Impact of Global Fuel Price Volatility on the Korean Electric Sector: Market Risk Estimation and Electricity Rate Cap

Abstract

This paper investigates the challenges that the Korean electric sector has encountered in 2022 under a regulated framework different from market-based approaches. The Ukraine-Russia war caused chaotic circumstances in every aspect of the global economy, and the energy market was not an exception. Every nation has been struggling in 2022 to secure its energy needs due to the supply chain disruptions associated with the geopolitical issues, as well as to minimize the economic impact. As electricity is a derivative product from fuels, it has serious vulnerability to fuel price volatility, unless the nation is self-sufficient in energy supply with 100% renewable energy sources or equivalent alternatives. When an electric market is deregulated with open market competition, the market cost of goods is simply passed through to end customers. However, it may not be the same case for a regulated utility that is subject to the rules set by public agencies. Korea Electric Power Corporation (KEPCO), a Korean public utility, has made every effort to stay away from bankruptcy due to its deficit of KRW 3 trillion (U$ 24 billion) in 2022. The main reason for the deficit is the regulated electric rate cap that KEPCO must charge to retail customers for the wholesale power purchased at market rates from the Korea Power Exchange. The price disparity may be explained by the year-on-year change in October: the rate cap is up 22% as opposed to the wholesale market price spike of 89%. This paper analyzes price diversions or volatilities of eight comparable asset classes, from a DJIA stock to the Korean electricity prices, in a historical context (January 2018-August 2022), and applies current fuel market parameters to estimate the value-at-risk, or price change, in Korea electricity prices to understand the estimated divergence between the two prices.