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Announcement:

Moody's: Lower LNG prices will reduce costs for Korea's state-owned utilities, a credit positive

 The document has been translated in other languages

27 Apr 2015

Hong Kong, April 27, 2015 -- Moody's Investors Service says that lower liquefied natural gas (LNG) prices will benefit Korea Electric Power Corporation (KEPCO, Aa3 positive), Korea Gas Corporation (Kogas, Aa3 positive) and the heating business of Korea District Heating Corporation (KDHC, A1 stable), all of which are majority owned by the Korean government (Aa3 positive). But the lower prices will hurt power generation companies because they will lead to lower wholesale electricity prices and narrow profit margins.

"Lower LNG prices will likely lift the profit margins and operating cash flows of Korea's state-owned utility companies relative to 2014, because the government is unlikely to match the falling input costs with lower tariffs," says Mic Kang, a Moody's Vice President and Senior Analyst.

"But gas-focused independent power producers in particular will see pressure on profitability, as lower LNG prices will lead to a decline in wholesale electricity prices and profits," adds Kang.

Kang was speaking on Moody's just-released special report on the Korean utility sector, entitled, "Korea Utility Sector: Low LNG Prices To Cut Input Costs for State-Owned Utilities, a Credit Positive." The report was co-authored by Kang and Sean Hwang, an Associate Analyst.

The drop in oil prices, coupled with new LNG supplies from Australia and the US, will push down LNG prices over the next few years. All of Korea's LNG import prices under long-term contracts are indexed to crude oil prices.

In addition, lower LNG prices will likely attract more users in the industrial and residential sectors, offsetting declining consumption in the power generation sector -- which is increasingly turning to even cheaper nuclear and coal-fired power plants -- and ensuring overall stable demand for LNG over the next 2-3 years.

Moody's expects KEPCO to show the strongest improvement in operating performance over the next 12-18 months, assuming there is no excessive cut in the government-imposed tariff. Although Kogas and KDHC are subject to more frequent tariff adjustments than KEPCO, declining input costs will also offset the pressure on their credit metrics stemming from their debt-funded capital expenditure, and for KDHC from falling profits at its supplementary power business.

But lower LNG prices will reduce power generators' profits, because LNG prices are a key factor in determining wholesale electricity prices, and lower electricity prices narrow profit margins in power generation.

In addition, profits at gas-fired power plants will come under further pressure over the next 2-3 years as new coal and nuclear-powered baseload plants come on line, replacing the more expensive LNG-fired power plants.

Moody's expects declining profit margins in the power business, coupled with high capital expenditure, to pressure SK E&S Co. Ltd.'s (Baa1 negative) credit quality over the next 12-18 months, absent measures to increase its financial buffer.

But margin pressure for the six KEPCO-owner generation companies (gencos) -- Korea Hydro and Nuclear Power Company Limited, Korea South-East Power Co., Ltd., Korea East-West Power Co., Ltd., Korea Western Power Co., Ltd., Korea Midland Power Co., Ltd. and Korea Southern Power Co., Ltd, all of which are rated Aa3 and have positive outlook -- will likely be mitigated by the profit-sharing program between KEPCO and its gencos, underpinned by the close ownership ties and high degree of operational integration between the entities.

And although the lower LNG prices could make it more attractive for Korean utilities to directly import LNG, bypassing Kogas, Moody's expects Kogas' near-monopoly in LNG sourcing will remain intact. This is because a lack of their own LNG receiving terminals limits the Korean utilities' scope to directly import LNG.

Kogas and SK E&S have agreed to import US shale gas between 2017 and 2019, and the import prices for their contracts will be indexed to Henry Hub gas prices, which move independently from oil-linked indexes.

"While US shale gas imports are credit positive for Korea's utility sector, Moody's expects Korea's state-owned utilities to remain exposed to oil price volatility over at least the next 2-3 years, as their major LNG suppliers are still based in regions where LNG prices are indexed to oil prices," adds Hwang.

Subscribers can find the report at http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_1004495

NOTE TO JOURNALISTS ONLY: For more information, please call one of our global press information hotlines: New York +1-212-553-0376, London +44-20-7772-5456, Tokyo +813-5408-4110, Hong Kong +852-3758-1350, Sydney +61-2-9270-8141, Mexico City 001-888-779-5833, São Paulo 0800-891-2518, or Buenos Aires 0800-666-3506. You can also email us at mediarelations@moodys.com or visit our web site at www.moodys.com.

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.

Mic Kang
Vice President - Senior Analyst
Project & Infrastructure Finance
Moody's Investors Service Hong Kong Ltd.
24/F One Pacific Place
88 Queensway
Hong Kong
China (Hong Kong S.A.R.)
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

Terry Fanous
MD - Infrastructure Finance
Project & Infrastructure Finance
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

Releasing Office:
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Moody's: Lower LNG prices will reduce costs for Korea's state-owned utilities, a credit positive
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