South Korea’s state-run electricity monopoly Kepco last month announced its biggest quarterly price increase in 40 years as turmoil in global energy markets threatens a central pillar of the national export model built by Samsung, LG and Hyundai. :
It was the latest sign of a crisis that has also rocked the country’s bond market, which has had to absorb a record amount of debt issuance as Kepco, which relies on imported fossil fuels, tries to keep pace with rising energy prices.
After Russia’s full-scale invasion of Ukraine last year, the effects of the price spike were exacerbated by a sharp drop in the value of the Korean won against the dollar as the US Federal Reserve tightened monetary policy.
Kepco, which issued $17 billion in bonds last year, is expected to post a net loss of 30 trillion won ($24 billion) in 2022, compared with a loss of 6 trillion won in 2021, according to South Korea’s trade, industry and energy minister.
For decades, the utility has played an important role in providing cheap energy to Korean industry. But that model is under threat because of rising costs, a weakened currency, and corporate and activist pressure for a faster energy transition.
“We need to look at whether low tariffs, which have been the basis of corporate competitiveness for decades, are sustainable,” said Kim Yong-bem, who served as first vice minister of South Korea’s Ministry of Economy and Finance from 2019 to 2021.
Kepco’s 9.5 percent tariff hike, which will take effect on Jan. 1 this year, follows several smaller increases in 2022 and comes two days after South Korea’s National Assembly agreed to raise the company’s debt ceiling to a maximum of six even to its own capital compared to the previous ratio. from one to two.
The assembly initially rejected a proposal to raise the debt ceiling, prompting Kepco to warn of a systemic risk to the economy.
“Without raising the corporate bond limit, we will not be able to buy electricity or repay existing loans,” Kepco said in a statement after the National Assembly’s initial decision in early December not to raise the debt ceiling. “This could lead to a national economic crisis, disrupting electricity supply and paralyzing the electricity market.”
Moody’s noted that recent rate hikes “are not enough to fully offset rising fuel costs. . . as the series of tariff increases from April 2022 is still below Kepco’s increase in input costs.”
It added, however, that “the rate hike, along with the increase in Kepco’s bond issuance limit, shows the Korean government’s commitment to prevent the company’s financial performance from remaining weak for a long time and to ensure that the company maintains strong funding channels.” .
Analysts and bond traders say it is because of this implicit guarantee of government support that Kepco still enjoys strong credit ratings despite its shaky finances.
Moody’s rates the company’s long-term rating at Aa2, which is the same as South Korea’s sovereign credit rating for government bonds. The rating is six notches above its baseline credit rating of baa2, which Moody’s attributes to “our assessment. [Kepco’s] A very high probability and a very high level of dependence on the Korean government for emergency support if necessary.”
Despite an implicitly identical risk profile, last year Kepco’s bonds began to offer a healthy spread on South Korea’s sovereign debt, an anomaly that bond traders attributed to concerns about the strength of state guarantees after a local Korean municipality suggested in September that it would divest. On the guarantee of the debts of the developer of the theme park “Legoland”.
Kepco’s three-year bond yield reached 5.9 percent in October, while three-year Korean sovereign bonds yielded around 4.3 percent at the same time, according to data from the Korea Securities Depository. Kepco’s three-year bond yielded 4.5 percent in the first week of January this year, compared with 3.42 percent at the same time in 2022.
“The wide spread between Kepco and Korean sovereign bonds was due to investors getting worried after they realized that even provincial government-backed bonds could go sour,” said a bond trader at Hanwha Investment & Securities in Seoul. Choi Jae Hyun.
“Nobody really thinks that Kepco might default, but bonds issued by state-owned companies are not as liquid as government bonds, so Kepco should offer a higher yield,” Choi added. :
In response to the liquidity crisis, the Korean government last October announced a Won50tn package to bolster credit markets, under which it will buy a wide variety of bonds and commercial paper to stabilize the market.
The Bank of Korea has also launched a temporary program to buy Won6tn bonds, while local banks have also pledged billions of dollars to buy corporate debt.
Despite government support, analysts expect yields to remain high. “The financial crisis in the corporate debt market has now subsided due to the government’s response,” Min Joo Kang, senior economist for South Korea and Japan at ING, wrote in a note last week. “However, it is expected to resurface as corporate bond issuance increases at the start of the year and high interest rates continue.”
“The credit market has stabilized somewhat, but Kepco’s current structure of covering losses by issuing bonds is not sustainable,” said Park Chong Hoon, head of research at Standard Chartered in Seoul.
“The squeeze on the credit market will also continue unless the Bank of Korea starts to cut interest rates,” he said. The BoK raised its interest rate by 25 basis points to 3.5 percent on Friday, but economists predict the tightening cycle may be over.