Nicholas Watson in Prague -

When one of Romania's leading state-owned electricity producers is declared insolvent, as Hidroelectrica was on June 20, it's unlikely to be because, as management claimed, drought had cut its sales by 20%. Rather, analysts believe there's an almighty battle going on between the government, Hidroelectrica's management and the holders of juicy long-term power contracts with the utility that are so beneficial they are being investigated by the European Commission.

On June 20, a Bucharest court accepted Hidroelectrica's application, filed June 18, to be declared insolvent, allowing it to reorganise its business under supervision of a specially appointed administrator without going into bankruptcy. "We would like to assure all our commercial partners, clients, contractors and financial institutions that all contracts will continue to function in transparent, efficient and legal conditions," Hidroelectrica said in a statement.

To say the insolvency application of a company that made a €9m profit last year and expects a profit of at least €23m this year caught everyone by surprise, would be an understatement.

Two of Hidroelectrica's five board members told local media they knew nothing about the insolvency request. Neither did Franklin Templeton, which manages the multi-billion-euro Fondul Proprietatea, or Property Fund, that holds stakes in Romanian companies, like the 20% one it has in Hidroelectrica. Fondul Proprietatea has said it would mark to zero its RON3bn (€672m) stake in Hidroelectrica if, as has just happened, it falls into insolvency.

The International Monetary Fund (IMF) too appears not to have been consulted, judging by comments from Hidroelectrica chairman Remus Vulpescu. Under the terms of Romania's €5bn precautionary loan from the IMF and European Commission agreed last year, a 10% stake in Hidroelectrica was to have been sold off, along with stakes in other major state companies like nuclear power producer Nuclearelectrica and gas firm Romgaz. In addition, Hidroelectrica, which has a generation fleet of 273 hydropower plants and installed capacity of more than 6,438 megawatts, was to have its management "professionalized" and a series of long-term supply contracts with preferred customers to be renegotiated or cancelled.

And it's these contracts to sell electricity at below-market prices, which have caused an estimated €1.5bn in profits over the last 10 years to drain out, that are regarded as at the centre of the brouhaha.

Smartest guys in the room

The government pledged to its international lenders to address these long-term, bilateral contracts with companies such as aluminium producer Alro, which are under investigation by EU competition authorities for possible state aid in selling electricity below market prices.

One theory has it that the government and management have grown exasperated at their inability to cancel or renegotiate these locally dubbed "smart guys' contracts", which will expire between 2015 and 2018. Even the newly announced investigation by the European Commission, which would mean any extra monetary benefit to companies, dating back as far as the country's 2007 accession to the EU, would have to be paid back, has not helped. "It had reached a point where management were exasperated and forced into making a big move, which was communicated disastrously," argues Otilia Nutu of Candole Partners in Bucharest. "It was a combination of shooting off the deep end and stupidity."

Of course, this being Romania, some suspect darker motives, such as insiders trying to squeeze extra money out of the holders of these contracts, or indeed an attempt to sabotage Hidroelectrica's listing on the Bucharest Stock Exchange this year. If that's the case, it's worked; "We didn't eliminate or rule out the possibility of getting money for Hidroelectrica through a share sale, but it doesn't seem possible this year," Vulpescu was quoted by newswires as saying.

Whatever the true reason, the cack-handed way it's been handled lends yet more credence to the theory that investing in Romania remains a perilous business. Hidroelectrica has about €400m in outstanding loans from commercial banks, some of whom expressed concerns about the company's ability to service them during the unpredictable period of the insolvency.

Indeed, Moody's Investors Service on June 20 downgraded to 'B2' from 'Ba1' the long-term corporate family rating and probability of default rating of Hidroelectrica. "The four-notch downgrade of Hidroelectrica's ratings to 'B2' from 'Ba1' follows the company's recent filing for insolvency, which indicates significantly increased payment default risk, and incorporates the inherent unpredictability of future developments under the insolvency proceedings," says Richard Miratsky, Moody's lead analyst for Hidroelectrica. "The downgrade also reflects that we have revised downwards our assumption of extraordinary support for Hidroelectrica from the Romanian government, reflecting its inactivity and lack of transparency concerning recent developments at the company."