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Credit ratings need to include the risks of coal

South Korea’s state-owned power utility The Korea Electric Power Corporation (KEPCO) is haemorrhaging billions of dollars, as it faces skyrocketing fuel costs whilst relying heavily on coal and LNG (Liquified Natural Gas) for electricity generation. This week it continued its record breaking debt raising spree with a USD denominated green bond priced on October 6th.

After KEPCO reported an unprecedented operating loss of 7.8 trillion won ($6.1 billion) in the first quarter, the government announced that it would raise the electricity rate for the July-September 2022 period to cover the utility’s record-setting loss. However, KEPCO and financial experts say that this increase is insufficient for recovery, and Prime Minister Han Duck-soo has called for KEPCO to reflect upon the cause of its losses. This is where the message from financial experts and climate activists from all over the world becomes relevant: fossil fuel dependency is a financial risk and one of the major causes for KEPCO’s financial problems is its reliance on coal.

A structural cap on the amount the company can borrow from the market will likely mean that the borrowing limit will be reached before year’s end; this means that KEPCO will need a capital injection from the Government if it reaches this limit which onlookers have suggested will happen.

In light of KEPCO’s challenges, S&P Global Ratings downgraded some KEPCO credit ratings. Even so, KEPCO has continued borrowing and S&P believes that KEPCO will need to borrow again before the end of the year, threatening that borrowing cap further still. KEPCO issued the bonds to stay afloat, and the market responded with optimism. Another leading rating agency Fitch Ratings then affirmed KEPCO’s AA- credit rating with a stable outlook. However, this calls into question whether investors are fully aware of the risks of investing in a fossil-fuel dependent company like KEPCO, and whether they are being given the right information; Fitch Ratings did not mention the company’s reliance on coal once in their rating.

KEPCO is a core part of a South Korea that is still overly tied to the fossil-fuel sector. South Korea has the lowest share of renewable energy usage of all International Energy Agency (IEA) countries. New Prime Minister Han Duck-soo has criticised KEPCO for its financial management as the company stands at odds with South Korea’s commitments to global climate-related targets, like those agreed as part of the Paris Accord. Seemingly in response to this criticism, KEPCO has announced that it will sell all coal plants it owns outside of South Korea, which are considerable given the country’s reliance on coal.

The current crisis engulfing KEPCO is made worse by the reality that the company cannot fully pass on the costs of the increase in fuel that it needs to, though that has not stopped the company from trying. The implication of this is that the South Korean Government may be forced to intervene. In 2021 it increased the price of electricity in the country, and it has recently announced that it will be implementing more price increases from October 1. KEPCO cannot pass on all of the cost increases it needs to (up to 50% more than usual) because of the vulnerable financial position and age of many South Korean citizens. Yet, coal reliance is a much bigger issue for KEPCO and is proving costly.

In 2021, major investors pulled away from KEPCO because of its commitment to coal and though the recent bond offerings have been nearly 10x oversubscribed, major sustainability-related funds have shunned the bonds because of the company’s connection to coal. In addition, KEPCO is finding that insuring its new coal-related ventures is becoming increasingly difficult, with insightful researchshowing that a recent plant in Vietnam needed more than 20 insurers, some of whom were not even A-rated by leading credit rating agencies, which is very unusual for transactions of this type. Coal is and will continue to be a massive problem for KEPCO, and by extension, South Korea.

South Korea must commit to its globally stated declarations of support for meeting global benchmarks concerning emissions. However, there is also something needed from credit rating agencies to achieve this goal. Though some investors and companies are shunning the fossil fuel industry, a lot more must be done. The investment market needs to know just how risky coal is, and how that risk is being understood by the leading credit rating agencies. Generally, credit rating agencies merely provide information on the development of a commodity such as coal and its investable position. What is also needed is a window into how the credit rating agencies see industry development, inclusive of risks and volatility when viewed against the development of renewable and sustainable energy sources.

We call on the leading rating agencies to publish easy-to read, and easy-to-access (not behind a pay- or registration-wall) stand-alone reports that detail their views on the development of coal. The market will find this useful as it will be able to be incorporated into the question of the future of coal as we know it.

About the authors

Daniel Cash has started the Credit Rating Research Institute at the Aston University, and in January 2017 – he was awarded his PhD, with his doctoral thesis entitled ‘The Regulation of Credit Rating Agencies: An Analysis of the Transgressions of the Rating Industry and a measured proposal for reform’. Daniel’s research is exclusively concerned with the regulation of the credit rating industry, with a wider focus on the financial regulation of financial service providers, and the relationship between the financial sector and its impact upon society.

Bill Harrington is a Senior Fellow at Croatan Institute. His work centers on boosting the sustainability of the world financial system with the dual aims of rationalizing economic decision-making and avoiding bailouts. He focuses on governance decisions in the financial sector that establish the capitalization and regulation of complex finance, particularly credit rating, derivative contracts and structured finance products. Bill has evaluated products in the international financial markets since 1987, most recently as a research journalist at Debtwire ABS and before that as a senior vice president and derivatives analyst at Moody’s Investors Service (Moody’s).

KEPCO Credit rating
By Daniel Cash and Bill Harrington