On 22 June, Kogas said that it will acquire a 10% stake in the Prelude FLNG project through Kogas Prelude Pty Ltd, its 100%-owned Australian subsidiary. Kogas will inject capital of USD700 million to the overseas subsidiary mainly to support the acquisition. Kogas will also lend up to USD800 million to the subsidiary, which will need to take on onerous additional expenditure to convert the project to the production stage, which is scheduled in 2016, from a developed one.

The project is majority owned and operated by Royal Dutch Shell Plc (Shell, Aa1, stable).

Kogas plans to source around 3.6 million tons (around 10% of its 2012 LNG import volume) from the project, as well as other gas fields run by Shell from 2016.

"The high reliance on debt for the acquisition of this stake will weigh on Kogas' financial profile because its cash flows from operations are volatile in the absence of an automatic cost pass-through tariff system," says Mic Kang, a Moody's Vice President and Senior Analyst.

In addition, the debt-funded acquisition will be detrimental to the recovery of Kogas' currently weak financial profile. In 2011, the company's retained cash flow to debt was 4.3%, while funds from operations to interest stood at 2.2x. Both metrics were weak, as the company's overseas investments were substantially debt-funded amid low returns due to the lack of a transparent, automatic tariff system. Debt to capitalization was high at 72% at end-2011.

While Kogas is considering various measures to address its weak financial metrics, the effectiveness of these measures remains unclear.

Although the project, if successful, could lead to long-term benefits, such as the diversification of LNG supply sources and access to LNG at competitive prices, Kogas will need to bear execution risks until the project commences operations in 2016.

Continued substantial debt-funded investments and acquisitions will weigh on Kogas' credit profile, but Moody's expects that the Korean government will provide support, if needed, because the company has a strategically important policy role of importing, transmitting, and wholesaling natural gas for the country.

The increase in the company's debt as a result of the Australian project is not material enough to pressure its rating immediately.

As the country's only fully-integrated natural gas company, Korea Gas Corporation (Kogas) has an effective monopoly over the import, transmission, and wholesale of natural gas in Korea. It owns and operates three LNG terminals in Korea, with an aggregate storage capacity of 8.3 million kiloliters and a nationwide pipeline network of 3,023 kilometers as of December 2011.

Its major customers include city-gas distributors and power plants, and it derives the bulk of its revenue from residential and power utility end-customers. In recent years, it has increased its investments in natural gas exploration and production (E&P) projects via joint ventures. Listed on the Korea Exchange, Kogas is 61%-owned by the government, directly and indirectly, through Korea Electric Power Corp and local governments.

Mic Myoung Heung Kang Vice President - Senior Analyst Infrastructure Finance Moody's Investors Service Hong Kong Ltd. 24/F One Pacific Place 88 Queensway Hong Kong China (Hong Kong S.A.R.) JOURNALISTS: (852) 3758 -1350 SUBSCRIBERS: (852) 3551-3077 Patrick C Mispagel Associate Managing Director Infrastructure Finance JOURNALISTS: (852) 3758 -1350 SUBSCRIBERS: (852) 3551-3077 Releasing Office: Moody's Investors Service Hong Kong Ltd. 24/F One Pacific Place 88 Queensway Hong Kong China (Hong Kong S.A.R.) JOURNALISTS: (852) 3758 -1350 SUBSCRIBERS: (852) 3551-3077 (C) 2012 Moody's Investors Service, Inc. and/or its licensors and affiliates (collectively, "MOODY'S"). All rights reserved.

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