Competitive Bidding for Coal and Minerals Blocks Allocation

The Group of Ministers has approved the proposal for allocation of mineral blocks, including coal, through competitive bidding process. The proposal has signaled a paradigm change in the mineral industry. However, the restrictions on the eligibility for bidding, particularly so for coal blocks, will continue to keep the market skewed towards the captive consumers of minerals. Nonetheless the beginning of a new era is made.

The process of coal and mineral block allocations is reported be based upon the lump sum payment that the bidders quote, which is expected to be over and above the royalty and dead rent payments. The lump sum will thus be determined by the expected profits out of mining the minerals. This in effect makes the State governments a beneficiary of the mineral resources business, thus, and quite deservingly so, the governments will have a larger share of economic benefits from the non-renewable resources.

The advantages are manifolds. The first and foremost is the objectivity of the process. The current methods of allocation on first-come-first-serve basis and based on point scale for a host of variables ranging from net-worth to extent of completion of the end use projects, have inherent subjectivities. These approaches may not suffice the purposes of most efficient usages of minerals, their conservation and earnings for the government. The point scale basis becomes ineffective when the number of applications is large. The 750 applications for 18 coal blocks identified for power sector in the current round of allocation is a case in the point, where the parameters chosen for development of scale resemble qualifying criteria and make it almost impossible to decide on allocation without a fair bit of subjectivity. Competitive bidding has the effect of improving mine efficiency and thus a better value of scarce resources. The bidder investing large upfront money has the incentive to extract the optimal quantity deploying modern technology, as against those who have the comfort of paying when the production begins.

The bidders are expected to bid for coal blocks with their sight on the final output price, which may be regulated, as is the case for power. In power generation sector, the prime determinant of the quote for coal block will be the levelized variable tariffs for power produced. The competitive bidding may thus reduce the arbitrage in coal production and power generation, where the power supplies are also made through competitive bidding. In such cases, the prime motivation for coal mining may then shift from margins to fuel supply security. However, in the regulated power business with cost plus regime, the coal component of the total tariff is usually a pass through. For such cases, the competitive bidding process for coal mining may increase the tariffs. The solution for this may lie in regulatory interventions, which may not be welcome for the coal mining industry.

The amendments may have far reaching impacts. The government is likely to benefit from the additional revenues, which may be spent for the social development in the mining areas. The coal mining companies will have a pressure on the margins, particularly so when the royalty rates are also marked to the revenues. The bidders may be exposed to investment risk, if the commitments are made early on through the initial payments and if the industry fails to provide adequate returns.

From the point of view of end users of coal, which in many cases would be integrated power generation, steel manufacturing, cement manufacturing and other specified consumers, the input costs are likely to witness a rise, but that may not have an adverse impact if the coal costs are passed through.

The initial payments will have incentive mechanism for faster implementation of projects. The delay in mining project implementation, wherever controllable, will be shortened due to the penal capital costs that such initial lump sum payments will result in.

There are challenges in the implementation of the process. The uncertainty and inaccuracies in the geological data have always caused improper assessment of extractable reserves. The bidders will have to bear the geo-technical risks in the bidding process, since there may not be recourse to the initial payments made to the government, should the reserves be any different from initial assessment.

Access to debt funds will also be a key determinant in the bidding process. The returns for a bidder will be maximized if the debt component in the financing structure can be optimized. The process, therefore, will be favorable to companies with greater access to loan funds. For mining industry, the debt markets have not been the prime sources of funding, since traditionally the government owned companies have taken pride in debt-free balance sheets. However, the financial markets are likely to see more funds flowing into mining projects with the advent of competitive bidding process for coal and mineral blocks allocations.

The change in the policy is a welcome step, primarily because of the credibility it brings to the process of allocation through transparency. The implementation will help the government have a large share in the profits from the natural resources it owns. The coal mining companies will have greater incentive to implement projects. There may be upward pressures on prices, which may be checked through regulatory mechanisms or through opening up the markets for a greater participation from both the private sector and the government owned end users.

(This article was published in the Economic Times)