The European Commission requested Hungary Wednesday, following an in-depth investigation under EC Treaty state aid rules, to end long term power purchase agreements for electricity because they constitute unlawful and incompatible state aid to the power generators.
The PPAs should be terminated before the end of 2008.
Hungary must at the same time recover the aid granted to the generators concerned since Hungary's European Union accession.
Competition Commissioner Neelie Kroes said: "The phasing out of long term purchase agreements is a crucial step in the liberalization of the electricity market in Hungary. The termination of very similar agreements in Poland in April this year has already led to lower electricity prices. A well-functioning free market can now develop on the Hungarian wholesale electricity market too. I hope that the advantages of genuine competition both for competitors and for consumers will become apparent on the Hungarian market as rapidly as they have in Poland."
Around two thirds of the electricity generated in Hungary is sold under long term power purchase agreements to the state owned Magyar Villamos Muvek Zrt. Such agreements can restrict competition because they close off a significant part of the market from new entrants. New entrants therefore get only a limited chance to compete on the market, and competition cannot develop properly.
Following an in-depth investigation, the Commission found that the PPAs concluded between MVM and 10 power generators between 1995 and 2001 have been conferring unlawful and incompatible state aid to these generators from the accession of Hungary to the E.U. May 1 2004.
The Commission's final decision orders the termination of the agreements within six months. Hungary must furthermore recover from the power generators the revenues which they could not have obtained from the market without PPAs.
The Commission recognizes the major investment in power plants made by the power generators before accession. The Commission has already allowed other member states to grant state aid in order to help power generators to recoup investment made prior to the liberalization of the electricity market, provided that the negative effects of such aid on competition was minimized. In 2001, the Commission issued the 'stranded costs methodology', which lays down the principles for assessing this form of aid.
The Commission's investigation revealed that the PPAs in Hungary don't constitute an appropriate tool to compensate the generators for their pre-accession investments. Instead of helping these incumbents to adapt to the conditions of free competition, PPAs rather shield them from competitive pressure. The Commission's decision only concerns the Hungarian PPAs; should Hungary notify another compensation mechanism, this would need to be assessed on its own merits.
In the case of the PPAs in Poland, the Commission could in the same decision request the termination of the contracts and approve the compensation notified by Poland, which was found compliant with the principles of the 'stranded costs methodology.' In the mid-90s, Hungary's main objective in the energy sector was to ensure security of supply and the modernization of power generation infrastructure. In order to reach these capital intensive aims, the state introduced a system of PPAs as an incentive for power generators to invest in Hungary. Under these agreements, which have been signed between 1995 and 2001 and expire between 2010 and 2024, MVM has the obligation to buy a fixed volume of generation capacities, a fixed quantity of produced electricity at a fixed price. The PPAs thereby guarantee the generators a return on investment without any commercial risk. PPAs strengthen the position of PPA-bound generators in comparison with others.