Reforming the Electricity Rate System Is Essential

The author is an analyst of NH Investment & Securities. He can be reached at minjae.lee@nhqv.com. -- Ed.

 

Cost reductions stemming from a drop in the Dubai crude price (to US$30/bbl) are to be reflected from 3Q20. And, changes in electricity demand following the Covid-19 outbreak are to translate into higher electricity sales prices. But, it will be essential to reform the electricity rate system.

Earnings improvement to begin from 2H20

We maintain a Buy rating and a TP of W26,000 on KEPCO. Power generation costs are to shrink from 3Q20 on a drop in raw material prices. In detail, under Korea’s formula for determining the SMP, a decrease in the oil price (Dubai crude) leads to lower LNG-based power generation costs. In 2H20, the SMP is expected to fall to the mid-60/kWh level. Of note, in Jun 2016, given: 1) an oil price of US$35/bbl and the won/dollar rate of W1,170/US$; and 2) a six-month lag between KEPCO’s purchase and input of oil, the SMP stood at W65/kWh.

A decline in power demand in the wake of the Covid-19 outbreak is also to bring about changes in the portions of energy sources based upon which the SMP and the electricity sales price are set. Since 2011, LNG has been used to set the SMP more than 90% of the time. In 2Q20, however, the frequency has narrowed to below 70%, affected by a rise in the number of occasions when the SMP was set based on coal. Given such, we size 2Q20 SMP at 71W/kWh. With the Covid-19 crisis having led both to a slowing in the economy and an expansion of telecommuting, residential electricity sales have been climbing, whereas industrial and commercial electricity sales have both been shrinking. Of note, an hourly rate plan is applied for industrial and commercial use charges, but a tier-rate system is employed for residential use charges—accordingly, the changes in power demand amid the pandemic are favorable for KEPCO’s overall sales prices.

Without electricity rate reform, deficits to become chronic from 2022

The core goals of the Korean government’s Green New Deal include expanding the use of both renewable energy sources and smart grids, for which W5.4tn is earmarked to be invested by 2022. This large-scale initiative is to induce active investment by public institutions such as KEPCO. But, owing to an aggravating environmental cost burden, without an electricity rate reform, KEPCO is likely to turn to loss again in 2022. Against this backdrop, with electricity rate changes likely to be discussed in 2H20, we believe that more than an increase in rates is required—for example, the introduction of a cost-based pricing system.

 

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