Unbundling experiences in Hungary László Varró Chief Economist EPP-ED Public Hearing, 13 February, 2008

New Europe: inefficient markets due to supply dominance and inadequate infrastructure Excessive reliance on one single source Lack of interconnections Insufficient storages No LNG High prices due to lack of competition Bad energy efficiency Resulting a much higher economic and social cost of gas supply security problems The bad case: New Europe 2 Composition of gas sources Meshed networks vs. parallel East-West transit routes Share of gas in primary energy Prevalence of gas in heating Reliance of the electricity system on gas Lack of significant transit flows The strongest national interest for developing infrastructure and enhancing infrastructure The worst case: Hungary

Efficient markets reinforce supply security Prices as signals: demand reaction Reorientation of trading flows The value of peak, market based storage investment The big lesson: the January 2006 almost crisis

Unbundling: a key of efficient markets Access to infrastructure Incentives for infrastructure developoment Barriers to entry, cross subsidies Facilitating the emergence of new gas sources Capacity utilization, incentives for market liquidity Avoiding conflicts of interests

Legal unbundling is an illusion Legal unbundling Network operation and trading interests still in collusion with respect to network investment and capacity allocation High monitoring and enforcement costs Fails to deliver non-discriminatory TPA Ownership unbundling Deep, serious remedy BUT Long lasting structural improvement for the market Welfare benefits Proper regulation Information asymmetry between regulator and regulated entity is too deep High costs of the regulatory regime Non-structural solutions cannot create fair competition

Legal or Bundled unbundling: techniques in the practice Cash pool between the trading and the network company. Pledging the network assets as collateral for the trading positions. Joint outsourcing of key operations to the holding company which is not under regulatory oversight. Inadequate Chinese walls, linked IT system

Timeline of the liberalization of the Hungarian gas market MOL has been vertically integrated dominant player on the Hungarian market January 1, 2004 Market opening: New Gas Act entered into force, but very little competition. Market split into regulated and competitive markets until July, 2007 (formally) 2005 MOL-E.ON Ruhrgas transaction Originally MOL retained 25 % of supply, 75% of transmission network DG Competitions condition for transaction approval was full unbundling: E.ON purchased 100 % of supply, MOL retained 100 % of transmission 2008 Residential sector is also free for competition

Structure of the Hungarian gas market changed due to the sale of MOLs certain gas assets to E.On Ruhrgas International Gas market before the gas transaction Gas market today Import gas source Regula -ted market Gas transmi -ssion Gas storage Gas distribu- tion, consum- ption Import gas source Regula -ted market Gas transmi -ssion Gas storage Gas distribu- tion, consum- ption Compe -titive market Domesti c gas source MOLs presenceOther market participant(s) Compe -titive market MOLs re-entering in progress Domesti c gas source

Competitive gas market has grown significantly since the market opening in January 2004 mcm / month

MOLs experience: Ownership unbundling: a nice idea that works Regulatory aspects Better investment incentives Truly independent TSO behavior TSO objectives now aligned with the regulator Lower compliance burden More market based balancing Management aspects Clear incentive structure More transparent management structure Focus on core competences Positive effect on corporate culture of the TSO Better reputation among stakeholders

Norway West-Africa Russia Middle East Libya Central Asia + Caspian Egypt Algeria Source: IEA, OME 2004 With proper infrastructure, Europe could have an efficient diversified market Indigenous Production Carib. 11 Estimated natural gas supply structure of the EU in (billion m³/year) Estimated natural gas supply structure of the EU in (billion m³/year) * EU-27, Switzerland and Balkan states

NETS: An unbundled infrastructure platform Proposal to unite Central and South- Eastern Europes gas pipeline networks within a new and independent regional natural gas transmission company Significantly higher value for shareholders than operating separate systems Would be well positioned to leverage international capital markets to finance major projects Consumers would also enjoy the benefits of an integrated platform for natural gas supply and a greater overall security of supply Austria Czech Republic Italy Hungary Slovakia Greece Romania Bulgaria Turkey Bosnia Germany Ukraine Moldova Croatia Slovenia Serbia Albania Montenegro Poland Macedonia Source Company Information

NET, as an unbundled transmission company would be a natural ally for the required massive infrastructural investments New infrastructure investments through NET Main planned new investments in the region Nabucco pipeline project and Adria LNG providing the entire region with new source Interconnectors between the national gas transmission systems Capacity de-bottlenecking optimizing regional balance system Establishment of a regional hub(s) NET as a platform for new investments The united gas transmission company would be much more capable of carrying out infrastructure investments, which would be further enhanced through a possible IPO Most of the planned projects in the region affect the countries in question NET as a growth story NET would provide a tremendous growth opportunity on several counts Based on its sound financial background, NET could easily become an active player of the regional (and European) privatizations and other transactions The expected total European ownership unbundling would lead to a high volume infrastructure transactions wave only available for independent operators like NET After a possible IPO, NET shares would represent the growth opportunity of planned international projects with already diversified country risk The establishment of gas hubs facilitates the development of secondary trading

Thank you

Harmonization of regulatory systems enhances NETS and further contributes to market efficiency Enhancement of the operation of existing gas transmission infrastructure Unified grid codeAn entry-exit tariff system Current system of Transpor- tation tariffs Clear and easy to understand tariff system Reflection of location differences Establishing a new regional entry- exit tariff system A clear regional tariff system enabling investors to understand the expected position of the infrastructure company Reflecting location differences in marginal costs Providing price signals for congestion management Mitigating excess capacity demands The bulk of the revenue would come from relatively short period capacity reservation fees and volume related fees Reservation period should not exceed one year NET would encourage secondary trading of booked capacity Enhancing the development of an efficient market Facilitating spot trading Medium term capacity utilization risk Could be socialized within NET countries NET, as an entity, should assume this risk due to its superior knowledge of the system and its strong balance sheet

NETS is gathering momentum A dialogue of TSOs is under way Policy framework build on existing regulatory cooperation Strong interest from national energy policymakers Preliminary work on several issues: structure, governance, business model