Policy promises new era - Article published by High Grade magazine

APPROVAL by India’s Group of Ministers (GoM) of a new competitive bidding process for mineral and coal blocks maintains restrictions on bidding eligibility, particularly for coal, keeping the market skewed towards captive consumers of resources. However, the regime change signals a paradigm shift in the mining industry.

Reflecting Indian Government concern about the lack of foreign investment in exploration and mining in the country, the GoM-supported policy changes which will now go to the national cabinet for final approval also put forward a new state royalty system designed to win the support of regional governments.

Minister of State for Mines T. Subbarami Reddy has said the new mining policy aims to increase mineral exploration levels five-fold on available land.

Existing state mineral royalty rates are relatively low and are seen by regional governments as inadequate in the face of predicted increases in resource investment and possibly greater foreign mine ownership. New rates are expected to be higher, though states will only have rights to change royalties for minor minerals and the Central Government will retain its control over rate setting for other minerals.

But the biggest proposed changes are related to longstanding processes used to allocate land for mineral and coal exploration and development, with the first-come-first-served system for minerals, and point-scale-based system for coal, to be ditched in favour of a simpler and seemingly more transparent process of lump-sum bidding and payment.

Lump-sum payment quotes by bidders will be used for the first time to determine coal and mineral block allocations. States are said to be supportive of a new system they believe will confer to them a larger share of economic benefits from mining.

Existing allocation methods come with built-in subjectivities.

Notwithstanding the transparency issues for bidders, these methods are not seen to promote efficient resource use, optimum conservation, nor equitable earnings distribution to government.
The point-scale system becomes ineffective when the number of applications is large. The 750 applications for 18 coal blocks identified for the power sector in the current round of allocation is a case in the point, with parameters chosen for development of scale resembling qualifying criteria and making it almost impossible to decide allocations objectively. In a rationed system there will be over-applications as there is a chance to profit from gains. But while the 750 applications probably over-estimated demand, the number of applications also indicated the level of confidence companies have in their own efficiencies and expected margins from coal mining.

From a national resource management perspective, competitive bidding promotes greater mine efficiency and thus improves the value of scarce resources. The bidder investing large up-front money has an incentive to optimise productivity and returns by deploying modern technology, as against those who have the comfort of paying when production starts. Low rates of dead rent have also been one of the reasons why many of India’s coal and mineral tenement title holders have not begun project implementation.

Challenges

For bidders to be able to quote a true market price, regulatory provisions must be clear.
There should be no price controls, for example, while royalty rates shouldn’t vary wildly as this will, in the case of coal, make resources uncompetitive against other fuels. In this area the “lex specialis” provisions of the Government of Indonesia may be a guide where the tax rates and royalty rates are fixed for the coal mining company at the time of coal contracts of work and remain unchanged until the contract expires.

Another important matter is dealing with political risks.
Rehabilitation and resettlement (R&R) issues are contentious and the winner of a block may face unreasonable pressure from opposition political parties and from motivated NGOs. This risk will force companies to bid conservatively.

For an effective and successful competitive bidding process, a public leveraged model for public-private partnership may be suitable. The government may provide support for land acquisition and several clearances and approvals, and get the expenses reimbursed by the winning bidder. At the very least the government must provide resources companies with assurances that the “rule of law” will be applied and that it would to the extent possible safeguard them against unreasonable pressures.

In the tariff-based competitive bidding regime for bulk power supply, the bidders are expected to bid for coal blocks with sights fixed on the final output price.

The prime determinant of coal block prices will be the levelled variable tariffs for power produced. The competitive bidding for coal blocks may thus reduce the arbitrage in coal production and power generation, where power supplies are also made through competitive bidding. In such cases, the prime motivation for coal mining may shift from margins to fuel supply security.

In the regulated power business with cost-plus regime, the coal component of the total tariff is usually a pass through. In such cases, the competitive bidding process for coal mining may increase tariffs. But the existence of market mechanisms and the regulatory mechanism of merit order dispatch may ensure that tariffs do not rise uncontrollably.

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. However, there is a limit to which costs can be passed through. Cement companies will now, for example, be subjected to competition from imports from Pakistan and Bangladesh. Substitution is a clear threat. As coal customs duty is only 5%, the lowest for any energy source, pricing of coal companies will always have an upper ceiling.

While a system in which bidders make up-front payments builds in an incentive mechanism for faster development of projects, implementation of a competitive bidding regime also opens up the possibility of steel, cement and such other non-utility users able to pay a premium for coal diverting the supply of coal “meant” for utilities. This is something that could be balanced over time, or it could be resolved by maintaining the current the practice of classifying coal blocks for end use, with power utilities only able to bid for certain coal blocks and the same for cement producers and other users.

There are of course other challenges in the implementation of the new process.
Uncertainty around, and inaccuracies in geological data, has caused improper assessment of extractable reserves. Bidders will have to bear the geo-technical risks in the bidding process, since there may not be recourse to initial payments made to the government should the reserves be any different from initial assessment.

While bidders are likely to be provided with the geological reports, they will have to conduct their own assessments. Geo-technical risks will be higher for blocks which are “regionally explored”.

As has been noted previously, Coal India Ltd coal blocks put into the allocation process are only those “de-reserved” for others to pursue. CIL has been allowed to keep coal blocks it plans to develop by 2026.

The GoM policy submission has been welcomed primarily because of the credibility it brings to the process of allocation through transparency.

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