Asian power companies hammered by rising coal costs

KEPCO and Tenaga are losing millions, and they are blaming it on thermal coal prices that reach a 20% increase: a new record high.

Last Wednesday, state-run Korea Electric Power Co. (KEPCO, A1 stable) joined Malaysia’s majority state-owned Tenaga (Baa1 stable) in reporting worsening financial results owing to high fuel costs. Such increases in expenses are credit negative for public utilities in Korea and Malaysia because they are unable to automatically pass these higher costs on to customers. Governments are reluctant to significantly raise power tariffs at a time when high and rising fuel prices are pressuring consumers.

Despite higher revenues, KEPCO’s net loss in first quarter 2011 doubled from a year earlier to $500 million, while Tenaga’s comparative profits during the same period fell by more than one third to $208 million. Both companies cited rising prices for thermal coal, up 20% this year to record highs, as the reason for the results. Factors driving the price surge include flooding in the key coal-exporting countries of Australia and Indonesia, and Japan and Europe’s increased coal demand as an alternative to idled nuclear power plants.

We expect the Korean and Malaysian governments to raise electricity tariffs, but not enough to fully
offset the rise in input costs. Political concerns of the Korean government over inflation, which
already exceeds official targets, and a likely general election in Malaysia are making governments
hesitant to add to consumers’ rising expenses. Nevertheless, these governments all tend to support their majority-owned utilities either in the form of tariff increase or direct subsidies, given the strategic importance of the firms to their national economies.

Regulations in developed markets like Hong Kong, Singapore and Australia enable utilities there to
recoup their costs at a reasonable rate of return, but without extracting monopoly profits. Because
Korea and Malaysia do not have transparent and efficient formulas for passing on cost increases for electricity generation to consumers, the countries in effect subsidize consumption with one-off
government subsidies to Kepco and special rebates for electricity bills to end users in Malaysia. These days, average residential electricity tariffs in Korea and Malaysia are approximately two-thirds of those in the US, for example.

The most recent tariff adjustments in Korea of 4.5% in November 2008, 3.9% in June 2009 and
3.5% in August 2010, as well as a one-off, $609 million subsidy in 2009, did not fully offset
KEPCO’s losses after a similar spike in coal prices in 2008-09. The lack of a sufficient increase in
tariffs led us to downgrade the utility in 2009