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C O N F I D E N T I A L SECTION 01 OF 03 BUDAPEST 000078 
 
SIPDIS 
 
STATE FOR S/CEE FOR AMB MORNINGSTAR AND REBECCA NEFF, 
EEB/ESC FOR DOUG HENGEL AND ALEX GREENSTEIN, EUR/CE FOR 
JMOORE, EUR/ERA FOR SJOHNSON, AND EUR/RUS. COMMERCE FOR 
HILLEARY SMITH. ENERGY FOR MAPICELLI AND MCOHEN. PLEASE 
PASS TO NSC JHOVENIER. 
 
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. 
 
BUDAPEST 00000078  002 OF 003 
 
 
 
... 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 
 
BUDAPEST 00000078  003 OF 003 
 
 
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