When Did Korea National Oil Corporation, Exploring Pohang Yeongil Bay, Start Experiencing Capital Impairment and Why? [Seungseop Song's Financial Light]

Yeongilman Drilling Costs 100 Billion Won at Once
Dedicated Agency Korea National Oil Corporation Faces 'Capital Erosion'
MB Government's Resource Diplomacy Failure Leads to Ballooning Debt
Government Plans to Cover Costs Through Overseas Investments

Vitor Abreu, CEO of Act-Geo, a U.S. company that analyzed the possibility of up to 14 billion barrels of oil and gas deposits in the Yeongilman area of Pohang, Gyeongbuk, is drinking water while briefing on the development of the East Sea deep-sea gas field at the Ministry of Trade, Industry and Energy press room in the Government Sejong Complex on the morning of the 7th.
[Image source=Yonhap News]

Since President Yoon Suk-yeol announced on the 3rd that there is a high possibility of oil and gas deposits in the Yeongilman area of Pohang, there has been much debate over the costs involved. In particular, although a single drilling operation costs a staggering 100 billion won, attention has been drawn to the fact that the dedicated agency, Korea National Oil Corporation (KNOC), is in a state of 'capital erosion.' What exactly is capital erosion? Why has the Korea National Oil Corporation fallen into capital erosion, and how do they plan to cover the drilling costs?

Simply put, capital erosion refers to a state where losses accumulate, debts pile up, and the invested capital gradually diminishes. This gradual reduction of capital is called 'partial capital erosion' in accounting terms. If partial capital erosion continues, the capital itself may be completely depleted, which is known as 'complete capital erosion.' A company experiencing complete capital erosion has more liabilities than assets, resulting in negative equity.

Let’s look at the financial statements of the Korea National Oil Corporation. According to the public institution management information disclosure system 'Alio,' the total assets of KNOC last year amounted to 18.2294 trillion won. However, total liabilities were 19.5781 trillion won, meaning debts exceed assets. In financial statements, assets are shown as the sum of liabilities and equity. Therefore, equity stands at -1.3486 trillion won. In other words, even if KNOC were to sell off the entire institution, it would not be able to repay all its debts.

KNOC was not originally an institution with poor financial health. Its liabilities were only around 3 trillion won in 2006. However, by 2011, liabilities had exceeded 20 trillion won. In just over five years, liabilities ballooned at an extremely rapid pace. Ultimately, KNOC fell into complete capital erosion in 2020 on an annual basis. This was the first time since its founding in 1979. In less than 20 years, KNOC had become a company burdened with excessive debt, paying 400 billion won annually in interest alone.

How did KNOC fall into capital erosion? Many experts point to the 'failure of resource diplomacy.' In 2008, then-President Lee Myung-bak launched a resource diplomacy initiative to secure overseas oil and minerals. Accordingly, KNOC purchased the Canadian Harvest oil field for 4.8 trillion won and the Scottish oil and gas exploration company 'Dana Petroleum' for about 3.4 trillion won. They also invested 1 trillion won in the Iraq Kurdistan oil field and social overhead capital (SOC) linked projects.

It would have been good if the investments had succeeded, but the related projects were close to disastrous failures. A representative example is the Harvest investment. Except for 2019 and 2020, Harvest recorded losses every year. The cumulative investment performance was also poor. According to data submitted to Rep. Jung Chung-rae of the Democratic Party last year by KNOC, the total amount invested in Harvest was 7.5766 trillion won, but the amount recovered was only 49.02 billion won. The lack of thorough project planning and verification, along with irrational investment decisions, are cited as reasons that led KNOC into capital erosion.

The problem is that drilling in the Yeongilman area of Pohang, where the resource volume could reach up to 14 billion barrels, requires enormous costs. Each drilling attempt costs more than 100 billion won. The Ministry of Trade, Industry and Energy plans to drill a total of five wells in the East Sea deep sea by 2026, so a simple calculation suggests that the total cost will exceed 500 billion won. Although KNOC has been profitable for only two years now, considering it is still in a state of capital erosion, this is not an easily affordable expense.

They need to raise funds from somewhere, but the budget allocated to KNOC this year for related projects is woefully insufficient. KNOC receives about 39 billion won for oil and gas drilling development investment projects. To cover this, the government has announced plans to secure necessary funds through consultations with related ministries and the National Assembly. They also plan to utilize the corporation’s overseas investment returns. Additionally, in the long term, attracting investments from major overseas companies has been discussed.

Editor's NoteEconomics and finance are difficult subjects due to complex terminology and background stories. Financial Light delivers easy-to-understand economic and financial stories every week. Even without any prior knowledge, these stories will ignite your interest in economics and finance.