By Michael Kahn
PRAGUE (Reuters) - Central and southeastern Europe, once seen to have big potential as a regional power market, will provide only niche opportunities as reluctance to integrate pushes out financial players needed to fuel liquidity.
Because of the small size of the region's roughly dozen individual markets, stretching from Poland to the Balkans, traders say it makes sense to trade central and southeastern Europe as a whole.
But market dominance by state-owned generators and legal obstacles such as export fees in Bulgaria and a value-added tax in Romania have dented such hopes.
"For banks and London players you have to set up infrastructure to trade at least five markets," Czech utility CEZ's director of trading, Michal Skalka, said. "New players aren't coming because of the obstacles."
With the thin trading volumes in their electricity markets and their lack of appeal for large foreign traders, countries will find it more difficult to attract investors willing to modernize ageing power plants and grids.
An executive at a leading bank in London said the financial barriers of entry were too high to make the risk worthwhile.
"Eastern Europe power trading is too much of a hassle in an already tricky environment, so we're focusing on the big markets such as German power or UK gas," he said.
Falling electricity demand due to slow economic growth has been another reason that financial players have pulled out or reassessed plans in emerging Europe, market participants say.
Claus Urbanke, Statkraft's head of new markets, said the region would continue to remain a niche market for specialists who have local knowledge and expertise.
"It is a combination of numerous national markets too small to be markets on their own," Urbanke said.
With speculative traders preferring to look to the much bigger and highly liquid German market, the likely future for the region is slow, if any, growth of trading volumes, market participants say.
David Kurcera, chief of the Prague-based Power Exchange Central Europe (PXE), which has seen volumes drop from 34.8 terawatt-hours (TWh) since launching in 2007 to 19.8 TWh in 2012, doubts big banks will return on a large scale.
"If there is any growth in volumes, it will be driven by consumers who are buying electricity from suppliers," he said. "I don't believe the big banks will come back soon."
Statkraft's Urbanke said that a Nordic solution, with one exchange serving the entire region, rather than numerous national exchanges was needed.
The combined Nordic power market of Denmark, Finland, Norway, Sweden, Lithuania and Estonia is one of Europe's most liquid wholesale power markets, and it is seen as a model case for liberalization.
In western Europe, Europe's biggest energy users, Germany and France, and the Benelux states of Belgium, Netherlands and Luxembourg have integrated their markets into the Central West Europe (CWE) region, which has led to high volumes of cross-border trading.
The Nordic and CWE regions also trade with each other, and CWE is connected to Britain's big energy market.
The problem in central and southeastern Europe is that governments often use charges to head off competition and protect a dominant national utility.
"Some regulators in the region have license fees based on the volume of sales," Arben Kllokoqi, a regulatory adviser at EDF Trading told a recent energy conference.
"This undermines liquidity because the signal of it is you should trade less."
Despite the fall in volumes, there are success stories. Many cite the Czech Republic as an example of a market with clear regulation, ample cross-border capacity and an energy exchange offering physical and financial futures.
The merging of the Czech, Slovak and Hungarian spot markets in September 2012 has provided a deeper, more reliable day-ahead price, traders say. Poland is the next country likely to join.
But the bloc may not grow much further unless countries remove barriers to their markets.
Most traders say their power markets will prosper only if they are unified into one large market.
"Market coupling is important because it will require countries to eliminate import and export fees," CEZ's Skalka said.
(Editing by Henning Gloystein and Jane Baird)