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The Road to Hungarian Energy Security

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Hungary, with the highest gas dependency ratio in Central and South Eastern Europe, serves as a good example as to how a natural gas import-dependent country can meaningfully address its national energy security challenges. The road to security is not, however, paved with gold but beset with potholes. The overall picture of the country’s domestic energy fuel mix is not appealing. It has relatively low quality and limited reserves of its own fossil resources, a high share of primary energy imports, natural gas dominance in heating, and nuclear and natural gas dominance in electricity generation. Although policy measures have been sometimes delayed, the country has worked to reach a condition of preparedness for possible supply interruptions.

Hungary’s energy infrastructure pattern bears the typical characteristics of most other Eastern European countries. Its main energy supply infrastructure was built during the Socialist era, which put the country dependent on energy supplies coming from the East, now from post-Soviet states. Several energy resources like oil, natural gas and electricity were imported from the Soviet Union in exchange for industrial products during the Cold War.

The political system shift in the early 1990s marked a new era for Hungary’s national energy policy. The overall shift in emphasis was to increase energy security by lowering unilateral import dependency and to increase strategic storage levels, as stated in the Hungarian Government’s energy policy of 1992. In line with these targets, the level of oil reserves was increased from 20 to 90 days of average consumption. Electricity power generators that ran on oil or gas products had to secure their own stockpile for 16 days. However, this new regulatory framework did not address the importance of natural gas at that time.

Although a bulk of crude oil imports came from Russia, the Friendship (Druzhba) oil pipeline has a design capacity for reverse flows from the Adriatic Sea (West-East) that can ship oil from a Croatian port to Hungary.

Figure 1: Share of Primary Energy Imports


Nuclear excluded as it counts 100%
* includes estimated firewood, vegetal materials and wastes, geothermal, biogas, solar electric, etc. energy
** non vegetable-based waste burning

Source: Energiaközpont Kht. 2010

As Figure 1 shows, despite cited political aims in 1992, Hungary’s primary energy import dependency increased during the first decade of the country’s formal independence. The period of economic restructuring after independence provided a relative easing on energy demand as the national economy slowed. The impact of the economic downturn was that many inefficient mines and power plants were scheduled for closure in the mid-term of their plant life-span. Thus, despite the increase in coal imports, coal consumption gradually decreased over time, and its role has become less relevant to the nation’s power production. At the same time, this change has reduced the nation’s energy diversity by increasing gas import dependence.

Electricity

Hungary was part of the East European Integrated Power System (CDU), which meant that the Soviet Union was one of Hungary’s primary electricity suppliers. However, after regaining independence the countries across the region almost immediately announced their intent to join the Union for the Co-ordination of Transmission of Electricity (UCTE). In order to demonstrate each country’s capability to take its own responsibility and to coordinate action on electricity supply, Poland, Hungary and the Czech and Slovak Federal Republic formed CENTREL, which became the first step in UCTE membership.

Although Hungary’s installed power generation capacity can theoretically meet its demand, the country has imported around 10% on average of its electricity needs over the last decade. Due to production related costs it has been cheaper to import electricity than to produce it domestically. This highlights the fact that Hungary has few adequate domestic generation capacity reserves, as is shown in Figure 2. Although the country can meet its peak demand, it is well below the UCTE average of around 22% (marked with orange) or the Central and South Eastern European (CSEE) average (marked with black) that is around 30%. Capacity reserve security is guaranteed with available cross-border import capacities.

Figure 2: Mid-term Electricity Security of Supply in Central and South Eastern Europe 2008 ((Available capacity-Peak demand)/ Peak demand)

Source: REKK SoS project

To sum up, by 2000 all basic energy security issues were addressed in the oil and electricity fields; a legal framework was established and privatization of the oil and electricity sectors was on its way. However, energy policies concerning natural gas did not provide sufficient diversification or reserves of natural gas supplies.

The issue of natural gas

Hungary’s gasification took place gradually. The country, with its own natural gas resources, had historically significant reserves of its own. However, the mass scale gasification of the residential sector during the 1980s and 1990s rapidly turned the country into a net importer. Hungary’s dependence on foreign origin natural gas significantly increased, while production peaked and started to shrink (see Figure 3). Natural gas consumption growth, besides the direct cause of gasification mainly for heating purposes, in the residential sector was indirectly stimulated by (1) regulated natural gas prices that were kept artificially low for end-user consumers, (2) the fact that the government supported replacement of small power generation facilities running on heating oil or coal to gas fired ones (and at the same time stopped subsidizing fuel oil prices) and (3) economic restructuring in the 1990s that created an investment climate that has been unfavorable for investment projects with long-term investment cycle runs. As a result, since 1990 only natural gas fired power plants (CCGT) above 50 MW installed capacity have been constructed. These plants are quick to construct, and have a shorter investment cycle versus larger projects with larger capital requirements.

Figure 3 Natural Gas imports, production and consumption in Hungary

Source: Energiaközpont Kht. 2010

The dual effect of residual and electricity generation demand increases was that natural gas became a dominant primary energy source in the country at a time when domestic production could only meet 20% of total demand and conventional reserves were in decline (and are likely to be depleted by 2025).

Figure 4 Share of Primary Energy Usage in Hungary in 2008

Source: OECD 2010

The policies which favored increased natural gas consumption were addressed in part—from a supply security perspective—with a new interconnector to Austria and a new small natural gas storage site (Maros-1). The Hungarian-Austrian Gas Interconnector (HAG) was built in 1995 and was put into operation a year later. The new capacity of 12 million cubic meters (mcm)/day could replace one third of the Ukrainian interconnector’s 30 mcm daily capacity at the time (half of this capacity was allocated for Serbia and Bosnia and Herzegovina). HAG was a great step forward to diminish dependence on one single pipeline, but it did not mean supply diversification. In Austria the same Russian gas was available for similar prices as at the Ukrainian border. Nevertheless, the HAG could provide a safety back up in case of any interruption from Ukraine and could support further gasification of the Western part of the country that earlier suffered from low pressure problems. Thus, in a case of supply interruption from Ukraine, small scale diversified transport capacity was available from the West. Nonetheless, the new interconnector capacity and the available storage capacity that time (51 mcm/day or 3.16 bcm annually) were barely sufficient to meet an N-1 criterion, which stands for the ability to meet demand even if the largest supply point fails to operate.

Growing gas demand forced transmission service operators (TSOs) to implement upgrades of the national grid, but security of supply issues were not addressed through the new interconnectors or gas storage developments after 1996. As result, security issues were not being addressed properly, and no tangible results surfaced until foreign investors were allowed to enter into the natural gas sector in 2006.

Figure 5 Natural Gas consumption by sectors

Source: Energiaközpont Kht. 2010

Positive side effects of the accession to the European Union

Hungary’s accession to the European Union in 2004 obliged the country to comply with EU legislation and regulation requirements in the energy sector. As a consequence of this, and also due to domestic political issues, MOL, the Hungarian national champion of the oil and natural gas sector, opted to sell its natural gas sector branch in order to more easily comply with EU market regulations. MOL kept only the production sites and the transmission system, while distribution, storage, wholesale (including Russian long-term contracts) and retail trade were sold to E.On Ruhrgas International.

The deal had to be approved by the European Commission. In order to comply, E.On agreed to different remedies. This was a step forward to a more liquid market. Some cite that market liquidity or diversity increases security. However, E.On Gas Release—an open auction that offers 1 bcm natural gas annually at competitive prices for an 8-year period (2006-2013)—and Contract Release—an offer up to 50% of the contracted national natural gas production volume purchase by a third party—have not resulted in adequate liquidity or increased security. E.On has remained a dominant supplier of gas to the Hungarian market (approximately 70% of Hungary’s gas market share).

Storage capacity

Nevertheless, the ownership change from MOL, along with the 2006 gas crises, triggered gas storage development. As a result of the significant Ukraine-Russia gas dispute, Russia cut its exports for four days in 2006. This emergency motivated the government in Budapest to take serious security measures and to invest in strategic storage capacity. MOL offered one of its production sites (Szőreg-1) to be converted into a strategic gas storage facility. The construction costs of USD 750 million have been borne by the price to the end-user to create a 1.2 bcm gas storage facility with a 20 mcm daily withdrawal capacity. This project began realization in 2007 with a proposed implementation deadline at the end of 2009. As a result of this timeframe, the additional gas was not available during the 2009 January gas crisis.

The new storage capacity owner—E.On Földgáz Storage—also saw a gap in the market. Its investment commitments have brought security benefits for the country. The earlier 3.4 bcm storage capacity was increased to 4.2 bcm, reaching a 55 mcm daily withdrawal capacity that can account for more than half of the highest ever measured demand peak of ~90 mcm a day.

New interconnectors

Another advantage of the EU accession process has been that Hungary has benefited from the formulation of a common Union-wide policy of energy security that partly seeks to address the dependence on Russian supplies. The Commission’s 1364/2006 Directive, commonly referred to as Trans-European energy networks project (TEN-E), named several cross-border interconnectors along the Hungarian border that are eligible for Community assistance. This includes new interconnectors between Hungary-Romania, Hungary-Croatia, and Hungary-Slovakia. The first one, Hungary-Romania interconnector, is already operational, the second is under construction, and the third one is on its way. The TEN-E also supported a capacity increase in the existing Ukraine-Hungary and Austria-Hungary interconnectors. The latter was not supported by the Hungarian Energy Office, while the first was realized in 2009.

Despite the above mentioned development projects in 2006-2009, the country was not yet ready for the major gas supply crisis that occurred in January 2009, which cut supplies completely for 14 days. The crisis fell at a time of cold temperatures across the nation. As infrastructure developments (strategic storage, new interconnectors) were not yet ready, the system was not able to meet its full demand load. Large industrial consumers—22 in total—were partly or totally cut off from supply. A three-level restriction protocol was put in place, but consumers were not satisfied with its operational results. The weakness of the three-level protocol was that it was never tested in a probe mode prior to the crisis. It did not distinguish properly between major gas consumers by their strategic importance in the production supply chain (e.g. food-processing) or by measuring a minimum necessary level of supply that could obviate damage to machinery. After the crisis the initial protocol was replaced by a seven-level protocol that has taken into account these needs. However, it has not been tested in a probe mode either, which increases risks during a possible future crisis management situation.

Long term natural gas security-of-supply measures

Hungary’s diversification aims date back to the mid-1990s when the HAG interconnector was built. Although the HAG interconnector is significant (as discussed), it has not been sufficient for import supply diversification as it has not transported alternative supplies of non-Russian origin. In 2002, the Nabucco project was announced, which foresaw alternative natural gas supplies from the Caucasus, Middle East, and Central Asia to Central and Southeast Europe. Nabucco would bring 31 bcm annually through Turkey, Bulgaria, Romania, Hungary and Austria. Involved companies’ ownership varies between private and public, thus making the realization of the project extremely challenging. The Hungarian government itself has never been directly involved in the project, as the government has no ownership role in MOL aside from one symbolic share.

National governments have expressed their support for the Nabucco project. Political commitment for the pipeline has grown with every gas crisis (2006, 2009). However, many other competing Southern corridor projects have also attracted political support across the region, such as the South Stream project and the Azerbaijan-Georgia-Romania Interconnector (AGRI). These projects in fact are even less likely than Nabucco to be realized as they are regarded as red herrings. In any event, Hungary—well suited with storage capacity—supports them; it could profit from increased gas transit and partial diversification, thus increasing gas supply security. Nevertheless, showing support for all these proposals sends a wrong signal, as investors do not understand clearly which supply diversification plan is seriously supported. This maneuvering also casts a shadow across the government by raising doubts  as to whether it really has a clear strategy for supply diversification.

There are other projects that have been less successful in gathering adequate political support. In 2005, the Ukrainian government proposed the forerunner to the AGRI pipeline, the so-called White Stream Pipeline (Georgia-Ukraine-European Union GUEU), which did not receive Hungarian support as it was largely viewed as unfeasible.

The two decade old Croatian LNG plant proposal on the island of Krk has had weak support as well. The project owners (OMV, Total, E.ON, Geoplin) have conflicting interests that stand as a barriers to project implementation. Although Budapest’s weak support suggests skepticism, the intergovernmental agreement between Hungary and Croatia agreed to a reverse flow capability for the interconnector that could provide Hungary potential alternative gas flow from Croatia. At the same time Hungary would like to provide transit for Russian gas to Croatia and the Western Balkan region. This intention is underlined by the doubling of the Ukraine-Hungary interconnector capacity, which is otherwise unjustifiable based solely on security considerations. The capacity increase of this interconnector has also been supported by the EU, as it is seen as key to increasing gas supply liquidity for the entire region.

Gas supply futures

All in all, Hungary’s mid-term natural gas security perspective is promising. After the recent economic downturn it is not likely that the Hungarian peak demand (90 mcm/day) will be reached again before 2020. While no significant capacity increase in gas storage is expected, the network of new interconnector capacities will significantly increase. By 2015 the country’s transit capacity is expected to increase further by 11.5 bcm annually, and the new reverse flow capabilities of the interconnectors will mean an additional 16.1 bcm supply capacity, reaching 42.4 bcm total. This level of surplus capacity will enhance market liquidity in the post-2015 era. This falls in line with the reshaping of the Hungarian domestic market in light of a new import contract with the Russian supplier and the end of gas release and contract release schemes. These developments are able to serve as a guarantee of gas supply security and to counter-balance the side effect of expected further decline in domestic production until 2020. However, proper supply security can only be addressed with alternative import supply sources of non-Russian origin.

Table 1.: The daily peak and annual capacity of the Hungarian gas system

  Daily System Peak CapacityAnnual Capacity 
 Underground Storage 80.1 mcm 6.13 bcm
 Domestic Production  10.2 mcm 2.8 bcm
 Imports 72,1 mcm 26.3 bcm
 Transit 16.2 mcm 5.85 bcm

Source: REKK data collection from industry sources

Conclusions

Hungary has successfully addressed its short to medium term security issues in the main energy sectors (oil, natural gas, electricity). The political willingness to integrate into Western European electricity networks enhances supply quality and safety. The intention to address natural gas supply security has led to building strategic natural gas storage capacity. Security has been further increased by the new entrant E.ON investments in commercial storage, by EU support for new interconnector capacity-building, and by upgrading existing interconnectors.

Long-term security measures have been addressed but not yet implemented. The region badly needs alternative import sources of natural gas through the Southern corridor. The implementation of a region-wide natural gas interconnector capacity still does not sufficiently address Russian-origin gas dependence. Further electricity generation diversification is unlikely to occur. Nuclear and natural gas remain the main electricity sources for the upcoming decades, whereas renewables will play an increasing but not dominant role.

Contributor Kornel Andzsans-Balogh is a Research Associate at the Regional Centre for Energy Policy Research (REKK), Budapest, Hungary.

 

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