Licensed to Mine - Contract Mining in India

Contract mining is fast catching up in India as the preferred mode for development and operations of mines. The business model of hiring contract mining companies for overburden removal and even mineral winning is not a recent innovation. There are large numbers of new projects being planned through contract routes. Even the traditional mining companies like the Coal India Limited and National Mineral Development Corporation have been contracting out their mining operations, albeit partially. In coal sector, because of captive mining requirements for coal block allocation to the power utilities and steel companies, contract mining has become preferred mode for mine development and operations.

When to consider contract mining?

Contract mining should be considered an option when the owner does not have the required capability to develop or operate the mine, or when the owner’s investment in terms of management time and efforts do not justify self mining. This is the era of specialization and the owner may like to focus on its core competencies. In India, the government ownership of the mining companies may at times make it difficult for the companies to efficiently develop mines, and hence, it may be advantageous to outsource some or all the activities. For the companies with no prior experience in mining it may be the best alternative to avoid time delays in building capacities and traversing the complete learning curve.

In some cases, the contract mining company may have competitive advantage in terms of their technical expertise and relationships with the government, regulatory agencies and local communities, which may help shorten the project gestation period and decisively alter the project feasibility. In cases of state government owned utilities hiring contract coal mining companies, the contractor may have competitive advantage even in financing the projects and cost of funding.

The growth of contract mining services as an industry in its own right may also reflect cost-cutting measures on the part of the mining industry. In the USA, mining companies often cut costs by increasing use of nonunion workers to perform many of the tasks previously performed by union workers. This, however, may not always be the case in India due to different legal set up for hiring contract labor.

Alignment of contractor and owner goals and objectives

The key success factor for contract mining business model is the alignment of goals and objectives of the owner and contractor, including investment tenure, expected returns, utilization of existing resources, benefit sharing and such others. If the goals and objectives of the owners and contractors are not aligned, it may lead to severe operational risks and risks of disrepute and disputes. However, assessment of contract mining company’s goals and objectives is difficult and may involve detailed research on their investment patterns, management styles, performances on their earlier contracts, and study of their relationships with mine owners.

While the owners objectives may be minimizing risk, lowering cost, minimizing contract variations, seeking guaranteed output quality and quantity, seeking opportunity to lower rates in future, and minimizing disputes, the contractor may have objectives of seeking highest rates, maximizing contract variations for greater business opportunity, and such other objectives which may be conflicting. Prudent alignment of objectives and selection of a culturally-fit contractor may lead to good working relationship between the owners and the contractors.

Alternative contract business models

With specific services contracted out, owners can avoid a large commitment of capital investment and contract mining companies can get profitable ventures. The mining companies are increasingly facing erratic demand conditions, and cyclic price trends, making smoothened production and effective cost management needs for survival. With contract mining, the industry can expect flexible conditions of production and efficient utilization of equipment and human resources. This efficiency can result in consumer value add and enhanced profitability of the owners.

There are several contract models in mining, which depend upon the owner’s preparedness, risk appetite, technical expertise and financial resources. Based on these, the owners may undertake some of the mine development activities and outsource the rest to the contract mining company. In India, there have been several variants of contract mining in both coal and metaliferrous mining sectors.

In a typical contract, the owner acquires the mineral rights, gets the clearances and approvals, acquires land and develops the mine access and supporting infrastructure, and then invites the contract mining company to operate the mines. Though generally not opted for, financially sound owners may even invest in the heavy earth moving equipment and require the contractor to operate and maintain the equipment achieving expected levels of performance. Cash rich companies may prefer such contracts, which also provide the owners with depreciation benefits and also lower contract expenses due to absence of return on investment component in contractor fees.

A modification of the above model is when the contract mining company invests in or hires the equipment. Large number of overburden removal contracts given out by subsidiaries of Coal India Limited is of this type. Mahanadi Coalfields Limited, for example, has contracted overburden removal in Talcher coalfields where the contract mining company brings in drills, excavators and haulage equipment. Sarasthali coal mine of Integrated Coal Mining Limited, a subsidiary of CESC Limited, is also being operated on this model.

In some cases, the owners complete the initial preparatory works like the mine plan preparation and approval; environmental impact assessment and management planning and their approval; and land acquisition; and then the contract mining company invests in development and operations, including investment in all equipment. Andhra Pradesh Power Generation Corporation Limited (APGENCO) has progressed on this model and is currently in the process of selection of contract mining company through competitive bidding.

In a total outsourcing model, the owners contract out all the processes including statutory approvals and clearances, land acquisition, mine development and operations. The recently floated tender of Mahaguj Collieries Limited (MGCL), a joint venture of Maharashtra State Power Generation Corporation Limited and Gujarat State Electricity Corporation Limited is a proponent of this model. The prospective bidders for the 30 MTPA project are expected to conduct their own geo-technical assessments, study the feasibilities and bid for the long term contract.

Tendering

Selection of contract mining company in itself is Herculean. Negotiated partnerships have not been prevalent even in private sector in India. Government owned companies tend to conduct competitive bidding process to select the contractor. The processes and evaluation criteria differ for such competitive bidding. The bidding process begins with calling for expression of interest, followed by requests for qualification, technical and financial proposals. These components may be clubbed all together as in case of Mahaguj Collieries Limited or may be split into three steps as in case of Pakri-Barwadih bid of NTPC Limited and Tadicherla bid of APGENCO. Evaluation criteria generally are the mining services fees per unit of run-of-mine. However, in one of the bids for selection of coal mine developer and operator, discount over comparable CIL prices was, quite uniquely, the evaluation criteria.

Risks and risk sharing

Contract mining has its risk profile based on the contract model and style. The risks also depend upon the objectivity of the process of contractor selection and the alignment of objectives. Price risk of contract depends upon the preparedness of the owner to undertake the tendering process as also the availability of information about the mineral property. Absence of reliable geological information may lead to higher contract fees. Also, absence of objective specifications of the project and fully defined scope of work may lead to greater risk perception by the bidders that may be manifested in unexpected bids. There does exist a risk of disrepute if the contractor does not comply with the environmental and safety requirements as expected by the owners. Risk of non-performance, project delays, defaults and others may be covered using clauses in the contract agreement, but they may still result in significant losses, if prudence is not exercised in the qualification requirements and evaluation criteria. It may sometimes be fraught with risk to evaluate the bids entirely on economic terms, as has been the case in India.

Contract mining risks include risk of project delays. Delays can be due to extrinsic reasons of delay in regulatory and legal sanctions or they could be due to contractor’s incapacity or willful negligence. Provision for liquidated damages may partially compensate the owner from the financial losses. There may be risks of non-performance in terms of both quantity and quality, which may be mitigated through serve-or-provide conditions. Risks of non-compliances with regulatory or statutory provisions, particularly so of the environmental compliance, may be covered through appropriate indemnification and through insurance products. In case of defaults, not caused by force majure conditions, there could be provisions for compensation for financial and production losses, including those which may result from substitution of the contractor with another.

The contract agreement must clearly and objectively state the responsibilities of each party, payment mechanism, quantity and quality measurement methodologies, dispute resolution mechanism, reporting and compliance requirements, default events and their impacts, delay identifications and compensations, force majure conditions, schedule of project implementation and deliveries, and mechanism for contract administration. As a safe approach, the agreement document may be provided to the bidders before the submission of the price proposals. In case of a state government utility, the agreement was proposed to be drafted after the selection of the contractor. This approach can clearly lead to disputes even before the contract is effective.

During the tender process, failure to ensure proper drafting of contractual agreement may cost the owner and/or the contractor severely over the life of the project. These losses can arise directly from claims being made under the contract and indirectly from inefficiencies in operations. Appropriate planning at the tender stage can minimize these risks.

Conclusion

Contract mining in India as a business model is here to stay and flourish. It may provide competitive advantage to the owners to focus their resources on their core competencies and also bring in operational efficiencies. However, there are risks in contract mining, many of which can be mitigated through prudent planning and devising of qualifications required scope of work, evaluation criteria and contractual agreement. For the rest, the owners and contractors need to have alignment of objectives which can be achieved through relationship building.

(The article was published in the Power Line magazine in August 2007)