How CEZ and EPH work together in practice.

In the first part of this article, we looked at the theoretical underpinnings of the happy relationship between CEZ and EPH. We shall now explore the recent transactions between the two firms –transactions which in our view illustrate how CEZ and EPH work together in practice to achieve their shared goal of weakening Czech Coal.

Prazska teplarenska

In 2008, Energotrans, then owned by Prazska teplarenska (a joint venture between the City of Prague, the British firm International Power and the German EnBW), had started to negotiate with Czech Coal the renewal of its lignite supply contracts beyond 2012.

These negotiations coincided with the joint acquisition by CEZ and J&T (which sold its energy assets to EPH and Daniel Kretinsky in 2009) of the German lignite mine MIBRAG, which was offering to supply Energotrans at a price, which included the transportation of the coal, below that of Czech Coal.

The three shareholders in Prazska teplarenska could not agree on whether to accept Czech Coal’s offer, which, though more expensive, made more sense because the boilers at Energotrans are designed to burn Czech, not German, lignite. One shareholder, EnBW, preferred the MIBRAG offer. The critical decision of whether to renew Czech Coal’s supply contracts beyond 2012 was delayed, and then overtaken by events –the exit of International Power from the Czech Republic.

The circumstances of International Power’s departure from the Czech Republic are worth describing at this point. The British firm announced its intention to exit in mid-2009, and a tender was called to choose the buyer of its local assets, in which several domestic players, including Czech Coal, were planning to bid. But the evening before the deadline for submitting bids, International Power, under pressure from J&T to accept its offer that very day, agreed to sell to J&T. The tender was aborted, and Czech Coal, as well as other potential buyers, prevented even from bidding. The deal was signed with J&T on 30th June 2009 for CZK 22.5 billion.

How fascinating it would be to look inside the unopened envelope containing Czech Coal’s bid. I assume that J&T paid more than even Czech Coal would have dreamt of offering, in order to convince International Power to abandon its tender process, at great embarrassment, at the eleventh hour.

Most of what J&T bought from International Power, it immediately sold to CEZ, and as we shall see below, had in fact already promised to sell to CEZ before its offer was accepted by International Power. This premium should properly be labelled the ‘CEZ Premium’, the price CEZ was willing to pay to prevent Czech Coal from acquiring a lignite-fired plant.

There is abundant evidence that CEZ and J&T coordinated their approach to the sale of International Power’s Czech assets, the most compelling piece of which is the written agreement between EnBW, J&T Finance Group and CEZ on cooperation in the Czech energy market, signed on 24th June 2009 by Daniel Kretinsky of J&T, Vladimir Schmalz of CEZ and Johannes Zugel of EnBW.

The parties agreed before the transaction that J&T would formally buy all of International Power’s assets. J&T would then sell Prazska teplarenska (which included Energotrans) to CEZ, and EnBW would receive J&T’s assets in Prazska Energetika. The agreement, among other things, stipulates that EnBW is to refrain from bidding for International Power’s assets, and is to support MIBRAG’s offer to supply lignite to Prazska teplarenska.

In addition to this legal agreement, there is circumstantial evidence that CEZ and J&T coordinated their approach to the sale of International Power’s Czech assets. For example, CEZ’s Vladimir Schmalz accompanied J&T’s Kretinsky to the London headquarters of International Power to negotiate the deal.

The strongest circumstantial evidence that the two firms co-ordinated their approach is the fact that, following the exit of International Power, CEZ paid the whole value of Prazska teplarenska to J&T in cash immediately upon the signing of the contract, notwithstanding the fact that the deal had yet to be cleared by the competition authorities –it received unconditional approval by the Czech competition office in November 2009.

The cash received from CEZ by J&T for Prazska teplarenska amounted to 60% of the value of J&T’s transaction with International Power, making it rather hard to avoid the conclusion that J&T acquired most of International Power’s Czech energy assets on behalf of CEZ. And yet in an interview with Hospodarske noviny in April 2010, Vladimir ‘Shpërndarje’ Schmalz, in the face of this evidence, categorically denies that the three firms had prepared in advance their respective positions. In fact, this is the express purpose of the written agreement made by the three firms, signed just six days before the International Power deal was concluded –to prepare in advance their respective positions.


Passive observers

Schmalz stated in his interview that CEZ was no more than an ‘observer’, in other words, not an active participant. This interpretation is not supported by the agreement, which Schmalz himself signed, which commits the signatories jointly to approach the City of Prague in order to amend the contracts to allow EnBW, J&T and CEZ the full consolidation of their stakes in Prazska Energetika and Prazska teplarenska after the departure of International Power.

So that, dear reader, is the story of how the brilliant young Daniel Kretinsky bought one of Czech Coal’s more important customers, Energotrans, on behalf of CEZ.

MIBRAG

Let us now briefly turn to story of how CEZ and J&T bought a German lignite mine called MIBRAG, on behalf of Daniel Kretinsky –you will recall that both CEZ and J&T subsequently sold their stakes in MIBRAG to EPH.

Possible evidence of collusion between the two, reported in the local media, is an unspecified sum of money allegedly paid to J&T by CEZ, in exchange for J&T’s pledge not to build a power plant on MIBRAG’s site following its acquisition of CEZ’s stake in MIBRAG.

The fact that MIBRAG’s lignite can be used in some Czech lignite-fired plants is evidenced by the serious consideration given to its offer to supply Energotrans in 2008. Recall as well that EnBW undertook, in its agreement with CEZ and J&T, to support MIBRAG’s offer to supply Energotrans. We may reasonably suppose that CEZ invited J&T to participate in the MIBRAG deal in order to weaken Czech Coal, by offering cheaper supplies of lignite to Czech Coal’s customer, Energotrans.

The fact that today a CEZ-owned Energotrans continues to buy its lignite from Czech Coal, not from CEZ’s own mines or from EPH’s MIBRAG, hardly alters the fact that Czech Coal’s negotiating position with CEZ on this particular contract has been weakened in the last five years due to the events described above.

An immaculate conception

Soon after the International Power transaction in June 2009, in which J&T momentarily acquired all of International Power’s Czech energy assets, J&T’s energy assets, including MIBRAG, were transferred to EPH and Daniel Kretinsky.

The timing of these transfers is not irrelevant, as it allowed the ever willing Czech competition authority to grant its unconditional approval to the International Power transaction, on the grounds that, by November 2009, when the ruling was delivered, J&T had no energy assets and no relevant connection to Kretinsky.

Isn’t that lovely! Kretinsky’s conception as an energy entrepreneur was, in effect, fatherless –an immaculate conception no less.


Active participant

This ruling is a triumph of special pleading by the country’s most laborious legal minds. It makes a mockery of competition policy, setting out in painstaking and formalistic detail the ownership structures of numerous holding companies registered in exotic locations and operated by J&T et al, in an effort to demonstrate that J&T and Kretinsky had no relevant role in the Czech energy sector in November 2009. It wilfully ignores the measurable changes in market concentration that have occurred as a direct consequence of International Power’s exit.

The contrast between the formalistic approach taken by the Czech competition authority in this case and the common practice of the European Commission is remarkable. The Commission seeks actively to define markets and build evidence, by no means limiting its enquiries to the submissions of notifying parties.

The notified transaction between International Power and J&T was approved despite the fact that the law mandates the competition office to scrutinize the transactions which followed the notified transaction if there are reasonable grounds for assuming that the transactions are connected. The intentional and coordinated consolidation so well described in the written agreement between CEZ, J&T and EnBW is dismissed as irrelevant by UOHS.

In our view, the timing of the transfer of J&T’s assets to EPH and Daniel Kretinsky was calculated to avoid competition scrutiny. At the time of the transaction, J&T was active in the energy sector, owning or controlling numerous energy assets. Kretinsky himself signed both the cooperation agreement with CEZ and EnBW, and the purchase agreement with International Power, presumably in good faith.

The cooperation agreement between the three firms explicitly states that J&T intends to improve and consolidate its position in the Czech electricity sector, committing J&T to swap assets with EnBW and to cause MIBRAG to extend the validity of its bid for lignite supplies to Prazska teplarenska.

We consider it improbable that CEZ was not aware of J&T’s intentions to transfer all its energy assets to EPH and Kretinsky soon after the first transaction occurred in June 2009. And we consider it improbable that CEZ was not a party to the plan from the outset, coordinating its moves with them both.

Conclusion

To conclude then, CEZ and EPH demonstrably work together to weaken Czech Coal, in particular through the acquisition of assets that EPH, for reasons of cash flow, would have difficulty in acquiring without CEZ. And through the acquisition of assets that CEZ, for reasons of market dominance, would have difficulty in acquiring without unwanted scrutiny from competition authorities. It is exactly this scrutiny that Czech Coal initiated, in its complaint to the European Commission in 2009, and which is only now reaching its conclusion over three years later.

So let us return to Lenka Zlamalova’s loaded question, of why EPH is allowed to earn so much money at CEZ’s expense. The success of EPH’s energy division, now named EP Energy, may be considered, at least in part, to be an outcome of the supporting role EPH plays in CEZ’s efforts to maintain its dominant market position, in particular its efforts to avoid ceding influence over the setting of prices of lignite, its most important fuel source.

The next question Ms Zlamalova might like to consider is, how soon before the roles of EPH and CEZ are reversed, with EPH’s supporting role to CEZ becoming CEZ’s supporting role to EPH –which was, I suspect, the actual thrust of her original question.