[Dong Si-Ron / Yang-Hoon Son] ‘Heating bill bomb’ is a predictable energy shock

[Dong-A Ilbo, February 9, 23] PERI Adjunct Research Fellow (Yang-hoon Son / Energy & Environment)

[Dong Si-Ron / Yang-Hoon Son] ‘Heating bill bomb’ is a predictable energy shock

The heating bill debate continues. The winter chill is gone, and the debate is hot. When the January bills come in, they’ll be even higher. The controversy could get worse. As consumers complain, the political blame game heats up.

Currently, most domestic heating fuels are liquefied natural gas (LNG). Not surprisingly, LNG is imported entirely from overseas, but the way it’s acquired is unique and somewhat complicated. To get to the bottom of it, we need to understand the structure, even if only briefly.

There are two main types of imports: long-term contracts and spot purchases. Long-term contracts are contracts with producers that last around 20 years. Most are tied to the price of oil, but the purchase price varies from contract to contract. Long-term contracts are a burden that must be fulfilled, but they have their own advantages. The price is stable. To avoid the risk of price fluctuations, we buy about 80% of our oil on long-term contracts and currently have 13 contracts with producers. The remaining 20% or so is supplemented on an ad hoc basis in the spot market, where prices are more volatile. This is the golden ratio for a strategic importer like us.

Last year, this golden ratio was broken. I bought a lot of gas on the spot market, mostly at sky-high prices due to the war in Ukraine. We were getting ripped off. Our strategy was to minimize our spot purchases during price spikes, but we failed to do so. As a result, we imported more than $50 billion in LNG last year, double the amount of the year before. That’s double the amount from the year before, and nearly triple the amount from a few years ago. This is a major contributor to the trade deficit. What could have caused such an outrageous situation?

In part, the last government’s rush to decommission nuclear power plants and slow energy transition has added to the confusion. Two reactors, Kori and Wolseong 1, were actually decommissioned, but they were the worst failure in terms of ‘power mix’. Shinhanul Units 3-4, which were to be newly built, were not allowed to start, Shinsegori Units 5-6, which were under construction, were delayed, and Shinhanul Units 1-2, which were already built, were not allowed to operate. Under the original plan, five of these units would have been mostly completed by last year.

In the meantime, renewables don’t play a role at all when there’s no sun or wind. The only option was to run the natural gas plants day and night. With no long-term contracts in place, the only option was to buy large quantities of very expensive gas on the spot market. This led to a sharp increase in the average unit cost. It quietly accumulated as a receivable, only to surface a long time later in the form of a heating bill bomb. We could have seen it coming five years ago.

There are two more reasons to take the prognosis of the heating bill bomb seriously. The first is that they have accumulated nearly 10 trillion won in receivables without raising prices. That’s a lot of money to pay for heating for a long time. Even though international natural gas prices are currently plummeting, this is a huge pile of bad debt that needs to be paid off. The second is the lack of long-term contracts. Most of our current long-term natural gas contracts predate the last administration. The last government did very little long-term contracting because they were trying to be carbon neutral, and in the meantime, we sat back and watched as the Chinese led the way and wiped out the long-term contracting market. As a result, we were left exposed to the fluctuations of the international market, and for a significant period of time, we were extremely vulnerable to an energy crisis.

The world is suffering from an energy shock. European countries are raising prices to the point where consumers are freaking out and resorting to desperate demand management. We put off raising our rates and only recently realized that an energy shock was just around the corner. When energy prices are high, it’s time to reduce consumption and invest in efficient energy use. Saving energy is also about reducing carbon emissions.

The international situation surrounding energy markets is changing rapidly, and the structure of the supply chain is changing rapidly. Governments should orient their energy policies to ensure energy security. Only a detailed supply and demand plan, including long-term contracts, can overcome the current energy crisis.

February 9, 2023

<Yang-hoon Son, PERI Adjunct Research Fellow> Professor of Economics, Incheon National University / Former Director of the Energy Economics Research Institute