Korea Ratings, one of the top three credit rating agencies in the nation, changed the credit outlook[1] of Gangneung Eco Power, Goseong Green Power, and Samcheok Blue Power from 'stable' to 'negative' on May 18, 2021. Likewise, the Korea Investors Service changed Samcheok Blue Power's credit rating outlook to 'negative' on June 2. At this point, it is difficult to predict the possibility of a change in credit rating, but the fact that credit rating outlooks are changing suggests that investors are becoming more aware of the risks associated with coal-fired power plants.

1. The outlook for three new private coal-fired power plants has been revised to "negative"

There is a need to pay attention to risk expansion rather than the possibility of immediate downgrade

Korea Ratings changed its rating outlook to "negative" based on ① increased business uncertainty due to unfavorable policy stance, ② weakened status as a baseload power for coal-fired power generation, ③possibility of postponement of performance variability expansion and improvement of financial structure. Typically, domestic credit rating agencies conduct annual evaluations of effective long-term ratings such as issue ratings and non-guaranteed bonds once a year. Nice Rating has not completed its regular evaluation[2] as of June 2, 2021, making it difficult to confirm the rating outlook.However, the change in the rating outlook of Korea Ratings can be interpreted as an increasing risk of coal-fired power generation businesses compared to 2018 when the companies (Gangneung Eco Power, Goseong Green Power, and Samcheok Blue Power) were graded at first.

Furthermore, GS Donghae Electric Power (Bukpyeong Thermal Power Station) was excluded from this year's rating outlook change because it continues to operate in a relatively stable manner and thus less effected by future policy risks since its venture began upon being recognized by the cost evaluation committee for 2.2 trillion won in investment and 4.49% of the appropriate investment rate in 2017.However,the introduction of the total volume system of coal power generation and plans to increase renewable energy capacity may mean that each coal-fired power plant may not be able to maintain its current high utilization rate, making accurate risk assessment an urgent necessity.

2. Checking the risk factors of private coal-fired power plants

1)A review of whether to maintain the Settlement adjustment coefficient system for private coal generators is scheduled

The application of settlement adjustment coefficient to coal power generation operators limits the excess profits of power generation companies whileensuring appropriate profits through adjustment of adjustment coefficients. In other words, it is difficult to expect excess profits, but appropriate profits can be secured, so it has been evaluated favorably by creditors and credit rating agencies who prefer stable principal and interest repayment capabilities based on high business stability and low volatility.The fact that there was a time when the settlement adjustment coefficient of power generation subsidiaries approached 1 as SMP fell in 2016 due to falling oil prices further strengthened their beliefs. In practice, however,the settlement adjustment coefficient cannot exceed 1. Thus, if both SMP and utilization rates are reduced, even appropriate profits may not be guaranteed, and losses may occur.

The application of the settlement adjustment coefficient system to operators of the private coal power generationhas been controversial. The cost evaluation detailed operation regulations of Korea Power Exchange established a standard by applying the settlement adjustment coefficient to private coal generators in 2012. This decision was made out of concerns that private power generation companies that entered the coal power generation following the massive rolling blackout of September 2011would profit excessively from electricity bills and a significant financial burden on the KEPCO.However, in 2014, the government announced the introduction of the "vesting contract" system in response to criticism that the application of the settlement adjustment coefficient to private power generation businesses violates market principles.This is a system in which private coal-fired power generation operators and KEPCO enter into a long-term contract at the base price and settle the difference between the spot CBP market price and the base price.However, as the gap between the base price and spot price, which was being discussed due to falling oil prices in 2016, was expected to increase, the introduction of the "vesting contract" system was canceled and the settlement adjustment coefficient system was applied. At this point, the system introduced to prevent excess profits from coal power generation operators is rather recognized as a system that enhances business stability and is welcomed by investors, which is an irony of the system.

If the settlement adjustment coefficient system for private coal generators is abolished, financial variability is expected to expand.

However, as prescribed in Table 3, the application of the settlement adjustment coefficient to private coal generators is considered every five years. Considering that the Bukpyeong Thermal Power Plant, the first private coal-fired power plant, began commercial operation in 2017, whether to maintain the system will be decided by 2022.If the settlement adjustment coefficient system for private coal generators is abolished, it is expected that the financial variability of private coal power generation operators will increase due to changes in SMP.A higher LNG unit price than bituminous coal, combined with excellent utilization as a baseload power source, might result in improved financial structure faster than expected.However, considering the recent cost competitiveness of direct-introduced LNG power generators, the environmental supply of 「The 9th Basic Plan for Long-Term Electricity Supply and Demand」 (reflecting the fuel cost of greenhouse gas emission trading costs), and the plan to introduce the total volume system of the coal power generation, the possibility of satisfying the prerequisites is limited (refer to the utilization rate forecast on page 6 herein).Therefore, financial variable risks may be exposed downward rather than upward.

Even if the system of settlement adjustment coefficients for private coal generators is maintained, disagreements in standard investment costs persist

Even if the settlement adjustment coefficient system is maintained, there is a risk to the recognition of investment costs due to widespread disagreements regarding standard investment costs between power exchanges and private power generation companies.Media reports indicate that the government's standard investment cost for private coal power generation operators ranges between 3.6 trillion won and 3.8 trillion won, but the actual project cost is expected to be 4.9 trillion won to 5.6 trillion won, which is why the two sides disagree.If the cause of the difference between standard project cost and actual construction cost is reasonably explained, it is recognized as an investment cost (Table 3). However, given the negative social acceptance of coal-fired power plants, recognizing their investment costs may be difficult.According to Figure 2, the GS Donghae Electric Power Plant's Bukpyeong Thermal Power Plant, which began commercial operation in 2017, was recognized for 2.2 trillion won as investment costs, and the construction costs per unit are smaller than those of other private power plants.Source:Current status of power exchange’s power plant construction project

2) Even if the settlement adjustment coefficient system is maintained, it is inevitable that utilization rate and profitability will decrease due to the introduction of the total volume system of coal power generation, etc.

In 2018, the government announced the Nationally Determined Contributions (NDC) and planned to reduce greenhouse gas emissions in the conversion sector from 270 billion tons in 2018 to 190 million tons in 2030.The 9th Basic Plan for Long-term Electricity Supply and Demand, released in December 2020, incorporated such a greenhouse gas emission reduction plan. If the policy for emission reduction (the total volume system of coal power generation, etc.) is implemented, coal power generation is expected to fall from 40.4% in 2019 to 29.2% in 2030.[Table 4].

The fact that existing baseload power sources (coals, nuclear power) are difficult to flexibly cope with the Duck Curve phenomenon caused by the expansion of new and renewable energy generation is also factor that can threaten its position as a baseload power source. According to the analysis of Chungnam National University ([Figure 3]), the occurrence of duck curves intensifies as the proportion of solar power increases. At this time, since coal power generation has a long minimum operation/suspension time limit, it is difficult to respond flexibly, so it may be necessary to perform two shifts between operation and suspension. 

The results of simulating the utilization rate of each coal-fired power generator in Korea by reflecting such an environment are as shown in Figure 4. In order to achieve the 2030 NDC and 2050 net-zero goals, the utilization rate of many generators appears to decline between 2030 and 2035.In addition, assuming that SMP remains at 109.7 won per kWh, which is the average for the past decade, if the utilization rate of individual generators falls below 40%, the settlement adjustment coefficient will have to exceed 1, and it is confirmed that the utilization rate of many generators will fall below 40% between 2030 and 2035.It should be noted that the realistic utilization survival line may be higher than 40%, considering that the recent SMP level falls short of the average level over the pastdecade (Annual average of land SMP at 94.64 won/kWh in 2018, 90.09 won/kWh in 2019, 68.52 won/kWh in 2020) due to falling oil prices.Compared to other groups, coal-fired power plant groups entering the market after 2020 will show a much higher utilization rate, at approximately 75% in 2030 and 60% in 2035; but it should be noted that they generally planned for and raised capital in anticipation of utilization rate of 80%.

Nationally Determined Contributions(NDC) for 2030 will be raised further

In addition, at the 2021 Leaders’ Summit on Climate in April and P4G Seoul Summit in May, president Moon Jae In announced that he would further raise the 2030NDC and present it at the 26th United Nations Climate Change conference in November.As a result, the goal of reducing emissions in the conversion sector in 2030 will be further strengthened, and if a stronger total volume system than the existing plan is introduced and implemented after 2022, the outlook for coal-fired power plant utilization may fall further.In conclusion, even if the current total production cost compensation system is maintained, a decrease in utilization rate is inevitable.Accordingly, it may be difficult to recover capital according to the planned schedule. 

3. Conclusion

During the period between 2016-2018, when investors were actively recruited to build private coal-fired power plants, they viewed the acquisition of PF Loans and corporate bonds related to coal-fired power plants as medium-risk medium-return investments.This was because investors expected the government to maintain a stable profit structure under the current electricity market structure.Yet, in any case, investorsare always liable for their investment judgment.Therefore, securities firms and credit rating agencies that provide information to investors should endeavor to accurately judge risks.It may have been a correct decision at the time, but now the situation has changed.Absolute trust in the total cost compensation system is dangerous.Private coal-fired power plants should be capable of accurately analyzing and reporting investors on the impact of factors emerging as risks to the profitability and financial stability of each coal-fired power plant, including energy conversion, NDC, coal power generation total volume system, environmental power supply, and SMP trends in 2018.

Reference

Ministry of Trade, Industry and Energy,the 9^th Basic Plan for Long-term Electricity Supply and Demand (2020~2034),Dec. 28, 2020.

CTI, SFOC, Chungnam National University, End in sight: how South Korea can force coal offline by 2028, 2021.04