South Korean power sector may be excluded from next ETS

South Korea's power sector may not be included in the third phase of the country's emissions trading scheme (KETS), which would help sustain coal's relative generation cost advantage over natural gas.

The South Korean government is currently finalising new rules to govern the third phase of the KETS, which will be implemented during 2021-25, as well as the ninth basic electricity plan. But policy makers disagree about the rules for the power sector.

The question of whether or not to include marginal carbon costs in the calculation to determine dispatch orders — known as "environmental dispatch" — is delaying the process, a source at the energy and trade ministry (Motie) told Argus.

The South Korean merit order is currently set using the ascending short-term marginal costs — excluding carbon — for power plants, which benefits coal as one of the cheapest fossil fuels.

The environment ministry has sought to introduce environmental dispatch in the upcoming KETS phase, which would boost the competitiveness of gas-fired generation and push coal further down the merit order.

Motie originally agreed to adopt this framework to help reduce South Korea's heavy reliance on coal. But the ministry is now concerned that the move would lift power prices in the long term and distort South Korea's wholesale power market.

South Korean fuel-switch potential is already set to increase through the remainder of this year as domestic gas prices have started to fall sharply as a result of weaker oil-linked LNG import prices. Gas units that are running on spot LNG are already ahead of South Korean coal units in the merit order, and forward oil-linked LNG prices suggest that more high-efficiency gas units could overtake low-efficiency coal-fired units during the fourth quarter.

But the recovery in the oil market means that oil-linked LNG prices will start to rebound early next year, which will likely restore some of coal's cost advantage for power generation unless emissions costs are included in the merit order calculation.

Motie has therefore proposed a plan to reduce coal-fired power generation by increasing plant restrictions, instead of through environmental dispatch. It is not yet clear when the ninth long-term electricity plan will be finalised, but the dispute is also delaying South Korea's new KETS rules for the third phase of the scheme, which was expected last June.

By Evelyn Lee