Required rate of return climbs from 16.1% to 17.0%, raising the bar for commercial viability

US Commerce Secretary Howard Lutnick (center) previewed "semiconductor-targeted tariffs" on Aug. 2 (local time), warning in multiple media interviews that those who do not manufacture in the United States "will pay the price." Lutnick is seen presiding over the G20 Innovation Ministers' Meeting in Chapel Hill, North Carolina, with South Korea's Minister of Trade, Industry and Energy Kim Jung-kwan (far right) and other attendees. [Yonhap]
US Commerce Secretary Howard Lutnick (center) previewed "semiconductor-targeted tariffs" on Aug. 2 (local time), warning in multiple media interviews that those who do not manufacture in the United States "will pay the price." Lutnick is seen presiding over the G20 Innovation Ministers' Meeting in Chapel Hill, North Carolina, with South Korea's Minister of Trade, Industry and Energy Kim Jung-kwan (far right) and other attendees. [Yonhap]

South Korea and the United States are widely expected to announce the first project under Seoul's US investment package as early as this week — before the Chuseok holiday — but a late-breaking variable has emerged: rising long-term US government bond yields.

When long-term US Treasury yields — the benchmark for the principal and interest repayment rate — rise, the required rate of return on any investment project rises with them, making it harder to meet the "commercial rationality" standard the South Korean government has set as its guiding principle for US-bound investment.

According to financial industry sources, the yield on 20-year US Treasury bonds stood at 4.73 percent per year when South Korea and the United States signed a memorandum of understanding on strategic investment last November. It has since climbed to 5.40 percent.

Under the MOU, the repayment interest rate on South Korean investment funds is set at the 20-year US Treasury yield plus a spread. The spread is determined through bilateral consultations and reflects South Korea's funding costs and the risk premium of each individual project.

Assuming a spread of around 0.3 percentage points, the repayment interest rate would rise from 5.03 percent at the time the MOU was signed to 5.70 percent today.

The rise in long-term US Treasury yields is not inherently disadvantageous for South Korea — higher yields mean a higher repayment rate, which in turn means more interest Seoul can recover. The problem is that actually collecting that money requires the US investment projects to generate sufficient cash flow.

Moreover, South Korea agreed to split cash flows from the projects equally with the United States until the principal and interest are fully repaid. In effect, the project must earn $2 for every $1 South Korea recovers.

Assuming the principal and interest are repaid in equal annual installments over 20 years, the required annual rate of return for the entire project rises roughly 0.9 percentage points — from 16.1 percent at the time of the MOU signing to 17.0 percent today.

The Encinal gas combined-cycle power plant in Texas (6.3 GW), widely cited as the leading candidate for the first investment project, has also emerged as a particularly challenging case for securing profitability.

For South Korea to recover its principal and interest from the project, estimated at $22.3 billion, the Encinal plant would need to generate total cash flows of $68 billion over 20 years — roughly $3.8 billion per year.

Korea Southern Power, the first South Korean power company to enter the US market, announced Sept. 3 that it had repatriated $100 million in operating profit from its 1.085 GW Niles gas combined-cycle power plant in Michigan, which began commercial operations in June 2022.

The comparison underscores why analysts say generating several billion dollars in cash annually would be a tall order, even for a plant with far greater capacity than the Niles facility.

Experts say robust safeguards are essential — including long-term power purchase agreements with AI data centers and similar large consumers, US government payment and loan guarantees, and commitments capping claims for cost overruns.

Analysts warn that if the profitability structure of the first project is not designed properly, the same problems could recur in subsequent projects, and that getting the first deal right is critical.

At a press conference Friday, President Lee Jae Myung said of the US investment negotiations: "I'm told we've nearly reached an agreement, but when I looked at the details, there were parts I found difficult to accept, so we are in the process of talking again."


oskymoon@heraldcorp.com