Moscow , Russia April 1, 2010

Russian Annual Meeting of Energy Regulators Comparison of key objectives, tasks and problems facingthe EU and non-EU ERRA member energy regulators Moscow, Russia April 1, 2010 dr. Gábor Szörényi Chairman of ERRA Director of Hungarian Energy Office

I would like to offer my sincere condolences to families of metro blast victims and to the Russian nation! I would like to express my deepest sympathy to people of Russian Federation!

Common objectives, tasks, problems identified in different regions with different emphasis Special effects of financial and economic crisis in the transient period of market building Demand and price forecast (estimation) Main topics

EU market: ~3000 TWh ERRA market: ~2000 TWh

The primary objective of European energy policy and legislation and consequently also of the national regulatory authorities (NRAs) is to promote a competitive, secure and environmentally sustainable internal market in electricity. ERRAhas no energy policy because it is a professional organization for regulatory exchange and development. Objectives I.

Key objectives: Security of supply Competitive market Sustainability (climate change, environmental protection) A certain shifting of emphasis: EU: A well-functioning internal energy market could solve security of supply issues in electricity (through right investment signals). Non-EU ERRA: Security of supply has priority (with some state intervention; less belief in market solutions) + affordability (low end-user prices) There are countries targeting implementation of EU Directives (Energy Community Treaty Contracting Parties [SEE: Serbia, BiH, Croatia, Albania, Montenegro, Macedonia, UNMIK ], Treaty Observer countries [Ukraine, Moldova, Georgia and Turkey]) Objectives II.

Concentrated (national) markets less chance for effective wholesale and retail competition  solution: creation of regional markets (mitigation of market power), EU internal market Problems: Concentrated Market Degree of concentration

Lack of transparency on transmission access and generation. Lack of adequate investment in energy infrastructure and generation  predictable, transparent transmission pricing + incentive mechanisms needed  energy efficiency measures + new renewable could be a solution partly The World Bank Report: „Lights out? The Outlook for Energy in Eastern Europe and Central Asia” highlights: „The total projected energy sector investment requirements for the region (30 countries) over the next 20-25 years are huge – about $3.3 trillion (1,1 – electricity) or some 3 percent of accumulated GDP over the period. ……. Cont. Problems: Lack of InvestmentI

„…..Although the public sector in these countries will clearly have to finance a portion of these investments, it will not have the capacity to meet the full investment needs. The countries in the region will therefore need to call on the financial depth and technical know-how of private sector investors and energy companies.” „ In order to attract these investors, countries will need to create enabling environments that provide secure ownership rights, are subject to the rule of law, foster transparency, and enable reasonable risk mitigation.” Problems: Lack of Investment II

Implementation of legislation EU: the implementation of current Directives and the „new” Third Internal Energy Market Package is essential  Infringement procedure against 25 Member States Non-EU ERRA: lack of detailed secondary legislation in some cases + lack of harmonised cross border trading rules  less intensive regional trade (compared with possibility/need) Problems: Legislation

Market integration EU: Regional Initiatives  harmonised, common rules in regions on; Congestion management (cross border capacity calculation and allocation rules, market coupling), Transparency (available data/information for market players), Integrating balancing market  increasing political engagement; MOU of eight Baltic Sea Member States + MoU of seven states: Central Eastern European Forum for Electricity Market Integration EU-wide coordinated congestion management Non-EU ERRA: some regional agreements + Energy Community + regulatory efforts on cooperation and harmonisation of procedures, rules Problems: Market Integration

Price trends Brent crude oil price peaked ~ 92€/bbl ($147) in July 2008  went down as 27 €/bbl ($37) by the end of 2008 (decrease of 70%)  then increased in 2009 despite weak demand (mid 2009 ~ 50%) Oil price has a direct impact on gas wholesale price (link in long-term gas supply agreements) Gas wholesale prices influence electricity wholesale prices The financial and economic crisis resulted in a significant fall in the consumption of gas and electricity Problems : Price Trends I.

Price trends The fall in oil prices and in energy demand was not entirely reflected in end-user gas and electricity prices (imperfect markets, learning process of end-usersin risk management) Problems : Price Trends II. %Rate of change in electricity prices for industrial consumers second half-year 2008 – first half-year 2009 Customer Groups by Consumption IC: 0,5-2 GWh/year ID: 2-20 GWh/year

EU: The EC sector inquiry (2007) report highlights the phenomena of regulated end-user prices acting as a market distortion, especially for industrial users Non-EU ERRA: Hybrid model (regulated end-user price in major part of retail market  indirect cap for the free market as well) Problems : Price Trends III.

Regulated end-user price for industrial users is not speciality of emerging markets out of 29 16(13) EU members have end-user price control at household (non-household) consumers „Universal Service” (USP) with regulated/controlled/monitored prices could be an umbrella for customers At what stage of wholesale market building, should Governments/Regulators clear the way of market processes in pricing; market based energy price for the retail market? What are the indicators which ensure that the functioning wholesale competition shall „control” the energy prices (instead of the price-regulation of energy component)? Problems : Price Trends IV.

Low wholesale (energy component only) prices in some ERRA countries not allow private investment in generation Problems : Price Trends V. Price of electricity (only the energy component) paidby non-household consumers EEX prices (2008) EEX prices (2010)

Problems: Independence of network operators EU: Out of 29 Member States 19 go beyond the present requirements of legal and functional TSO unbundling. First cross-border TSO: E.ON sold its high voltage transmission network to the Dutch state-owned TSO (TenneT). All Member States will have to adopt their legal framework to new unbundling requirements of Third Energy Package (ownership unbundled TSO, ITO, ISO) Non-EU ERRA: Missing detailed unbundling rules in most cases! Decision making practice of network operators in network access independently from trading interest is essential for functioning markets

EU: Different regulatory powers and competencies in Member States  in some cases less chance to enforce compliance with EU rules. The Third Energy Package has detailed rules governing the duties and powers of regulators. National Regulatory Authorities (NRAs) should be authorized (empowered) – among others; to make independent (autonomous), transparent decisions, to promote competitive, secure and environmentally sustainable energy market, to fix (set) or approve tariff or tariff-methodology for access to and use of transmission and distribution networks, to ensure compliance of network operators with network access (TPA) rules (especially cross-border) to enforce consumer protection measures Agency for the Cooperation of Energy Regulators (ACER) will ensure regulatory oversight of cross-border issues. Problems: Regulatory Power I.

Non-EU ERRA: Wide variety of regulatory competencies; Fewer duties on promotion of competition, Less power on enforce non-discriminative TSO/DSO operation (unbundling, TPA, congestion management) Voluntary harmonisation of cross-border and licensing issues Those countries targeting implementation of EU Directives (Energy Community Treaty : Contracting Parties and Treaty Observer countries) has common legal basis and should have adequate regulatory power Problems: Regulatory Power II.

EU: Retail markets are not liquid enough in most cases, Existence of dominant incumbents especially in household customer- markets in some cases reduces the chance of customer choices Difficult measurement of customer’ switching rate (no clear picture) Demand for easier supplier switching EU politicians force template bills and recommendation for good practice in billing, Complaint handling procedure Role of DSOs on smart metering/smart grid and energy efficiency Problems:Customer ProtectionI.

Non-EU ERRA: There is some market opening for wholesale and retail customers underway, but very limited cases of functioning and liquid retail markets, Market segment (hybrid model) with regulated / controlled (politically reduced) end-user prices limits (distorts) retail competition Different complaint handling practice Less interest (competence) on smart grid / smart metering / energy efficiency Problems:Customer ProtectionII.

A dispute between two companies (Gazprom and Naftogaz) led to an unprecedented crisis in the EU’s gas supply in January 2009. Countries with high gas dependency were in a serious, very fragile situation  restriction, contingency New national strategies; Energy efficiency measures, New sources (renewable, nuclear), Different supply routes and gas sources, New storage facilities LNG Common EU position + new Regulation (preventive actions and preparations for crisis management + infrastructure standards) foreseen to be adopted in 2010 Network development plan (10 years) Generation adequacy Problems: Security of Supply

Orientation of NRAs supporting governments to achieve key objectives EU: Regulators are required to promote competitive, secure and environmentally sustainable energy market More focus on issues related to network access (new entrants, congestion managements, unbundling, incentive network/system pricing, compliance monitoring, transparency, consumer complaints as minimum condition for competition and free customer switching between suppliers  Preparation of EU-wide binding grid codes by ENTSO  regulatory requirement prescribed in Framework Guidelines Less focus on licensing, end-user „energy only” pricing New focus on consumer switching procedures, on smart grid/metering and on energy efficiency, renewable support More focus on market monitoring and ex ante promotion of efficient competition Regulatory tasks achieving objectives I.

Non-EU ERRA: In most cases there are no clear distinctionbetween responsibilities on different time-horizons promoting competition; Ex ante: NRAs (through approving network codes, market operation rules) Ex post: behaviour-analysis and anti-trust actions Generally less effort on transparent network access (congestion management) rules and practice. [As part of the Energy Community market development: one significant activity is the cross-border transmission market monitoring work being done in Southeast Europe.] Less effort regarding Climate Change related energy issues (renewable support schemes, energy efficiency, smart grid / smart meter, end-user involvement in system regulation) Regulatory tasks achieving objectives II.

Concentrated national markets  regulatory task: mitigation of market power EU: Regional Initiatives Target Model Consultation process: harmonisation among regions targetingcommon EU internal market AHAG: European cross-border capacity calculation concept based on a common grid model and flow based calculation, target model for intraday trade, governance framework for day-ahead market coupling Non-EU ERRA: Voluntary cooperation of harmonisation  regional market building Significant Market Power concept (ex ante obligations) Very slow process If there is a threat of capacity shortage and/or security of supply problems politicians may become concerned and often interact in a way, which does not support competition and regional market building (support national champion, priority at borders, artificial barriers at borders) Regulatory tasks solving key problems I.

Regulatory challenge: Convincing politicians to avoid maintaining or re-creating isolated, relatively small national markets instead of establishing regional market conditions. The lack of regional market and the national administrative measures discourage new private investments, especially large scale new generation investment. Regulated end-user pricing system coulddistort competition! Dilemma/Hesitation: At what stage of wholesale market building, should Governments / Regulators give way to market processes in pricing; market based energy prices for the retail market? What are the indicators which „ensure” that the functioning wholesale competition shall „control” the energy prices (instead of the price-regulation of energy component)? Challenge: Convincing politicians not to „create” a more robust USP umbrella and not to focus on household customers only, but to respond to industrial users as well Regulatory tasks solving key problems II.

Challenge: Convincing politicians not to distort prices when the wholesale market prices are high anyway Regulatory tasks solving key problems III. 2007 2008 2006 2004 2005

Lack of adequate investment in energy infrastructure (especially cross border network) and in generation (causing potential security of supply problems if demand grows again) during time-period which characterised by economic & financial crisis, and when wholesale market prices are low Situation: Demand reduction New foreseen financial policy of banks at present and in future [higher (regulatory) risk sensitivity in emerging markets, shorter lending periods, higher equity requirements] Reduced market based whole pricing creates grace period for regulators Regulatory tasks solving key problems IV.

Potential regulatory actions: „Real” evaluation of network asset ( depreciation and cost of capital could increase among network costs  network charge↑) Shorter amortisation period of network elements Network charge adjustment during pricing period (activated new investment elements could beaccepted) Accepted return could be adjusted to new economic situation (Returns on Government bonds + risk premium) Higher accepted rate of return for newcross-border investment Exemption from general TPA rules Regulatory tasks solving key problemsV. End-user tariff System charge Network charge increase has less influence on end-user tariff during low energy price time-period  time for adjustment Energy price

Avoid distortion of all prices (especially wholesale market price) Lack of indicative price on national markets → supporting the concept of regional Power Exchanges Active Regulatory (and Government) energy efficiency and energy saving and other Demand Respond programs, incentives could have a major role in capacity balance → e.g.: special tariff element (decoupled rates) Hopefully the economic crisis will end soon and the Demand Respond programs + distributed generation (renewable and combined heat and power) could „keep” the capacity balance Regulatory tasks solving key problemsVI. After the crisis, if the demand will grow again capacity shortage problem could be serious! Stable, non-discriminative, predictable, transparent regulatory system isthe key!

The energy demand forecast became very complex during crisis. The key unpredictable components determining electricity demand in medium term: The length of economic/financial crisis The new equilibrium where the financial market will be stabilized [new conditions financing industry (end-users) and energy projects] The new level of demand stabilized after economic crisis The effect of energy efficiency measures (based on initiatives of governments and/or market incentives) Price elasticity Demand and price forecast (estimation) The key message for governments / regulatorswishing to avoid capacity shortage problems  the energy efficiency measure could be a good solution!

Demand forecast (estimation) Peter D. Thomson Director, Sustainable Development Department Europe and Central Asia Region The World Bank Lights Out? The Outlook for Energy in Eastern Europe and Central Asia Projected Generating Capacity Additions, Rehabilitations and Retirementsin CIS/CSE region 2005-20 (GW) Average Annual GDP, Electricity Consumption, and Primary Fuel Consumption Growth Rate in the CIS/CSE Region, 2005–30 (%) Source: World Bank staff calculations Source: World Bank staff calculations.

PhelixBaseload Year Futures (Cal-10) Prices and trading volumes

Futures prices for 2011 Phelix Baseload Year Futures (Cal-11) Prices and trading volumes since 17.03.09 PhelixBaseload Year Futures (Cal-11) Prices and trading volumes from 2005

Thank you for your kind attention! www.erranet.org chairman@erranet.org Key objectives, problems and tasks of regulators

Moscow , Russia April 1, 2010