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Central and Eastern Europe – Potential and Challenges for the Energy Markets

The Central and Eastern Europe (CEE) region is mainly comprised of ex-Soviet states, some of which have joined the European Union. As most of these countries have adopted western-style free-market economies, Eastern European commodities markets have seen significant development and are increasingly of interest to commodity traders.

Countries such as the Ukraine and its neighbors have strong agricultural sectors, and a number of trading companies, both new and established, have opened offices in the region to provide origination and logistics support for the movement of agricultural commodities to sales locations across European and beyond. Nonetheless, significant infrastructure issues do exist, and political and regulatory risks can be high for traders operating in the region, particularly those trading gas and power.

The energy commodities picture across Europe, and particularly in Eastern Europe, is complex. Those countries that joined the European Union have had to begin restructuring in order to comply with the EU vision of liberalized power, while the other CEE region countries, Russia included, began the migration to competitive electric power markets of their own designs. Across the region, privatization of energy generation, transmission and distribution assets in the individual countries has proceeded at different rates and arguably, in one or two countries, the process has slipped backwards in recent times. Adding to complexity of business in the region, bribery and corruption can be an unfortunate part of the landscape, and contract legal risks can be high.

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The generation mix across the CEE region is heterogeneous and largely coal-based (more than 50%), with nuclear also playing a significant role. Oil-fired generation is diminishing, as natural gas has increasingly become the fuel of choice for peaking capacity. Some countries have made progress in developing renewable generation, primarily wind and solar, and this power now makes up around 15% of capacity. Despite the development of these new facilities, more generation is required as power consumption in the region, currently at only 57% of that in Western Europe on a per capita basis, is forecast to increase substantially over the next decade. Additionally, much of the existing generation is aging (with more than 60% of the region’s capacity greater than 30-years old) and will need to be replaced over the same period.

While power trading exchanges have been launched across Eastern Europe with active markets in Hungary (HUPX), Czech Republic (PXE), Romania (OPCOM) and others, problems have emerged. For example, the EU recently brought an antitrust complaint against OPCOM over restrictions on foreign entrants to the market and the banning of bilateral OTC trading of power, forcing all trading onto OPCOM. Furthermore, transmission grid bottlenecks are common across the region and, while a potential source of profit for traders, congestion has become an issue during periods of high demand, and has led to increasing instances of force majeure declarations.

Given that countries in the CEE region are all moving at their own pace in developing new power markets, trading across the region is a complex activity and requires a deep knowledge of the local markets. While energy licenses can be ‘passported’ across EU countries, several countries outside the EU require specific licenses to operate, as well as local operating subsidiaries. VAT and import duty complications also exist throughout the region and may arguably be misused by the states involved.

Natural gas is a different story altogether. The gas supply and delivery infrastructure in the CEE was originally developed to receive gas from the Soviet Union and, even within the wider EU, structural limitations have resulted in a liberalization effort that is lagging that of power. Though regional exchanges have developed in Western Europe, long-term supply contracts still dominate the markets as an underdeveloped pipeline network has prevented the development of a singular benchmark hub like that of Henry Hub in the U.S., limiting the development of a spot market and liquidity for trading. In the CEE region specifically, no trading hubs have yet developed, there is no access to the LNG market and the region remains highly dependent on a gas pipeline network supplied by Russia. Additionally, many of the CEE countries have limited storage capacity as compared to the rest of Europe, forcing those countries to rely on incremental supplies of Russian gas during peak demand, increasing their market and operational risks.

While the CEE region is certainly an area of interest and potential opportunity for energy and commodities traders, there remain many issues to resolve. Rather than look at the region as a whole, one is forced to look at the individual countries in terms of market development, regulations and regulatory infrastructure, licensing arrangements and political stability. For those traders seeking to enter the markets, the CEE countries that share a border with western European countries may offer the best opportunities, as their markets are generally more mature by virtue of the direct link; however, even within the CEE countries that share those borders and are members of the EU, there remain significant structural differences between them, and policy disagreements with Brussels, which will contribute to increasing both short- and long-term risks.

Claudio Capozzi