gradual development of the generation and distribution system and Hungary's past as a country largely dependent on electricity imports whose main concern was to distribute the imported electricity. The grid is not adapted to present and future requirements. In addition, large parts of the grid, especially the 220 kV grid, are old and in need of overhaul.

Distribution and Supply

All but a small part of the 120 kV network is united in the hands of the six distribution and supply companies. Hungary is fully electrified, with only 0.7% of homes and holiday houses not connected to the public grid.

Figure 41 Sectoral Shares of Electricity Consumption in the Supply Regions, 1997
Source: MVM

Figure 42 Electricity Consumption per Inhabitant in the Supply Regions, 1980, 1990 and 1997
Source: MVM

Figure 41 shows the sectoral shares of power consumption in the regions in 1997. It illustrates the high share of industrial electricity demand in the northeast and northwest of Hungary and its comparatively low share in the south.

Figure 42 shows the development of electricity consumption per inhabitant in the six supply regions between 1980 and 1997. It illustrates to what degree power consumption in the regions has caught up with power demand in Budapest over the last 17 years. This has happened in a somewhat peculiar way. The smaller the town or village, the higher the share of electricity consumption metered according to time of day (night vs. day). Whereas only 11.3% of electricity consumption was metered with a day-night meter in Budapest, the share for towns was 30.9% and the share for villages was 43%. These figures relate to 1997 but they confirm a long-established trend. The reason for this is that electricity used to be more expensive in remote villages than in Budapest or major cities, and making use of day-night tariffs enabled customers to make use of cheaper rates.

There is no competition in electricity supply in Hungary at present. Therefore, the distributors/retailers operate under an obligation to supply. They are also responsible - on the basis of the contracts signed with the local municipalities - for street lighting.


Restructuring and Privatisation

Since early 1992, ownership of MVM has undergone some dramatic shifts. Initially, nearly all shares of MVM (99.82%) were held by ÁVÜ, the Hungarian State Property Agency, which was responsible for managing state-owned assets in the early 1990s. MVM held 50% of the shares in the distribution companies and the grid company OVIT. The remainder was, in turn, owned by ÁVÜ; some small stakes in the distributors and in OVIT were also owned by municipalities.

In 1992, the Government created a state privatisation agency, ÁV Rt. (State Asset Management Company). In August of the same year, the shares of MVM were transferred from ÁVÜ to ÁV Rt., but ÁVÜ kept its shares in the subsidiary companies. In 1993, after the integration of economically viable coal mines with power plants (described above in Chapter 6 on Coal, and below), ÁVÜ proceeded to sell its stakes in the regional distributors, 46%-48%, depending on the individual company. ÁVÜ issued a call for tender for 15% stakes in these companies in September 1993. This sale was opposed by ÁV Rt. on the grounds that the conditions for realising the full value of the companies were not given, because the Government had not yet taken a decision regarding the future structure of the power industry. Subsequently, the shares held by ÁVÜ were transferred to ÁV Rt.

In order to facilitate the economic survival and privatisation of some of the Hungarian coal mines, the Government decided to combine collieries with power stations that could use their coal production. Thus, Mátra Power Co. was combined with the Visonta and Bükkábrány opencast lignite mines in 1993, Bakony Power Co. with the Padrag, Ármin, Jókai and Balinka coal mines in 1994, and Pécs Power Co. with the Külfejtés and Komló mines. All three mines were considered economically viable. These transactions were carried out as share swaps whereby SZÉSZEK, the Hungarian Coal Mining Restructuring Centre, received shares in the integrated companies in exchange for the transferred assets. SZÉSZEK received about one-quarter of the shares of the integrated companies, about half of this out of MVM's shareholding in the firms, and the other half directly from ÁV Rt. The process continued throughout the following years. In 1994/95, Vértes Power Co. was integrated with the Oroszlány and Mány mines, and Tisza Power Co.'s Borsod coal plant with the Lyukóbánya mine.

MVM believes that the share swap caused financial losses, and in the ensuing privatisation process, bidders were somewhat reluctant to buy the integrated companies. Eventually, auctioning off of the integrated plants failed. Two of them, Pécs and Bakony, were nevertheless privatised - the privatisation agreements were eventually signed on 23 December 1997 - but only after protracted direct negotiations. In addition, the Borsod coal-fired power plant, owned by Tisza Power Co., and the user of coal from the Lyukóbánya mine, was privatised separately from its mother company, although to the same foreign investor, AES. This enabled AES to buy a stake of 95.77% in Tisza but only 67.92% in the Borsod plant. The 171 MW Borsod plant consists of nine individual boilers of 4 MW to 30 MW nameplate capacity. Tisza Power Co. has two other plants, an 860 MW oil- and gas-fired plant consisting of four individual units of 215 MW each (Tisza II) and an old coal-fired plant (Tiszapalkonya).

In 1995, ÁVÜ, ÁV Rt. and the Treasury Property Management Organisation (KVSZ), another government asset management agency, were merged into one organisation called ÁPV Rt. (Állami Privatizációs és Vagyonkezel´o´ Rt., State Privatisation and Holding Company). This organisation is responsible for carrying out privatisations and managing residual state ownership. ÁPV Rt. became the new state shareholder in MVM and the second tier of the electricity supply industry, based on the Privatisation Act of 1995 (Act XXXIX of 1995 on the Sale of Entrepreneurial Property Owned by the State).

The 1994 Electricity Act does not mention any specific objective for privatisation of the electricity supply industry, but in December 1994 the Government decided to offer 50% plus one share of the six distribution and supply companies to strategic - preferably foreign - investors. Another 15% were to be sold to small domestic investors and institutional investors. The regional distribution companies were to be fully listed on the stock exchange by 1 January 1997.

The same privatisation strategy was to be applied to the eight generating companies, except for Paks. Here also, 50% plus one share were to be sold to strategic investors. Remaining shares were to be offered to domestic and institutional investors, and the generators were also to be fully listed on the stock exchange at the beginning of 1997. The Government in office in 1994/95 had plans to privatise a minority stake in MVM, including Paks and OVIT, and the Privatisation Act of 1995 effectively states that MVM could be privatised down to a 50% plus one vote majority shareholding for the State.

Two of the initially eight generators (Mátrai Er´o´m´u´ Rt. and Dunamenti Er´o´m´u´ Rt.) were partly privatised in 1995, and two more in 1996 (Tiszai Er´o´m´u´ Rt. and Budapesti Er´o´m´u´ Rt.). As mentioned above, Pécsi Er´o´m´u´ Rt. and Bakonyi Er´o´m´u´ Rt. were privatised in 1997. Paks remained in MVM's ownership as planned, and Vértes was not sold because no suitable sales agreement could be concluded. However, the intention persists to sell the plant.

In the process, several power plants were spun off as independent companies. As mentioned above, this was the case for the Borsod plant (Borsodi Energetikai Kft.), which used to be part of Tisza Power Co., but there were also other cases, e.g. the Csepeli Power Plant Co. (Csepeli Er´o´m´u´ Rt.) near Budapest, 100% owned by PowerGen. This plant had been used for autogeneration by the industrial company Csepel Industry Works Co. Today, there are 11 independent public electricity generating plants, including the two hydro-electric generators Hernádvíz Hydro Power Ltd. (one plant) and Tiszavíz Hydro Power Ltd. (two plants).

At the end of 1996, all six distribution and supply companies were privatised, and all have majority share ownership by foreign companies. The Government, through ÁPV Rt., retained a golden share in all of them, which, among other things, gives it control over mergers and acquisitions. Figure 43 shows the participation of new investors in the Hungarian electricity supply industry in 1997 before the sales agreements regarding Pécs and Bakony were concluded.

Figure 43 Privatisation in the Hungarian Electricity Supply Industry, 1998
Source: Hungarian Energy Office (MEH).

Modus Operandi of the Industry

The structural features of the reformed Hungarian electricity supply industry are a result of the complex reallocation and sale of shares in the power companies. At present, the industry operates in a co-operative mode. Electricity generation is hardly competitive: MVM manages the economic as well as the technical aspects of dispatch. MVM does operate under a requirement to buy the power it subsequently transmits and sells to the distributors at minimum cost. But dispatch is not governed by competitive short-term price bids. It is based on the long-term power purchase agreements concluded with generators, which specify MVM's purchase prices. The contracts contain capacity, energy and mining capacity price elements, but the prices are regulated and set by the Minister of Economic Affairs on the basis of published price-setting formulas. Competition occurs only for new units, and for some power generation - some of the generators are ready to offer electricity below the regulated prices. Generators are under a legal obligation to maintain their power plants available for generation.

Nor is there competition in supply: the six distributors/retailers enjoy exclusive supply licences. Only in exceptional cases will the Hungarian Energy Office issue direct supply licences to a generator, who may then directly generate and supply a customer. This is the case for the Csepeli plant now fully owned by PowerGen. Also, a holder of an exclusive supply licence may waive his right partly or fully to the benefit of other supply licence holders and upon approval by the MEH.

MVM is at the core of the industry and has wide-ranging responsibilities. First, it manages the wholesale electricity market. This means that it monitors final demand trends and develops demand estimates. These are used for system planning at different time horizons. Based on these estimates, MVM purchases electricity from the generators under long-term contracts, established over the last years. In this function, MVM can also conclude import contracts with foreign generators, or sell excess generation abroad. Moreover, it initiates the process of capacity expansion if new capacity is needed. These duties are to be carried out at least cost. The power purchase prices stipulated in the contracts with generators vary according to the characteristics of the plants. Some plants are old and have very low thermal efficiencies, so they produce at considerably higher cost, and there is no unique market price. The long-term power purchase agreements are subject to price control by the Hungarian Energy Office.

MVM and OVIT are also responsible for the technical side of system operation, i.e. dispatch, system control and operation, maintaining adequate reserve capacity, operation, maintenance and expansion of the transmission grid and international interconnectors, provision of ancillary services, etc. Operation and maintenance work of the transmission grid is carried out by OVIT on the basis of contracts signed by MVM.

On the downstream side, MVM also has long-term power delivery contracts with the six distribution and supply companies. All power must be purchased from MVM, except in rare cases of autoproduction and direct supply. There is one single sales price for wholesale electricity, regulated and published by the Minister of Economic Affairs. Finally, the distributors/retailers sell the electricity to final customers at prices which are under MEH surveillance. Figure 44 shows a simplified operational model of the Hungarian power supply system.

Figure 44 Functional Model of the Hungarian Electricity Supply Industry
Source: Hungarian Energy Office (MEH).

Lastly, the distribution and supply companies conclude so-called public utility contracts with the customers. According to the 1994 Electricity Act, these would normally be general public utility contacts between the retailers and the large number of individual small customers. These contracts are unlimited in time, and subject to the price-setting authority of the MEH and the Minister of Economic Affairs. So-called individual public utility contracts are concluded between retailers and large customers. They are freely negotiated, without price control by MEH or the Minister, and are valid for a limited time period. If customers eligible for an individual public utility contract fail to reach agreement in their negotiations, the general public utility contract applies - i.e. the supply is based on the regulated prices for a comparable customer group.

In the course of preparation for EU accession, Hungary is in the process of considering how the system can be adapted to the EU Directive on the Internal Electricity Market. It is the Government's intention to open up the market for retail competition to the required extent upon accession.


The Electricity Act (Act XLVIII of 6 April 1994 On the Production, Transportation and Distribution of Electric Power) defines the general regulatory framework for generation, transmission, distribution and supply of electricity. According to this general framework, the Hungarian power system is supposed to fulfil the following criteria:

The two main instruments of regulatory oversight provided for in the Electricity Act are, first, licences for power plant construction, generation, supply, etc., and secondly, ongoing regulation in the form of price regulation and regulatory resolutions. Both lie in the responsibility of the Minister of Economic Affairs and the Hungarian Energy Office (MEH), and are described below.

Licensing and Tendering

In the Hungarian electricity supply industry, activities subject to a licensing requirement are:

The licences are designed to ensure a minimum level of performance by the licence holder, and are the most important basis of industry regulation other than price regulation. They are issued by the Hungarian Energy Office, and can also be modified - or, in extreme cases, revoked - by the MEH. Following the entry into force of the Electricity Act, the Hungarian Energy Office began to develop these licences in 1995. All of the licensed activities require that the entity seeking the licence must be based in Hungary.

Application for the establishment of a new power plant must be made to MVM and the MEH, and must be based on a feasibility study that contains detailed descriptions of the technical and economic viability of the project, its financing, its staffing with qualified operating personnel, proof of the applicant's past performance and management expertise, and identification of the future customers of the power plant.

Approval is based on the MEH's opinion, but according to Section 4 of the 1994 Electricity Act, requires much broader consensus than that: for new power plants between 20 and 200 MW, approval from the MEH and the Minister of Economic Affairs is required, especially regarding fuel choice. Above 200 MW, the Minister of Economic Affairs must agree but must also seek approval of the entire Government (Cabinet). For power plant projects of 600 MW or more, the Hungarian Parliament has to approve. In addition to this, the Minister of Economic Affairs determines minimum levels of fuel to be held in stock on the site of each power plant and, jointly with the Minister of International Economic Relations, decides how much electricity Hungary can import and export, and how much has to be produced domestically.

Based on the demand forecasts and system development plan prepared by MVM, and any possible modifications made to it by the Hungarian Energy Office, the Minister of Economic Affairs submits a power plant establishment plan to the Government and to Parliament every two years. If there are applicants who propose power plants in accordance with this plan, the MEH can grant a preliminary licence for power plant establishment.

If there are no suitable applications, MVM issues a call for tender in close co-operation with both the MEH and the Minister. The winner of the bidding process is to be determined by MVM on a competitive basis in order to ensure that the new capacity is created at least cost. Aside from the relevant economic criteria, the selection criteria also encompass items such as fuel diversity, the use of domestic energy resources and renewables, environmental externalities and social considerations, especially employment. The bidder is free to choose the site for the plant. MVM's decision is subject to review by the Hungarian Energy Office and by an independent consultant.

Figure 45 Establishment Procedure for New Generating Capacity
Source: MEH.

Figure 45 shows the steps of the process to be followed for new capacity investment. The tendering procedure depicted applies to new contracts and generating plants of 50 MW or above, but also to new capacity in the form of major refurbishment, contract and plant lifetime extensions, and plant upgrades of 20 MW and above. The call for tenders specifies the total amount of capacity required, the time lines for capacity establishment, the fuel options as defined in the Government's power plant establishment plan, the type of plant (base load, load following, peaking capacity), possible transmission constraints that have to be taken into account, and in certain cases a price cap, i.e. maximum average price that the new plant can be expected to earn throughout its economic life.

In 1997, two parallel calls for tender were issued by MVM. The first one invited investors to submits bids for a total of 800 MW of smaller plants (between 20 and 200 MW), to come on stream between 2002 and 2004. The second call for tender concerns a total of 1 100 MW of plant above 200 MW, to start service between 2004 and 2006. In January 1998, the tender was modified, lowering the sought-for capacity to 500 MW of small plant and 600 MW of large plant. The new deadline was set to October 1998. Both rounds of tendering were largely oversubscribed.

Ongoing Regulation

The legislation relating to the Hungarian electricity market, and notably the 1994 Electricity Act, stipulates that electricity price regulation must allow reliable electricity supply at "reasonable" prices. These prices must ensure recovery of "reasonable" investment by the enterprises active in the market. The Electricity Act provides the main basis for price regulation but there are numerous decrees that set out the details of price regulation.

In accordance with the Electricity Act, the Hungarian Energy Office can become active and review or revise the level of electricity prices upon the initiative of any of the interested parties, customers and suppliers alike. Based on the 1990 Pricing Act (Act LXXXVII of 1990 on the Definition of Prices), in force until 31 December 1996, regular price adjustments were carried out annually. Following a decision taken by the Minister of Economic Affairs in December 1996, a quarterly price review mechanism was put in place in January 1997.

In every round of price determination, the companies in the market have to disclose all relevant information to the MEH. The MEH then prepares the new prices according to the methodology set out below. The Hungarian Energy Office is the pricing authority at the intermediate levels of price regulation, i.e. at power plant company level for the purchase prices of MVM, and at the level of MVM for the wholesale prices to the retailers. Price regulation is based on the principle that pricing for companies at each level of the industry should cover both capital and operating costs, and that the cost of purchasing electricity is to be passed through each tier of the industry. Companies submit applications for price increases, and the MEH prepares and adopts price resolutions, which are directly applicable. If companies disagree with the outcome, they can appeal directly to the Minister of Economic Affairs. If they disagree with the Minister's decision, they can appeal to the courts. For end-user prices, the final approval must be given by the Minister of Economic Affairs, and the new prices come into effect upon publication as a Ministerial Decree.

Figure 46 shows the current mechanism for end-user price regulation used by the Hungarian Energy Office. This mechanism applies to prices for heat and electricity. The price prevailing on 1 January 1997 - the so-called starting price - is used as the basis for price escalation. This starting price was determined based on a cost survey of all concerned energy companies, carried out in 1995 and 1996 by external experts on behalf of the MEH. It contains justified operational costs, including all capital investment required for power production, as determined by the MEH in 1995/96. The MEH is, of course, aware of the fact that cost data concerning the past can be little more than rough cost estimates, due to the complete absence of market evaluation. In order to fulfil its function as price regulator, the Energy Office monitors electric utilities' costs on an ongoing basis, and attempts to put downward pressure on costs through its powers to disallow certain costs or cost elements.

Figure 46 Pricing Mechanism for Electricity and Heat Prices
Source: MEH.

Figure 47 End-User Prices for Electricity, 1980 to 1998 Hungarian Forints
Source: MEH.

Once the cost of electricity supply is determined, an 8% rate of return on investment, also fixed in 1995, is applied. After adjustment for inflation, this yields the price basis for 1997. After incorporating further corrections to the price basis, i.e. justified costs incurred or identified after 1 January 1997, the corrected price basis is used to determine the new regulated price at the beginning of the regulatory year, which starts on 1 October each calendar year.

The corrected price basis is reviewed with regard to three indicators thought to be beyond the control of the utilities, i.e. the domestic industrial sales price index (excluding the energy and food sectors), the exchange rate of Hungarian forints versus US dollars, and an index expressing fuel price movements. In addition, Hungarian utilities are expected to make efficiency improvements and reduce costs, so an efficiency factor k, reducing prices by 5% to 15%, is included. The quarterly adjusted prices are determined taking into account the sliding devaluation of the forint.

Within this legislative and regulatory framework, a difficult transition had to be made between the very beginning of the reforms in 1991, and today. In the 1980s, prices were far from cost-covering, and they were much lower for residential than for industrial customers, which indicates vast cross-subsidies. Based on a commitment made by the Hungarian Government to the World Bank and the International Monetary Fund, prices had to cover costs by 1996, and as of 1989, electricity prices did indeed rise noticeably. Cost-covering prices meant that prices had to rise 50% to 80% above their 1994 levels, according to the customer category. The prices that came into effect in 1995 were, for the first time, higher for residential consumers than for industrial/commercial consumers. Figure 47 shows the development of end-user prices since 1980.

The graph shows that the rate of price increase accelerated noticeably after the Electricity Act came into force and the Hungarian Energy Office was established. Today, Hungary's end-user prices for electricity are cost-covering, and the cross-subsidies between residential and industrial consumers have been greatly reduced.

However, this process did not develop without disturbances. In 1997, the Hungarian Energy Office received 12 applications for price increases from power generators, and 6 additional applications from the electricity retailers. The MEH approved only a very small amount, some 16% on average, of the requested price increases. All electricity retailers and Vértes Power Plant Co. lodged complaints against these price resolutions. Following the complaints of the retailers, MEH had to carry out new proceedings, against which the supply companies also appealed in both instances. After their appeals were rejected, the suppliers began litigation procedures.

This dispute was not an isolated event. Throughout recent years, there were several disputes between the privatised energy companies on the one hand, and the Government and the Hungarian Energy Office on the other hand. These disputes concerned matters of principle as much as the detailed handling of regulation. A long-running dispute on principles concerned the cost elements that were to be included in the price base for regulated prices. Similar disputes in the gas industry had led investors to threaten litigation. Controversies linked to excessive regulatory discretion arose when the Minister of Economic Affairs chose not to follow the MEH's price proposals and revised electricity prices downward in the final decrees. Also, the quarterly price adjustment was deferred twice in 1997, due to social considerations and Parliamentary elections. The quarterly price adjustment mechanism was abolished at end 1998.

Eventually, all controversies were settled out of court, leading on each occasion to increased prices and the consideration of further cost elements. The last settlements were concluded between December 1998 and mid-June 1999. Following this, both the Government and electricity companies stated that the electricity and gas prices coming into effect in July 1999 are now fully cost-covering and ensure an appropriate rate of return. However, the process of adjusting allowable cost in the rate base is bound to continue in the near future; for example, more stringent environmental regulation will cause additional costs that have to be considered.

Apart from outright price regulation, the Hungarian Energy Office engages in other types of regulation. Under the 1994 Electricity Act, it is responsible for developing so-called restriction lists. These lists determine which customers are cut off first, and to what degree, in the case of a power shortage. Together with the interested parties in the electricity sector and other parts of Government, the Hungarian Energy Office developed the grid code, the dispatch code and the distribution code and monitors and enforces compliance with their provisions.

The MEH collects and deals with customer complaints and acts in cases where a real violation of the legislative and regulatory framework is recorded. At present, the vast majority of customer complaints, especially the complaints by residential customers, does not give rise to further proceedings because the consumers are still ill-informed about their rights and duties under the new law. Moreover, the MEH has the duty to monitor all important variables concerning the industry, and to provide information on it. Aside from data immediately relevant for conducting its core business, e.g. cost data, the MEH has started developing measures for quality of service and customer satisfaction. In 1995, it issued guidelines for the measurement of customer satisfaction. It also monitors the number and duration of outages and supply interruptions per year for each supplier.


Restructuring and Privatisation

The efforts Hungary has made to restructure its electricity supply industry, especially the divestiture of generation and distribution assets from MVM, are to be commended. The progress Hungary has made is impressive, given the very difficult starting position. In 1990/91, MVM was a fully vertically integrated state monopoly that imported record amounts of electricity from the former Soviet Union. It was burdened with a large amount of outdated, economically and technically obsolete generating capacity. Distorted prices were far below cost and showed extreme internal subsidies in favour of residential customers and Hungary was unable to face the inevitable re-investment cycle, necessary to maintain reliability, on its own.

Still worse, the cost of generating, transmitting, distributing and supplying electricity was not even known and had to be estimated through painstaking work carried out under the MEH's initiative and supervision years later. In addition, the cross-subsidies from industry favouring households had created a need for an internal compensation scheme involving the regional distributors. Since industrial customers were concentrated in the north and northwest, these regions had to finance the low-price but high-cost south.

Seen against this background, the progress that Hungary has made, first in unbundling the accounts of MVM, then in creating viable power and distribution companies, and eventually successfully privatising most of them, is substantial. Hungary has achieved an industry structure that can provide a starting point more suitable for competition than some long-standing IEA Member countries (in general, and in practice, government policy, including energy policy, is based on a multitude of goals. These encompass, to name but a few, economic prosperity and efficiency, stability and security of supply of all vital inputs to the economy, a clean environment, and an "equitable" distribution of wealth. While competitive markets may be an objective in their own right, their main merit lies in the fact that they appear to bring about economic prosperity better than any other type of market or economic system. Their effect on security of supply, the environment, and distribution is not uniform. These objectives are, and ought to be, promoted through specialised government policies. These policies should be compatible with competitive markets, because experience shows that prosperity often makes it easier to enhance security, environmental quality, and distributional "equity"). All this was achieved in a much more precarious macro-economic situation than most IEA Member countries have known: the painful transition in all sectors of the economy from a centrally-planned, command-and-control system towards a market economy meant that the necessary price increases created much more social hardship than in most IEA Member countries. Although the progress towards liberalisation did not occur in a linear way, and although at times progress appeared to stall on certain issues, such as the necessary re-balancing of prices between the various consumer groups, the progress made in the last eight years deserves praise.

Yet from the outset, the Hungarian Government struggled with the same issues as any IEA Member government intent on privatising and liberalising its power industry, only perhaps in a more intense form. In many countries, privatisation is one of the main drivers of reform, often to relieve a burden from the government's budget or to obtain funds for it, or to obtain private investment when the incumbent utility is unable to provide the necessary investment. There is some tension between this objective and the other important functions of the government as (indirect) share owner, as legislator/regulator, and as re-distributor, responsible for social cohesion.

The process surrounding the privatisation of power plants and their prior combination with coal mines illustrates the difficult path that had to be negotiated in Hungary in this respect. Integration with the coal mines proved a burden on the sell-off of the power plants, and the Vértes plant is still not sold. On the other hand, the conflict between ÁVU and ÁV Rt. regarding the timing of privatisation illustrates the conflict of interest which existed within the Government between the necessity to raise funds quickly to be able to pay off international debt, the desire of the Government as an indirect shareholder to realise the maximum value from the sale, and the necessity for the Government as legislator/regulator to take enough time to design a viable and effective structure for the new market.

There is a need to disentangle these conflicting roles some more in future. Advanced as it is, the Hungarian electricity market needs to undergo some more structural change if effective competition is to be introduced, and if EU rules for the internal market for electricity are to be fulfilled. The minimum in this respect must be the separation of the system operation function from MVM and the distribution companies. MVM and most of the big European utilities that now own the distribution and supply companies in Hungary also hold stakes in generation. MVM still owns and will continue to own the Paks nuclear plant, which, after all, accounts for no less than one-quarter of electricity generation in Hungary. Also, MVM has long-term contracts for more than 70% of the installed capacity in the Hungarian power industry.

Unless system operation is organised in the hands of an Independent System Operator (ISO), the playing field for competition will be so heavily biased in favour of MVM and the distribution-owning utilities that effective competition is very unlikely to arise. Creating an ISO is, in any case, a requirement under the EU Directive creating the Internal Market for Electricity. With an ISO in place, the Hungarian electricity market would have already made a lot of progress towards effective competition.

An even better solution would be to have MVM divest all its interests in generation and distribution/supply and become a pure transmission grid company. Divestiture would not necessarily have to mean privatisation of the remaining stakes in generation and distribution. The Paks plant could remain in government ownership - it might not be easy to sell anyway.

Currently, problems can arise from the fact that MVM as the system and market operator is not independent from generation interests and day-to-day government policy. Independence of the system operator from any particular interest, be it commercial interest or government intervention, is crucial. Maintaining a neutral role for the system operator and a level playing field for competition might require maintaining the system operator in public ownership. If the Government were to decide in favour of a competitive model with full vertical separation, Hungary could quickly become one of the most competitive power markets in the region. The Government might wish to study the example of Argentina, which introduced a very competitive market model in the face of the need for major investment, relatively low per-capita GDP, and the need for a rapid transition.

Whichever path is chosen, MVM cannot maintain its current position, which still contains elements of a vertically integrated monopoly, in its structure and even more in the behavioural rules that apply.

The Introduction of Competition

Since one of Hungary's most important policy objectives is to join the European Union in the first wave of new entries, the country has implicitly chosen the EU path towards reform of the electricity supply industry. The main question that needs clarification concerns the speed at which reforms will be introduced and the concrete model of competition that will be chosen. In any case, the far-reaching restructuring and privatisation have gone a long way towards a market structure which could allow effective competition - provided the appropriate rules for company behaviour are in place, and the structural changes suggested in the preceding section are introduced.

Once this is accomplished, the modus operandi of the industry will have to be changed. Supply to eligible customers will have to be opened up to competition, preferably through mandatory, regulated Third Party Access rules allowing eligible customers to conclude contracts freely with suppliers of their choice. These rules must be non-discriminatory and transparent. They should avoid conflicts of interest among the Government's different roles and should be implemented in a credible way.

The Government is at present looking into ways to implement the EU provisions within the Hungarian system. The Hungarian Energy Office is already exploring ways to use the existing framework to move towards more competition. One way in which it might attempt to accelerate the process is by issuing more licences for direct supply, i.e. licences that convey the right for a generator to supply an ultimate consumer. Another way might be to license generators as self-generators, thereby circumventing the requirement for power plants above 20 MW to submit proof that MVM buys their power, required under the normal licensing procedure. Laudable as these initiatives are, they can only provide an interim solution. Rules for grid access are an indispensable ingredient for competition and should be developed as soon as possible. In order to prepare for market opening, a number of issues will have to be addressed in detail, including how emergency back-up and top-up deliveries to eligible consumers should be organised and priced.

One of the issues under discussion in Hungary regards the specific timetable of market opening under the EU Directive. Taking the formula used to determine the degree of market opening under the Directive, the degree of opening in Hungary will fall short of the EU average. This is due to the fact that the size distribution of electricity-intensive companies is different from the EU average.

As of February 1999, end users in the EU with an annual electricity consumption of 40 GWh and above became eligible for competition. Whereas this represents some 25.4% of power demand throughout the EU, it only concerns 43 large customers in Hungary, representing 18.9% of total consumption. The next step, due in the year 2000 and concerning users with electricity consumption of 20 GWh and above, concerns 95 end users with a market share of 24.3% in Hungary but 28% throughout the EU. The last step of market opening (9 GWh and above) concerns 200 end users or 29.2% of the market in Hungary but 34% throughout the EU. The Hungarian Government is considering at the moment whether it would have to seek a derogation upon entry into the EU, depending on when entry occurs.

However, as far as the EU Directive is concerned, the percentage shares of market opening overrule the GWh thresholds - their function is only to provide an objective measure of the share of the market which must be opened at the moment when the threshold becomes active. This means that in the year 2000, all EU power markets must be opened to the community-wide market share of all customers using 20 GWh and above - whatever that share may be. On the assumption that electricity use will continue to grow slowly, it is likely that the share of market opening will diverge upward from 28%, if it does divert. For Hungary this means that full compliance with the Directive will amount to opening the market for customers below 20 GWh annual demand - unless a derogation is sought and granted.

Another issue that requires attention is the cost of transition, often referred to as stranded cost - not because the cost of transition is expected to be very high in Hungary, but rather because it depends on the behaviour of the Government and market participants today whether or not "new", unnecessary stranded cost is created. A large number of obsolete power plants in Hungary must be replaced soon, not least because of their very low thermal efficiencies and poor environmental performance. Since market participants already know that competition is likely to be introduced soon, they have an opportunity to avoid stranded cost by refraining from building above-market, expensive capacity or concluding contracts at excessive costs now.

Moreover, despite the fact that electricity prices in Hungary are now by and large cost-covering, they are still low in comparison with Western Europe and the EU. Participation in the EU electricity market means, of course, competition in the domestic market but also cross-boundary competition. Given the comparatively low electricity prices in Hungary, it is unlikely that foreign competitors will out compete Hungarian suppliers, at least based on price - unless the market is opened to Ukraine and Romania. This is not very likely in the near future, partly because it would involve re-connecting the disconnected systems via DC links. It is much more likely that Hungarian power companies will find lucrative export opportunities to neighbouring EU countries. The consequence of this would not be stranded cost but rather a quick adaptation of Hungarian electricity prices to the price levels which will then prevail in Italy, Austria, or Germany. Therefore, it is better to act quickly now to adapt to the EU requirements, in order to give clear signals.

There may be additional benefits to be reaped since Hungary has played a very positive role in strengthening the links between the CENTREL and UCPTE systems. The country should assess the further opportunities for transboundary electricity trade to improve security of supply, increase efficiency and generate savings by combining hydro power, situated in Hungary's neighbouring countries (e.g. Austria), and fossil generation in Hungary. These developments might lead to a future regional power market in which Hungary could be a significant player.


At present, regulation occupies an important place in the Hungarian power market. This is an important achievement compared with the recent past. The methods of regulation appear to be based on generally accepted regulatory principles, but the Minister of Economic Affairs enjoys excessive regulatory discretion.

The scope of regulation in the Hungarian electricity market will certainly shrink once competition is phased in and has reached a certain minimum number of consumers. When this happens, regulation will, by and large, apply only to transmission and distribution grid services and to those groups of consumers who will remain captive for the foreseeable future.

However, in order to reach this point, and to make the transition in an orderly way, the current regulatory procedures should be thoroughly reviewed and amended. The most important issue in this respect is the autonomy of the Hungarian Energy Office and its mandate to exert definitive, independent control over regulated prices.

It is important that the Hungarian Energy Office be made the country's main regulatory body for electricity and gas, and that its autonomy be strengthened. The fact that the Minister of Economic Affairs exerts the right of employer towards the President and Vice President of the Energy Office may already open possibilities for undue pressure on this crucial regulatory agency, despite the fact that outright removal from office appears to be difficult. The Government may wish to consider creating a governing board, impartially representing all important interests in the industry, which could be responsible for appointing the President of the Energy Office and his deputy.

Most important would be to eliminate the Minister's final authority over end-user prices, which opens the door to price distortions motivated by all kinds of concerns relating to macro-economic developments, social policy objectives and regional policy considerations, to name just a few. IEA Member countries which have had this type of institutional set-up have not had encouraging experiences with it, especially in times of high inflation or distributional conflicts, when the temptation to tamper with energy prices as a "quick fix" for deeper, structural problems can become overwhelming. In the same vein, the Minister should be replaced by the judicial system as the first instance of appeal. At present, the courts are the second instance of appeal, after the Minister. The competition authorities could also in future be consulted in cases where market participants appeal MEH's decisions.

It is of vital importance to separate the task of price control and responsibility for overall economic policy, situated with the Minister of Economic Affairs. The responsibility for price control should be attributed to the MEH, even though this move will create a certain amount of friction. The reason for this is that the regulator's task is to emulate as closely as possible the outcome of a competitive market where full competition is not possible, e.g. due to natural monopoly. Any failure to do this inevitably leads to inefficiencies. Although such inefficiencies may appear small in the short term, they may be very costly to society in the longer term. The reason for this is the pivotal role of the price mechanism in steering demand as well as future investment, technology use and development, and even research.

In contrast, the Minister's role is much wider and comprises objectives such as macro-economic stability and a certain degree of redistribution of wealth. These objectives are often in conflict with the goal of efficiency. The shorter-term imperatives of reducing inflation, for example, may lead to a strong temptation to reduce those prices that the Government can control below their optimal level, sometimes even below cost. This leads to delayed adaptation in the concerned sector, excess demand, and reduced or deferred investment, and can ultimately lead to poor service quality and environmental strain. This situation was experienced by some long-standing IEA Member countries after the oil crises.

It is also important to establish the regulator as a strong institution, appropriately staffed, and endowed with sufficient resources and far-reaching rights for company data disclosure. The task of emulating prices that would emerge in a competitive market is tremendous and requires considerable specialised knowledge and frequent use of computer-based economic modelling, or at least the capability to outsource modelling work to appropriate organisations. This task could not be carried out by any institution other than a specialised regulatory body. A Parliamentary committee, for example, would be overwhelmed by such a task and deliver inadequate work, possibly leading to much greater inefficiencies than unregulated monopoly.

Price regulation, especially if it is to persist in parts of a competitive market, must not favour any particular interest. This applies in particular to the prices for transmission and distribution grid services as well as grid access conditions, because they can determine whether the competitive playing field is level or not. Therefore, the Hungarian Energy Office should be given the mandate and resources to develop efficient, non-discriminatory and transparent transmission and distribution tariffs, based on international experience, as soon as possible. The same applies for grid access conditions.


The Government should: