Unbundling experiences in Hungary

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

2. New Europe: inefficient markets due to supply dominance and inadequate infrastructure Composition of gas sources The bad case: New Europe • 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 Meshed networks vs. parallel East-West transit routes The worst case: Hungary • 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 2

3. 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”

4. 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

5. 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 Non-structural solutionscannot create fair competition 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

6. 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

7. 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 Competition’s 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

8. Structure of the Hungarian gas market changed due to the sale of MOL’s certain gas assets to E.On Ruhrgas International • Gas market today • Gas market before the gas transaction 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 Domestic gas source Domestic gas source Compe-titive market Compe-titive market MOL’s re-entering in progress MOL’s presence Other market participant(s)

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

10. 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 MOL’s experience: Ownership unbundling: a nice idea that works

11. With proper infrastructure, Europe could have an efficient diversified market Estimated natural gas supply structure of the EU in 2010-2020 (billion m³/year) Norway 100 - 120 Russia 185 - 220 Indigenous Production 145-160 15 - 40 Central Asia + Caspian 5 - 10 25 - 60 12 - 25 Middle East Carib. 16 - 35 15 - 20 85 - 115 Egypt Algeria West-Africa Libya * EU-27, Switzerland and Balkan states Source: IEA, OME 2004 11

12. Poland Germany Czech Republic Ukraine Slovakia Hungary Austria Moldova Slovenia Romania Croatia Bosnia Italy Serbia Montenegro Bulgaria Macedonia Albania Greece Turkey Source Company Information NETS: An unbundled infrastructure platform • Proposal to unite Central and South-Eastern Europe’s 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

13. 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 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 opportunityof planned international projects with already diversified country risk • The establishment of gas hubs facilitates the development of secondary trading • 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)

14. Thank you

15. Current system of Transpor-tation tariffs Harmonization of regulatory systems enhances NETS and further contributes to market efficiency Enhancement of the operation of existing gas transmission infrastructure An entry-exit tariff system Unified grid code • 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 Establishing a new regional entry-exit tariff system Reflection of location differences Clear and easy to understand tariff system • Reflecting location differences in marginal costs • Providing price signals for congestion management • Mitigating excess capacity demands • A clear regional tariff system enabling investors to understand the expected position of the infrastructure company

16. NETS is gathering momentum • A dialogue of TSO’s 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