KEPCO Revises Overseas Project Return Calculations to Reflect "Actual Borrowing Costs"

Even high expected returns can turn into losses if borrowing rates rise

Korea Electric Power Corporation (KEPCO) is working to assess the profitability of overseas projects by factoring in the actual cost of borrowing funds. Even if an expected rate of return is high, borrowing at an even higher interest rate could result in an actual loss. The aim is to adjust investment criteria in line with changes in interest rates.

According to KEPCO on October 21, the company recently launched a study titled “Enhancing Overseas Investment Decision Metrics Based on Marginal Funding Rates and Developing a Deliberation and Decision-Making Model.” KEPCO believes that as borrowing rates exceed the weighted average cost of capital (WACC), its existing benchmark rate of return may not adequately reflect actual funding costs. For example, an investment expected to yield 5% annually would have lower actual profitability if funding it costs 6%. With high interest rates and high debt levels persisting, the company faces an urgent need to establish a system that can adjust return benchmarks in response to market conditions.

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KEPCO is considering adjusting the minimum required rate of return when its actual marginal funding rate exceeds the benchmark rate of return under the WACC model. The company currently allows a strategic selection range of ±20% for the benchmark rate in its overseas investment reviews, but believes there is a lack of standardized criteria for setting the upper and lower limits. It plans to specify minimum target returns by taking into account factors such as project risk, investment location, and project type. It will also review the evaluation variables applied to eight project types, including thermal power and solar power. KEPCO plans to analyze how overseas power companies adjust risk premiums and validate the proposed model by applying it to ongoing overseas projects.

KEPCO’s financial burden has also contributed to the planned changes. In 2022, the company incurred massive operating losses amid a surge in global fuel prices and covered its funding shortfall by issuing bonds. Its net funding that year reached KRW 32.464 trillion, stoking concerns about a “KEPCO bond shock” in which KEPCO bonds would absorb demand for corporate bonds. In the first half of this year, KEPCO issued KRW 8.04 trillion in new long-term won-denominated bonds. The average monthly interest rate on bonds issued during the first half rose by 0.94 percentage points, from 3.18% in January to 4.12% in June. According to the Korea Financial Investment Association, the yield on three-year KEPCO bonds stood at 4.271% as of October 20, remaining in the 4% range since reaching 4.013% on May 27.

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KEPCO’s financial burden is also behind the planned revision of its investment criteria. After posting massive operating losses in 2022 amid a surge in global fuel prices, the company covered its funding shortfall by issuing bonds. Its net funding that year reached KRW 32.464 trillion, heightening market concerns about a so-called “KEPCO bond shock” in which KEPCO bonds would absorb demand for corporate bonds.

KEPCO continues to face funding pressures. The company issued KRW 8.04 trillion in new long-term won-denominated bonds in the first half of this year. Monthly issuance fell from KRW 1.28 trillion in January to KRW 540 billion in March, then fluctuated to KRW 1.9 trillion in April, KRW 1.1 trillion in May, and KRW 2.14 trillion in June. The average monthly interest rate on bonds issued during the first half rose by 0.94 percentage points, from 3.18% in January to 4.12% in June.

Bond market interest rates have also remained high. According to the Korea Financial Investment Association, the yield on three-year KEPCO bonds stood at 4.271% as of October 20. It has remained in the 4% range for five consecutive months since reaching 4.013% on May 27. Even if KEPCO issues bonds to fund investment, high interest rates can increase its funding costs, making it increasingly important to account for actual financing conditions when assessing the profitability of overseas projects.

Bond issuance conditions are expected to remain a key challenge for KEPCO. The Korea Electric Power Corporation Act limits outstanding bonds to no more than twice the combined total of capital and reserves. However, a special provision raising the limit to five times that amount through the end of 2027 is in effect because of funding difficulties caused by massive losses. Once the provision expires, the original two-times limit will apply again starting in 2028.

The National Assembly Budget Office projected, based on KEPCO’s medium- and long-term financial management plan, that its bond issuance ratio would reach 2.3 times in 2028 and 2.1 times in 2029. This means KEPCO could exceed the statutory limit after the special provision expires, given its planned outstanding bond balance and financial structure. KEPCO expects its bond balance to rise further as it invests in expanding the power grid and in facilities to connect renewable energy sources.

At a recent National Assembly audit, KEPCO President Kim Dongcheol said, “If the bond issuance limit is reduced, a minimum increase in electricity rates will be necessary, alongside KEPCO’s self-help efforts,” and stated that electricity rates should be brought in line with actual costs to secure funding for grid investment. A KEPCO official said, “We plan to establish investment criteria that can respond flexibly to changes in market conditions, enhance the objectivity and rationality of reviews of overseas projects, and strengthen our financial soundness.”

Korea Electric Power Corp. President Kim Dongcheol answers questions from committee members during a parliamentary audit held by the National Assembly's Climate, Energy, Environment and Labor Committee on the 19th. Yonhap News Agency

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