With Exchange Rates and Oil Prices... Aviation and Refining Industries on High Alert

Aviation Industry Faces Threat of Capital Erosion
Refining Margin Records '0' in Third Week of September

[Image source=Yonhap News]

[Asia Economy Reporters Seong Giho and Oh Hyunggil] The decision by the Organization of the Petroleum Exporting Countries (OPEC) and the non-OPEC oil-producing countries coalition, OPEC+, to cut oil production by 2 million barrels per day has triggered a red alert for our industrial sector. Amid an already painful high exchange rate environment, concerns are rising that oil prices, which had recently shown signs of stabilization, will surge again, potentially leading to the worst-case scenario.

According to major foreign media and related industries on the 6th, OPEC+ announced on the 5th (local time) in Vienna, Austria, following its first monthly ministerial meeting since March 2020, that it had agreed to reduce daily oil production by 2 million barrels next month compared to this month.

Immediately after the outbreak of the Ukraine war in March, international oil prices soared to an all-time high of $147 per barrel. However, concerns over a recession due to the U.S. Federal Reserve's (Fed) tightening and a strong dollar caused prices to fall below $100 per barrel in July. Last month, when the Fed implemented a third consecutive giant step (a 0.75 percentage point hike in the benchmark interest rate), prices dropped to the $80 level for the first time since January. Nevertheless, there are forecasts that oil prices will exceed $100 per barrel again due to OPEC+'s large-scale production cuts. Earlier, Goldman Sachs predicted that if the large-scale cuts are implemented, Brent crude prices would surpass $100 per barrel.

If oil prices continue to rise, damage to our industrial sector will inevitably expand. The airline industry, already suffering losses due to the exchange rate, is on high alert. Typically, fuel costs account for 20-30% of an airline's expenses. According to Korean Air's semi-annual report, a $1 increase per barrel in oil prices results in approximately $28 million (about 40 billion KRW) in losses.

The problem is that the industry is already hit by the high exchange rate. According to real-time statistics from the Ministry of Land, Infrastructure and Transport's Aviation Information Portal System, the number of international passengers in September was 1,922,320, falling below 2 million. This represents about a 10% decrease compared to August. This decline is attributed to the end of the peak travel season in July and August and the soaring dollar-won exchange rate, which led travelers to give up overseas trips and turn to domestic travel.

Asiana Airlines recorded a foreign exchange loss of 358.5 billion KRW in the third quarter. Air Busan and Air Seoul have already entered partial capital erosion in the first half of the year. The industry expects that airlines such as T'way Air, Jin Air, and Jeju Air will inevitably face capital erosion due to the combined effects of foreign exchange losses and high oil prices.

Refining, petrochemical, and steel companies that procure raw materials overseas are also fully exposed to exchange rate instability. Although there are signs of another increase in international oil and raw material prices, concerns over a recession are reducing product demand, triggering alarms over profitability.

The refining margin, a profitability indicator for refineries, has dropped to zero. This means that refined petroleum products processed from crude oil have become cheaper than the raw crude oil itself. The Singapore complex refining margin has been below the breakeven point of $4-5 per barrel since the second week of September.

It fell from $8.4 in the first week of September to $2.7 in the second week and dropped to zero in the third week. Although it slightly recovered to $1.5 in the fourth week, it remains in the loss zone. Compared to the record-high refining margin of $29.5 per barrel in the fourth week of June, this is a decline of $29.5.

The petrochemical industry is struggling with sluggish business conditions due to weak demand caused by China's prolonged COVID-19 lockdowns, deteriorating profitability, and increased supply from regional capacity expansions. A petrochemical industry official said, "If the exchange rate continues to rise, the cost burden for basic materials such as naphtha will increase, and foreign currency debt will also grow, intensifying the burden."

The petrochemical and battery industries currently carry significant foreign currency debt due to large-scale overseas investments, so an increase in the exchange rate increases their burden accordingly. According to semi-annual reports, LG Energy Solution's consolidated foreign currency debt denominated in dollars surged 24.5% from 3.4119 trillion KRW at the end of last year to 4.2493 trillion KRW at the end of June this year.

Choi Go-woon, a researcher at Korea Investment & Securities, explained, "Although large-scale capacity expansions continue in the region, demand is falling short of expectations due to China's 'zero COVID' policy and the global tightening trend. It is difficult to generate profits with general-purpose products as the steeply increased cost burden cannot be passed on to product prices."

The steel industry, which imports raw materials such as iron ore and coking coal, is also experiencing reduced profitability due to the sharp rise in exchange rates. There are concerns in the market that the operating profits of major domestic steel companies such as POSCO Holdings and Dongkuk Steel in the third quarter could be nearly halved compared to a year ago.