The authors are analysts of NH Investment & Securities. They can be reached at firstname.lastname@example.org and email@example.com, respectively. — Ed.
e expect SMP and overseas natural gas mine values to rise in 2H21 in response to a surge in Northeast Asian natural gas prices. KOGAS should continue to see valuation re-rating on both improving margins for the Prelude FLNG Project (Australia) and the materialization of the firm’s hydrogen business.
Implications of rising Northeast Asian natural gas price
Per MMBtu (mn Btu), the Northeast Asian natural gas price (JKM, Japan/Korea Marker) is exceeding US$20/bbl, and the US natural gas price (Henry Hub) is topping US$6/bbl. This development is drawing market attention to the potential related impacts, particularly in Korea, China, and Japan, where fossil fuels account for more than 60% of power generation. Given an inevitable winter-time jump in demand for electricity, and further given restrictions on the operation of nuclear and coal power plants, the JKM price is highly likely to rise further.
In 1H21, with the JKM price soaring, the LNG price for domestic power generation also upped sharply. Of note, the price of LNG for domestic power generation came in at W373/m3 in 1Q21 and W425/m3 in 2Q21, higher-than-expected figures considering applicable Dubai oil prices (6-month prior figures) of US$45/bbl and US$60/bbl, respectively. This is attributable to rising portion of LNG spot imports on increased demand for LNG power generation during winter time; SMP for March stood at W84/kWh.
Considering the recent ascent in the natural gas price, we believe that: 1) the SMP will climb on a higher unit price of LNG for power generation; and 2) there will be an expansion in the value of overseas natural gas mines. Upon SMP hikes, earnings improvement should follow for independent power producers (IPPs) and renewable energy generators. In addition to this factor, profitability at KOGAS should also be helped by favorable earnings at its overseas natural gas development business.
KOGAS attractive: To enjoy earnings growth; hydrogen business materializing
KOGAS is engaged in both a domestic LNG wholesale business and overseas resource development business. KOGAS’s fair investment returns, which represent earnings at its domestic LNG wholesale business, are primed to increase by more than W50.0bn y-y in 2022. The fair investment returns for KOGAS are calculated by multiplying the rate base with the fair required rate of returns on investment (WACC). And, we point out that: 1) working capital, a major component of the rate base, has upped; and 2) the fair required rate of returns on investment has also risen amid recent interest rate hikes. Meanwhile, the short-long term contract ratio for LNG to be introduced in Korea is 85:15. In 2021, the oil price related to long-term contracts grew by more than 40%, and the JKM price related to short-term contracts rose by more than 90%.
For the Prelude FLNG project (Australia), the JKM price is the selling price of LNG. With the recent hike in the JKM price being applied to shipments scheduled for Oct and Dec 2021, we estimate 2H21 OP of W70.0bn for the project. For reference, with regards to the project, KOGAS booked 1Q21 OP of W36.0bn based upon a 1Q21 JKM price of US$16/bbl, and 2Q21 OP of W3.5bn based upon on a JKM price of US$8/bbl. Also boding well is the materializing (according to media reports since 2019) of KOGAS’s hydrogen business roadmap.