ČEZ prepares to pass the baton onto EP Energy in race to avoid massive EC fine...


A flat share price; depressed wholesale electricity price; retreat from failing foreign acquisitions; the impossibility of securing a private investor to share the commercial risk of Temelín 3 and 4 without photovoltaic-like subsidies underwritten by the Czech taxpayer; the reopening of criminal investigations into the business dealings of its former boss; and the prospect of many more such investigations in the future now that state prosecutors Rampula and Grygárek are out.

These are not reasons to be cheerful about ČEZ, which held its AGM this week.

But there is some good news as well. In the midst of all this gloom, we learn that ČEZ has 'pre-negotiated' a deal with the European Commission under which it would avoid a hefty fine for alleged market abuses in exchange for divesting some of its generation assets.

Readers should be aware of the fact that ČEZ has been hoping to get rid of a power plant for some time (Chvaletice) to a firm it has been best buddies with for ages (EPH's EP Energy). The problem is that no one wants Chvaletice and offloading it would not boost competition. So ČEZ is having to bundle it up with a more desirable power plant (Počerady).

How reassuring this must sound to ČEZ investors: No hefty fine and the replacement of a monopoly with what might be described as a duopoly. Fortunately for consumers, ČEZ's attempt to head-off the European Commission fine by dumping unwanted assets on its 'competitor' is unlikely to impress Brussels. It by no means spells the 'end of the EC investigation', as is being suggested by local analysts.

The Commission has indicated that ČEZ's commitments to sell 800 - 1000 MW of installed capacity might address the Commission's concerns but that "the procedural steps of the investigation will continue" and the commitments will be market-tested, by which is meant that the impact of these divestments on market concentration will be measured. Click here to view the actual EC text.

My understanding of events is that the EC has now completed its analysis, has defined ČEZ's relevant market for competition purposes as Czech, and has concluded that ČEZ is indeed abusing its dominant market position. When the Commission states that the ‘procedural steps of the investigation will continue’, it means that it will now endeavour to define more exactly what laws and regulations ČEZ has broken, the so-called 'Infringement' and whether this is in fact harmful to consumers. When it has defined the Infringement, it will then define the so-called 'Remedy’. ČEZ is presenting its decision to offload capacity as a settlement with the EC, which it is not. The EC has yet to define the Infringement and therefore the Remedy for dealing with it. So ČEZ has merely proposed to act in a way that it hopes will appease the EC.

The competition economists at DG Competition (and those few that remain in the Czech competition authority now that the findings of that office's own energy sector enquiry have been mothballed for reaching the 'wrong' conclusion, i.e. the same conclusion as the Commission) understand full well that selling 1000 MW of ČEZ's capacity, especially if this capacity is to be sold to EP Energy, a firm which has just been fined 2.5 million euro for obstructing an investigation into alleged cartel behaviour between the very same firm and ČEZ, is not going to reduce market concentration to an acceptable level.

The reasons why we believe that ČEZ's pledge to offload up to 1000 MW of generation assets is unlikely to satisfy the EC are set out in some detail in our own research on the subject published in 2010 (see the conclusions of Power Abuse in Czech and English linked here).

If the economists were to decide, and not politicians, on how to treat ČEZ, they would most likely impose a massive fine or the requirement that the Czech energy utility divest over 2,400 MW of lignite installed capacity (three times what ČEZ is proposing), possibly together with around 1000 MW of pumped-storage capacity. Market concentration levels would then fall to a level which could be considered an approximation of an oligopolistic market, such as Germany.

Given the importance of lignite for the Czech generation market, we would expect the EC to require as well that ČEZ divest Severočeské doly, thereby creating a market in the most important fuel for the generation sector.

Needless to say, these assets would have to be sold to several individual buyers to maximise the chances of a real market emerging. And of course, to minimise the risk that those assets are sold to a firm, which though formally separate, would act as a proxy for ČEZ.