South Korea’s state-owned electricity monopoly Kepco announced the largest quarterly price increase in over 40 years last month, as turmoil in global energy markets threatens a central pillar of the national export model that built Samsung, LG and Hyundai.
It was the latest sign of a crisis that has also roiled 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 a price spike following Russia’s full-scale invasion of Ukraine last year were exacerbated by a steep fall in the value of the Korean won against the dollar as the US Federal Reserve tightened monetary policy.
Kepco, which issued $17bn of bonds last year, is expected to have made a net loss of 30tn won ($24bn) in 2022, according to South Korea’s minister of trade, industry and energy, compared with a 6tn won loss in 2021.
For decades the utility played a vital role in supplying cheap energy to Korean industry. But that model is under threat as soaring costs, a weakened currency, corporate and activist pressure for a faster energy transition.
“We should look at whether the cheap tariffs that were the backbone of Korean corporate competitiveness for decades are sustainable,” said Kim Yong-beom, who served as first vice minister at South Korea’s ministry of economy and finance between 2019 and 2021.
Kepco’s 9.5 per cent tariff increase, effective from 1 January this year, follows several smaller hikes in 2022 and came two days after South Korea’s national assembly agreed to raise the company’s debt ceiling to a maximum of six times its equity, up from a previous ratio of two to one.
The assembly had initially rejected a proposal to raise the debt ceiling, prompting Kepco to warn of a systemic risk to the economy.
“Without raising the limit on corporate bonds, we will not be able to purchase the electricity or repay existing borrowings,” 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 with electricity supply being disrupted and the electricity market paralysed.”
Moody’s has noted that the most recent tariff increase “is not sufficient to fully compensate for a surge in fuel costs . . . because the series of tariff increases since April 2022 still remain lower than the rise in Kepco’s input costs”.
It added, however, that “the tariff increase — along with the increase in Kepco’s bond issuance limit — indicate the Korean government’s commitment to prevent the company’s financial metrics from remaining weak for a sustained period and to make sure the company maintains strong funding channels”.
Analysts and bond traders note that it is because of this implicit government guarantee of support that Kepco still enjoys rock-solid credit ratings despite its precarious financial position.
Moody’s grades the company’s long-term rating at Aa2, the same as its sovereign credit rating for South Korean government bonds. The rating is six notches higher than its baseline credit assessment of baa2, which Moody’s attributes to “our assessment of [Kepco’s] very high likelihood of extraordinary support from, and a very high level of dependence on, the Government of Korea, if necessary”.
Despite having an implicitly identical risk profile, last year Kepco bonds started to offer a healthy spread on South Korean sovereign debt — an anomaly that bond traders attribute to concerns about the strength of government guarantees after a Korean local municipality suggested in September that it would renege on a guarantee over the debts of the developer of a Legoland theme park.
According to the Korea Securities Depository, in October the yield on Kepco’s three-year bonds reached 5.9 per cent, compared with a yield on Korean sovereign three-year bonds of about 4.3 per cent at the same time. The yield on three-year Kepco bonds was 4.5 per cent in the first week of January this year, up from 3.42 per cent at the same time in 2022.
“The wide spread between Kepco bonds and Korean sovereign bonds was because investors got worried after they realised even bonds backed by a provincial government could go sour,” said Choi Jae-hyung, a bond trader at Hanwha Investment & Securities in Seoul.
“No one actually thinks that Kepco could default on its debts, but bonds issued by state-run companies are not as liquid as government bonds, so Kepco has to offer higher yields,” Choi added.
In response to the liquidity crunch, the Korean government announced a Won50tn package in October last year to shore up credit markets, under which it will buy a wide range of bonds and commercial paper to stabilise the market.
The Bank of Korea also launched a temporary bond-buying program worth Won6tn, while local banks have also pledged to contribute billions of dollars to buy corporate debt.
Despite government support, analysts expect yields to remain high. “The financial crunch 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. “But it is expected to come back to the surface as corporate bond issuance increases at the beginning of the year and high interest rates continue.”
“The credit market has stabilised somewhat but Kepco’s current structure of making up for losses by issuing bonds is not sustainable,” said Park Chong-hoon, head of research at Standard Chartered in Seoul.
“The credit market squeeze will also continue unless the Bank of Korea starts cutting interest rates,” he said. The BoK raised its policy rate by 25 basis points to 3.5 per cent on Friday, but economists predict the tightening cycle may be coming to an end.