ALLEGATIONS OF POLITICAL CORRUPTION SURROUND

C O N F I D E N T I A L SECTION 01 OF 03 BUDAPEST 000078

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E.O. 12958: DECL: 02/05/2020
TAGS: ENRG ECON EPET PGOV HU
SUBJECT: ALLEGATIONS OF POLITICAL CORRUPTION SURROUND
ENERGY UNBUNDLING LAW

Classified By: Economic Officer, Jeffrey M. Jordan for reasons 1.4 (b),
(d)


1. (SBU) Summary: The Hungarian Parliament recently passed
legislation to incorporate the EU's energy unbundling
directives. However, the legislation has been widely
criticized because of the influence of energy conglomerates
MVM and MOL on the bill, for the lack of input from
government or industry experts, and for extending a system of
controversial energy subsidies to gas-fired power plants.
Critics generally believe campaign financing, rather than
improved energy market competition, to be at the heart of
this legislation. End summary.

PARLIAMENT OUTSOURCES ENERGY UNBUNDLING LEGISLATION...


2. (SBU) On December 14, just before breaking for its winter
recess, the Hungarian Parliament passed a complex
modification of Hungary's basic electricity and gas
legislation to implement the energy unbundling provisions of
the EU's "Third Energy Package." The measure passed with an
overwhelming 329-17 majority that included the rare unanimous
support of the ruling Socialist and the opposition Fidesz
parties, two of whose members had submitted the legislation.
The move has come under intense criticism from energy experts
who accuse the Parliament of failing to consult with, or even
inform, relevant public administration organs such as the
Hungarian Energy Office, instead outsourcing the drafting of
the law to state-owned electricity company MVM and
publicly-traded oil and gas giant MOL, the two companies most
likely to benefit from the legislation.


3. (SBU) The Third Energy Package allows member states until
2011 to choose, on the basis of extensive expert studies and
consultation with stakeholders, from among three options to
separate energy supply and production activities from energy
transmission networks - i.e., gas pipelines and the
electrical grid. Under "full ownership unbundling,"
integrated energy companies would be forced to sell off their
gas and electricity grids. The "independent system operator"
(ISO) model would allow companies to retain ownership of the
network, but would require them to hand over management
control to an independent company, which would make
commercial and investment decisions. The "independent
transmission operator" (ITO) model, the lowest threshold for
unbundling allowed by the EU, allows energy suppliers to
retain ownership of their transmission system operators
(TSOs),provided that strict rules are in place to ensure
that the TSOs operate independently. The Hungarian
Parliament's selection of the third method, the ITO model,
essentially codifies the status quo, enabling MVM and MOL to
remain the dominant, vertically-integrated players in the
Hungarian electricity and gas markets.


4. (SBU) Parliament also extended by five years, until 2015,
certain energy producers' eligibility for Hungary's
"mandatory offtake" system whereby qualifying electricity
generators are able to sell power into the grid at a price
well above market rates (the so-called "feed-in tariff").
Originally conceived as a means to promote electricity
generation based on renewable energy sources, over time, and
due to effective lobbying, the system grew to include small
and medium-sized gas-fired co-generation plants, which
produce electricity as well as heat for district heating
stations. The system also includes Hungary's two large
coal-fired plants, Matra and Vertes, which qualified by
incorporating some biomass into their production process.
Currently, about 75 percent of the 80 billion forint (roughly
$413 million) annual subsidy goes to gas-fired co-gen plants.



5. (SBU) The legislation also incorporates the EU's so-called
"Gazprom clause," which mandates reciprocal market access for
non-EU countries with companies wishing to purchase stakes in
EU TSOs. In what appears to be an effort to further protect
MOL from Russian takeover, the Hungarian legislation applies
the Gazprom clause not only to TSOs, but also to energy
holding companies.

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... BUT LEAVES ENERGY REGULATOR OUT OF THE LOOP


6. (C) Gabor Szorenyi, Director of Electricity, Gas, and
District Heating Licensing, Monitoring and Consumer
Protection at the Hungarian Energy Office (HEO),confirmed to
Econoff that the HEO had been blindsided by the ITO law.
Szorenyi said that, based on the EU directive, the HEO had
been conducting "deep analysis" for six months to recommend
the most appropriate course for Hungary, but that Parliament
had approved the MVM/MOL-prepared text in a matter of weeks
without consulting the industry, the government, or the
regulators. According to Szorenyi, Parliament "totally
neglected the idea that unbundling is supposed to promote
competition." The legislation, he says, contains inadequate
provisions to ensure the independent operation of the TSOs.
The HEO plans to complete its study and present it to the
Hungarian Government, but Szorenyi is not optimistic that it
will have an impact. Szorenyi expressed his view that the
HEO is "alone in the fight" against this legislation, but
added that the EU has already registered its concerns as well.

INDUSTRY PLAYERS: LAW BENEFICIAL FOR ENERGY SECURITY, BUT
DAMAGING TO COMPETITION


7. (C) Laszlo Varro, Chief of Strategy for MOL, told Econoff
that the commentary in the press, and specifically the
complaints raised by the HEO, have mischaracterized the
issue. Varro said the ITO model is the only sensible course
for MOL because the risk is too great that the Russians, who
have already demonstrated their willingness to pay a huge
premium for Hungarian energy assets in their acquisition of a
21 percent stake in MOL, would end up owning the gas
pipelines. He noted that the ISO model had already been
tried at MVM when, during the previous Fidesz government,
grid operator MAVIR was run independently but subsequently
"re-bundled." According to Varro, a shortcoming of the ISO
model is that the TSO infrastructure often lacks needed
investment since two separate companies own and manage the
assets. Moreover, Varro says that MOL's TSO already operates
relatively independently and that it does not abuse its
position.


8. (C) MOL's competitors in the gas business, however, do not
share this benign view. Istvan Kutas, PR director for E.On
Hungaria, Hungary's primary importer of Russian gas and
dominant gas wholesaler, told Econoff that the ITO law would
strengthen Hungary's national champions, MVM and MOL, at the
expense of market competition. According to Kutas, the two
companies' trading arms are able to take unfair advantage of
grid information not available to other competitors and
suggested that they may also receive discounted access to the
grids due to their common ownership. HEO Director Szorenyi
agreed and added that the HEO currently lacks the capacity to
provide adequate oversight to ensure a level playing field.
"We haven't yet discovered all their tricks," he said.


9. (C) Kutas and Szorenyi separately noted that MVM and MOL
both appear to be actively growing their energy supply and
trading operations. MVM, already dominant in the electricity
market, recently applied for a gas-trading license and is
actively purchasing stakes in power plants, wind power
projects, and electricity distributors around Hungary. MOL's
trading division, MOL Energy Trade (MET),according to Varro,
primarily exists to manage oil, gas, and electricity supplies
for MOL's own operations (refineries, etc.),although Varro
admits that MET engages in some energy trading for purposes
of "portfolio management." Most contacts, however, view the
recent sale of a 50 percent stake in MET to Normeston
Trading, a Belize-registered offshore entity rumored to be
owned by "Russian individuals," as an effort to gain its own
access to Russian gas. Moreover, Kutas informed us that MOL,
together with Gazprom trading arm Centrex, has recently
cherry-picked some large customers from E.On and that MOL has
now replaced E.On as the sole supplier to troubled gas
trader/retailer Emfesz. (Note: MOL and MVM are both widely
considered to be possibe acquirers of nearly-bankrupt
Emfesz. End note.) In light of such developments, Szorenyi

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considers the ITO law a big step backward: "When MOL sold its
gas trading activities to E.On in 2004, that was real
unbundling, but now it is stepping back."

FIDESZ POLITICIANS: 1, FIDESZ EXPERTS: 0


10. (C) The legislation has brought to light some internal
divisions between the young experts and the old guard within
Fidesz, Hungary's main opposition party and probable winner
of upcoming general elections in April. Fidesz energy expert
Gellert Horvath told Econoff that Janos Fonagy, the Fidesz MP
who sponsored the legislation, managed to stifle internal
debate over the measures and obtain support for a party-line
vote, effectively sidelining a committee of experts the party
recently established to formulate its energy policy. As a
result, the committee suspended its operation in protest.

IT ALL BOILS DOWN TO PARTY FINANCING


11. (C) The energy law modifications featured prominently at
a recent conference the Hungarian energy NGO Energia Klub
sponsored to mark the release of its extensive study on
corruption in the energy sector. In her remarks to the
conference, Marty Nagy, former Vice President of the
Hungarian Competition Authority, called the law "the apex of
corruption," saying that Parliament had abdicated its duty to
the public in outsourcing the legal drafting to the vested
interests, probably in exchange for political party
financing. After the conference, Energia Klub Director Ada
Amon admitted to Econoff that it is difficult to find hard
evidence of corrupt transactions, but emphasized that in such
a case where vested interests are so clearly served and
public interests ignored, despite the protests of a wide
range of experts, corruption can be the only plausible
explanation. HEO Director Szorenyi also believes the
parties' quest for campaign financing, ahead of elections in
April, was a key motivation behind the legislation.


12. (C) Amon, Szorenyi, and Varro separately expressed
serious concern about the extension of the mandatory offtake
regime through 2015. Each interlocutor described the system
as inherently corrupt and driven by a powerful lobby, with
deep connections to the Socialists and Fidesz, that has
steered the subsidies away from the originally intended
recipients, renewable energy producers, and toward gas-fired
co-gen plants. The parties have repeatedly blocked efforts
by the HEO to reform this system. When the recent measures
were passed, the HEO was in the process of issuing statements
informing certain producers that, based on its calculations,
they were no longer eligible for the subsidy because they had
already recaptured their capital investment. According to
the new rules, such plants will be eligible for the subsidy
for 7.5 years, even if they're already earning a return on
investment.


13. (C) Comment: Parliament's passage of the ITO law
highlights the very real trade-offs Hungarian leaders must
make as they seek to ensure Hungary's energy security while
complying with EU competition directives. From this
standpoint, Parliament's attempt to prevent a Russian
takeover of the MOL gas grid is completely understandable.
However, the non-transparent manner in which the legislation
was passed suggests a possible modus vivendi between the
Socialists and Fidesz when it comes to illicit campaign
fundraising. It is an open secret in Hungary that MVM and
MOL provide significant funding to the two main political
parties, with MVM rumored to favor the Socialists and MOL
favoring Fidesz. MVM also provides substantial direct
financing for the Hungarian state in the form of annual
dividends: on December 23, the company announced a 20 billion
forint ($104 million) "advance dividend" on its 2009 profits.
End comment.

KOUNALAKIS