Energy crisis upsets KEPCO and the local debt market
South Korea’s state-owned electricity monopoly Kepco last month announced its biggest quarterly price increase in more than 40 years, as turmoil in global energy markets threatens the mainstay of the national export model that built Samsung, LG and Hyundai.
It was the latest sign of a crisis that has also gripped 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.
The effects of the price hike following Russia’s all-out invasion of Ukraine last year were exacerbated by the sharp depreciation 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, according to South Korea’s Minister of Trade, Industry and Energy, compared to a loss of 6 trillion won in 2021.
For decades, these utilities have played a vital role in providing cheap energy to Korean industry. But that model is under threat from rising costs, a weak currency, and pressure from companies and activists for a faster energy transition.
“We must look at whether the cheap tariffs that have been the backbone of Korean companies’ competitiveness for decades are sustainable,” said Kim Young-beom, who served as senior vice minister at South Korea’s Ministry of Economy and Finance between 2019 and 2021.
Kepco’s 9.5 percent tariff increase, effective January 1 this year, follows several small 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 times equity, up from the previous ratio. from two to one.
The assembly had initially rejected a proposal to raise the debt ceiling, prompting KIPCO to warn of systemic risks to the economy.
“Without raising the ceiling on corporate bonds, we will not be able to buy electricity or pay off existing loans,” Kipco 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 with blackouts and a paralyzing electricity market.
Moody’s noted that the latest tariff increase “is not sufficient to fully offset the significant rise in fuel costs . . . because the series of tariff increases since April 2022 still falls short of the rise in input costs for KEPCO.”
However, it added, “The tariff increase — along with the increase in Kepco’s bond issuance limit — indicates the Korean government’s commitment to prevent the company’s financial metrics from remaining weak for a sustainable period and to ensure that the company maintains strong financing channels.”
Analysts and bond traders note that because of this tacit government guarantee of support, KIPCO continues to have very strong credit ratings despite its precarious financial situation.
Moody’s rated the company’s long-term rating at Aa2, the same as the sovereign credit rating of South Korean government bonds. The rating is six notches higher than its baseline credit rating of baa2, which Moody’s attributes to “our rating of [Kepco’s] Very high probability of obtaining exceptional support from, and very high level of dependence on, the Government of Korea, if necessary.”
Despite an implicitly identical risk profile, Kepco bonds last year began offering a decent spread on South Korea’s sovereign debt – an anomaly that bond traders attribute to interests about the strength of government guarantees after a Korean local municipality suggested in September that it would back down from guaranteeing the debts of the Legoland theme park developer.
According to the Korea Securities Depository, the yield on Kepco’s three-year bond was 5.9 percent in October, compared with a yield on a three-year Korean sovereign bond of about 4.3 percent at the same time. The yield on Kepco’s three-year bond was 4.5 percent in the first week of January this year, up from 3.42 percent at the same time in 2022.
“The wide spread between Kepco bonds and Korean sovereign bonds was because investors worried after they realized bonds backed by the provincial government could default,” said Choi Jae-hyung, a bond trader at Hanwha Investment & Securities in Seoul.
“No one actually thinks that Kipco can default on its debt, but the bonds issued by state-run companies are not as liquid as government bonds, so Kipco has to offer higher yields,” Choi added.
In response to the liquidity crisis, the Korean government announced a 50 trillion won package in October last year to support credit markets, under which it will buy a wide range of bonds and commercial paper to stabilize the market.
The Bank of Korea also launched a temporary bond-buying program worth 6 trillion won, while local banks also pledged to contribute billions of dollars to buy corporate debt.
Despite the 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, chief economist for South Korea and Japan at ING, wrote in a note last week. “But it is expected to resurface with an increase in corporate bond issuance at the beginning of the year and interest rates remaining high.”
“The credit market has stabilized to some extent, but the current structure of KIPCO to compensate for losses through bond issuance is not sustainable,” said Park Chung-hoon, head of research at Standard Chartered in Seoul.
“The credit market crisis will also continue unless the BoK starts cutting interest rates,” he said. The Bank of Korea raised interest rates by 25 basis points to 3.5 percent on Friday, but economists predict the tightening cycle may be over.