Case study - A newcomer's view

Already present in the power markets of Slovakia, Bulgaria and Romania, Italian power utility Enel sees eastern Europe as ripe for physical acquisition and market participation. Enel's Fabio Mezzetti and Tatiana Glouchtchenko talk about the risks and rewards of being a new entrant to the eastern European market

Enel is upbeat about the potential of the eastern European power markets. Already present in Slovakia, Bulgaria and Romania, the company is now considering expanding into the Balkans and is looking acquiring power generation assets there.

Enel has been building up a presence in power markets outside Italy since 2002. Due to liberalisation it was forced to divest one third of its generating capacity by 2003 in order to comply with Italy's 50% market-share limit. Enel looked abroad to make up for curbed domestic business. As well as seeking out healthy markets in which to operate, Enel Group's focus is on finding investments with attractive returns for the cash accrued from divestitures, in order to maximise value for its stakeholders.

Therefore, we started building up trading activity from 2002 in the well-developed markets of France, Germany, Switzerland, Austria and Spain. The eastern European market, where liberalisation is beginning to take shape, is our next target. Through the acquisition of physical assets in Slovakia, Bulgaria and Romania, Enel has become a direct participant in energy trading in these fast-developing markets. The company believes European power markets will become more and more integrated thanks to better physical interconnections, so it wants to build a significant presence throughout the continent.

Presence in eastern Europe

Currently, Enel owns majority stakes in generation assets in Bulgaria and Slovakia, and distribution assets in Romania. In Bulgaria it has a 73% stake in the lignite-fired Maritza III power plant and in Slovakia it holds a 66% stake in the former monopolist Slovenske Elektrarne (SE). This makes a total of about 7 gigawatts (GW) of installed capacity, balanced between hydro, fossil-fuelled and nuclear plants. In Romania, Enel has acquired three distribution companies serving the regions of Banat, Dobrogea and South Muntenia. Including its assets in Spain - the fully-owned subsidiary Viesgo and a majority stake in Union Fenosa Renovables - Enel Group owns a generation fleet of more than 10GW outside Italy and a customer portfolio exceeding three million across Europe.

The acquisition of SE - Enel's largest purchase outside the domestic market - is regarded as one of our greatest accomplishments. Through this new asset, Enel returns to managing nuclear technology, which is a key step towards playing a leading role in the European power market.

Enel is also now considering expanding into the Balkans, and we are looking at acquiring generation assets there. Further afield, we already have a presence in Russia and believe we will be in pole position to exploit expansion opportunities when the Russian power industry opens up wholly to liberalisation in the next few years. As well as running a combined-cycle power plant in St Petersburg, we recently closed an agreement for the acquisition of a 49.5% stake in Russia's leading power trading and retail company RusEnergoSbyt. This represents, in our view, a unique opportunity to enter a market with enormous potential, and to grow further through the potential acquisition of generation assets in the expected liberalisation.

Through these acquisitions, Enel Trade is likely to expand its trading activity in central and eastern Europe, using Enel Group's assets.

Unified approach

All energy-trading activities within Enel Group are carried out by Rome-based Enel Trade, which acts as the only hub for all tradable commodities - electricity, gas, oil and coal, physical and financial transactions. The company also trades environmental certificates and carbon credits for Enel Group. The business opportunities covered by Enel Trade comprise group hedging and proprietary trading, as well as cross-border and arbitrage. Enel Trade balances its positions in power and fuel products on one side through both its sales and origination arms, and on the other side, by optimising its generation fleet. Therefore, Enel Trade's overall positions can benefit greatly from Enel's assets, which, together with top-in-class trading expertise, result in a privileged standing in the market.

Challenges for newcomers

A newcomer to the eastern European markets faces a completely different environment to that of western Europe. The main differences stem from the regulatory framework. There is only partial compliance with EU legislation. There are more fiscal and administrative constraints, and there's far less standardisation of products and contracts. Credit risk is higher, power exchanges are not fully operative and over-the-counter markets are illiquid and opaque. In addition to all this, it's necessary to set up a local subsidiary in almost all of the countries in the region in order to carry out our full range of business.

There are also some different structural starting conditions, such as the availability of primary energy resources or differences in fuel mix, which may have a large affect on market price fundamentals and volatility. Grid connections also impact the development of all cross-border trading opportunities between neighbouring markets.

Cross-border business is hindered in many places by long-term, multi-year contracts, signed by former state-run monopolies that freeze a remarkable share of the cross-border capacity and thwart allocation being given to newcomers. These contracts also distort the free-market functioning, as they are usually well below current market levels. In many cases it isn't known when they are due to expire.

It would be good to see calculation methods for net transfer capacities and eventually for available transfer capacities becoming more transparent.

However, hurdles in the current market situation can be overcome if a company is prepared to work out a specific solution for each problem encountered in a new market. Given the lack of standardisation in contracting, the deal origination should negotiate tailor-made contracts according to the different nature of counterparty and transactions (traders, generators, transmission system operators, consumers). The risk management function should provide guidelines and operative instructions to be taken into account case by case.

The various eastern European power markets have much in common, namely, fast-growing economies, relatively strong state influence, political commitment to restructure the markets, and the need for investments in the power industry. However, new entrants need to be aware of differences in the regulatory framework and be prepared for operating in a market with far less liquidity than they may be used to.

To give a brief comparison, Poland and Czech Republic are easier to approach for a newcomer in the power trading business, as these markets seem more advanced. For instance, market liquidity is higher than in other countries in the same region, and a notable end-user market-share has actually already jumped away from the large incumbents to the new entrants. On the other hand, Slovakia and Hungary seem less accessible for trade due to almost illiquid markets characterised by a small number of players.

Future strategy

Key to Enel's success has been its strategy to integrate its subsidiaries within Enel Group, sharing the same targets, common vision and policies. To achieve the required degree of integration we are designing and implementing processes and systems to support the whole array of both day-to-day and strategic actions and to ensure full functionality. This process is backed by a continuous enhancement of market know-how, which allows us to work out the best-fitting business solutions depending on the peculiarities of each market.

As far as cross-border trading is concerned, our approach is not merely speculative. We believe such trading activity should serve as a means of asset optimisation, which also generates a natural hedge and a backstop guarantee. Our trading skills and information ownership combine with the advantages from effective price strategies on cross-border capacity rights and generation dispatch. In such a way we can avail of the best opportunities springing from the price spreads between adjacent markets.

Enel's Fabio Mezzetti and Tatiana Glouchtchenko, are both energy traders focusing on eastern Europe.