Novel Challenges for Contract Coal Mining in India - Published by the Financial Express

Contract coal mining appears a promising business model given captive consumption mode being the preferred route for private sector participation in coal sector. A large number of the coal block allocatees have no expertise in mining, and they may need to develop the mines through contracting out on engineering, procurement, construction, operation and maintenance (EPCOM) basis. For such contracts, generally, selections of contractors thus far have been done through competitive bidding, which have had their own pros and cons.

There are significant differences in contract mining business models in India and those practiced in the other mineral rich countries. For example, the Australian contract mining industry appears to be matured with the well defined risk sharing mechanisms, whereas in India, a lot of ground still remains to be covered in terms of roles and responsibilities, and consequent risk sharing mechanisms, of mine owners and contractors. In many cases, particularly those with government owned companies as mine owners; risks are intended to be heavily loaded on contractors. Even legal, statutory and political risks are sometimes bourn by contractors, which may result in high cost of mining and limited competition for such projects.

The critical issues for survival of contract mining business, apart from contractual risks and available risk mitigation options, in India are - uncertain legal and regulatory framework and resource crunch. It has been widely debated whether, under the provisions of Coal Mines Regulations and Contract Labour Act, coal contractors can discharge their roles as agents and managers of mines. Similarly, their capacity to excavate and win coal is debated, with some views in favour of restricting contractors’ role only to overburden removal.

Resource crunch is also likely to have an impact on contract mining. With financial downturn, funding projects may be all the more difficult with high contractual risks of land acquisition and development included in the contractor’s scope of work. The shaken and stirred banking system may not have appetite for high risk lending to contract miners. Those who manage to get loans may have higher costs of debt financing. Higher cost of equity may also raise concerns about the financial viability of contract mining proposition in comparison to own-mining – the components of depreciation tax shields, returns on investment required and service taxes weigh down contract mining unless there are significant efficiency improvements that may offset these costs by sufficient margins.

Rise of contract mining has lead to concerns about safety and environmental issues. Aggressively bid contracts may sometimes have risks of compromising priorities and may have challenges of compliance. The mine owners may stand to lose on reputation, if they are too keen on lowest bids. Similarly, handling of rehabilitation and resettlement issues by contract miners may sometimes prove inadequate and result in project delays, cost over-runs and public outcry. In matured markets, mine owners tend to keep land acquisition, rehabilitation and resettlement works. In India, however, due to financial and organization capacity constraints, mine owners may like the contract miners to shoulder the responsibility.

A relationship based contract mining may be a successful model, which may contributes to high performance and commercial success of the project. This may also have solutions for ambiguous contractual obligations and amicable dispute resolution. However, relationships will hinge on cultural compatibility and mutual concern for commercial interests. In India, contractual relationships between government-owned and private companies have had shades of gray and the same is likely to continue in mining sector as well. But whether or not the contract miners take them in their stride and grab the opportunities has to be seen in times to come.

India Eyes New Laws To Usher In Coal Sector Reforms - Quoted in the Dow Jones Newswire

NEW DELHI (Dow Jones)--Taking a cue from its oil industry, India plans tostart auctioning coal mines to speed up exploitation of its vast coal resources- the fourth largest in the world. India desperately needs to raise domestic output as coal demand is expectedto grow fourfold to more than 2 billion metric tons a year within 20 years, andthe country is already suffering from shortages.

The government plans to tweak older laws, introduce new ones and to create anindustry regulator to gradually reform the coal business, in new steps towardscreating a more open and liberal energy sector. Commercial mining and selling of coal in India now is limited to a couple ofstate-run coal companies, even though India sits on 10% of the world's coalreserves - the biggest after the U.S., Russia and China.

By contrast, India has a huge deficit in oil, importing more than threequarters of its needs, but it attracts billions of dollars of private money toexplore and produce hydrocarbons through yearly auctions of oil and gasexploration blocks.

Coal India Ltd., or CIL, the government-owned mining monopoly, produces 80%of the country's coal but it can't keep up with demand because of a lack ofinvestment and technology.

Previous Failures

Previous governments had also tried to attract private investment in coal byallocating coal blocks for captive use by the power, steel and cementindustries. But most of these reserves haven't been developed "because of a lack ofcommitment and concerted effort to bring them into production," said N.C. Jha,technical director at CIL. Some blocks allocated more than a decade ago remain undeveloped as thecompanies involved don't face any financial risk if they don't start work onthem. To rectify that, the government last week introduced a parliamentary bill toamend an older law, which will allow competitive bidding in the allocation ofcoal blocks for captive mining. "It will streamline the process of allocating the mines and could potentiallyattract big investments, like the oil sector," said Kuljit Singh, partner,Ernst & Young India.

Once the competitive auction is in place, bidders will have to make firmcommitments to develop the mines and risk losing money if they don't deliver,said Dipesh Dipu, principal mining consultant at PricewaterhouseCoopers India. "It will increase the incentive and motivation for end users to makecommitments and improve project implementation," he said. Auctions will improve transparency and hasten project implementation,although they could also result in higher mining costs, he said. "But looking at the bigger picture and the urgency to develop coal assets toproduce coal to meet the growing demand, the pros certainly overweigh the consby quite a margin," Dipu said.

Other recent moves by India to shake up the sector include CIL in June offering several huge coal blocks to domestic and foreign companies wanting toset up coal-to-liquid plants.

Coal Regulator

After introducing the auctions, the government plans to set up a coalregulator to monitor the process and to make sure that successful bidders keeptheir commitments. Apart from the production side of the industry, the regulator is alsoexpected to usher in reforms in the coal marketing and trading sectors thatwill encourage higher output. "We need the regulator to be an impartial referee because the number ofproducers and consumers is growing," Coal Secretary H.C. Gupta told Dow JonesNewswires.

Coal is sold in India at roughly a third of international prices on an energycontent basis, but even so producers and consumers constantly tussle overprice. Once the regulatory body is established - for which the government needs tointroduce a new law - it would be responsible for fixing coal prices in India,currently decided by CIL, Gupta said. It would also determine the prices at which captive mine owners can sell coalto CIL while waiting for their user plant to come online. CIL has been able to keep coal prices low because it gets most of its coalfrom open-cast mines that are easier to excavate. With most of its future output growth likely to come from more expensivenunderground mines, the cost of production - and hence the coal price - islikely to increase significantly, said Jha. Because of current local prices, CIL loses INR30 billion ($600 million) every year producing coal from its underground mines, he said.

"The market economy may be the ultimate objective of the regulatory mechanismand the coal regulator may facilitate the transition from the current state ofnear monopoly," said PricewaterhouseCoopers' Dipu. The new laws should help India raise its output faster by making the industrymore transparent and increasing the participation of private players, saidDipu. "These are some transitory steps towards liberalization. But the governmentwill have to take a revolutionary step to make the kind of changes that arerequired. That would be clearing the bill pending since 2000."

India tried fully opening up its coal sector to private players in 2000,three decades after it nationalized its coal mines. The proposal met with heavy opposition and some 600,000 mine workers went onstrike. A privatization bill has now been languishing in the Parliament for eight years.

With the kind of demand-supply gap India is facing, it's a case of "if thisdoesn't work, try something else," said Bishal Thapa, a managing director atconsultancy firm ICF International.

-By Gurdeep Singh, Dow Jones Newswires; 91-11-4356 3308;gurdeep.singh@dowjones.com

Right policy paradigm for natural assets abroad - Quoted in the Economic Times

Speaking to ET recently, a senior official in the central government’s department of fertilisers said that even as the government , private fertiliser companies and potential investors are trying to buy rock phosphate and gas mines abroad to cut costs of phosphatic and nitrogenous fertilisers, the practicality of these ventures appeared somewhat doubtful because domestic policies and priorities of the countries holding these reserves don’t always converge with India’s . Unlike India, the Gulf countries are showing no predilection for fertiliser sector when it comes to gas allocation. Countries like Oman are in fact giving top priority to the electricity sector in their gas allocation policy.

India’s steel companies and coal PSU Coal India are in the throes of gaining ownership of coal assets abroad, the former to cut costs of coking coal, a key input for steel and the latter to make up for the drying up of domestic coal reserves. Some such transactions have indeed occurred in Indonesia, South Africa, Australia and Mozambique .

But, of late, there have been reports that the rush of Indian investors “have led to rise in valuation multiples, making coal assets expensive .” So, has the model of acquiring natural assets abroad come a cropper?

Speaking of the oil and gas sector, PricewaterhouseCoopers associate director Deepak Mahurkar said India’s acquisition of oil blocks abroad, despite many deals struck/attempted by OVL and ONGC, is ‘minute’ on a global scale and therefore can’t significantly impact valuations of these assets. As for the risks of policy changes by the reserve-holding nation , he said Indian players have almost unfailingly factored in the likely policy changes before the deals were struck or bids made.

For example, OVL knew Sakhalin 1 gas could not be brought to India and would need to be monetised in Russia itself. An exception is the Myanmar gas project, which has been affected by a policy change effected by the Myanmar government. Even in cases where policies changed after the acquisition was done (like in case of Venezuela), Indian plans are not hit because these uncertainties were factored in at the due diligence stage, said Mr Mahurkar.

So, any increase in valuation multiples in the oil and gas sector can be ascribed to the spike in oil prices, rather than a rush to acquire assets. This is evident from the fact that as crude oil prices crashed, the oil asset values have also sharply declined. But can that reduce India’s hunger for oil assets abroad? Certainly not. Even if the comparative advantage of buying assets abroad erodes in a given span of time because of a spike in valuation, India being hugely deficient in oil production can’t still negate that option.

But the situation is somewhat different in coal sector. Expectation of shortage of coal in the domestic markets of India and China have already resulted in a mad rush for assets abroad by the coal firms and users in the two countries. This has inflated the cost of these acquisitions. It appeared until July this year that acquisition of coal assets abroad is cost-effective (the prices of internationally traded coal had been rising relentlessly until July with thermal coal touching $180 a tonne, up from less than $50 a year ago).

But now that the prices of internationally traded coal have crashed, there might not be a strategic advantage for the consumers of coal in India to invest in coal assets and unlock the value in the difference in mining costs and spot/contract prices. So, the cost advantage seen in acquisition of coal assets abroad is not big enough to sustain the price cycles.

As PwC’s Dipesh Dipu puts it, independent miners from countries like Australia who have the wherewithal to operate in the open market would have an edge over Indian players who acquire mines abroad merely for captive consumption . India has proven coal reserves of about 101 billion tonnes and 87% of these are of thermal coal. Although some studies discount this figure our reserves could still last at least for another two centuries. So, efficient exploitation of domestic coal reserves coupled with strategic planning of imports could be a better policy paradigm than buying of coal assets abroad.

However, in the fertiliser sector, since India almost totally depends on imports to meet its phosphatic fertiliser requirement, it would indeed want to focus on acquisition of rock phosphate mines in African countries.

Coal, power ministries agree on imports - Quoted in the Mint

New Delhi: India’s coal and power ministries, which had locked horns over the supply of coal to new power projects, have reached a compromise by which 10-15% of the coal requirement for such projects will be made through imports by state-owned Coal India Ltd, or CIL, although this will increase the cost of the power generated by these plants.
The decision was taken at a recent meeting held between the ministries of coal and power, according to a government official who didn’t want to be named. The meeting was also attended by representatives of NTPC Ltd, CIL and Central Electricity Authority. The proposal to import coal was made by the power ministry, and the coal ministry agreed to it on the condition that the former facilitates the fuel supply agreement between the power utilities and CIL.
The power ministry had earlier asked the coal ministry for coal to generate 125,000MW, which includes 68,000MW for so-called independent power producers, or IPPs. It later scaled down its demand to 35,000MW, with half this amount designated for IPPs. The coal ministry had agreed to supply coal for only 10,000MW.
“There is no escape now. We will have to import coal. This will be applicable to all the utilities. It is not that we don’t need coal for the remaining capacity. We had prioritized the demand for 35,000 MW. With imports to constitute around 10% to 15% of the total coal requirement, the power tariff from these projects may go up,” said a senior power ministry official who asked not to be named because the issue remains a contentious one.
Imported coal typically has a higher calorific value, which reduces wastage and also improves the efficiency of power plants. Analysts estimate that one tonne of imported coal is equivalent to 1.56 tonnes of domestic coal.
To generate 1MW of power, around 5,000 tonnes of coal per annum is required. India has 256 billion tonnes of coal reserves, of which around 455mt is mined every year. The country currently imports around 40mt of coal.
Domestic coal demand is expected to touch around 2 billion tonnes a year by 2031-32, about five times the current rate of extraction, with the maximum demand coming from the power sector.
However, power project developers are not happy with the arrangement. “Even if the imported coal is priced at around $70 (about Rs3,346) per tonne at the entry ports, with inland transportation, it will come to around $94 per tonne. This, in turn, will increase the electricity tariff by around 10-15% depending upon the amount of imported coal used,” said a Hyderabad-based IPP developer on condition of anonymity. Domestic coal is available for Rs1,000 a tonne (including transportation costs).
While the coal ministry has expressed its inability to meet the demand due to the long gestation time required for the development of new mines, the power ministry is of the view that there is a shortage of 14mt even for the operating stations due to low production by CIL, the country’s largest mining company.
CIL has a coal output of 380 million tonnes per annum, or mtpa, and plans to increase it to 405mtpa by 2009-10.
H.C. Gupta, coal secretary, said, “We need to maximize domestic production and any gap has to be met through imports. The coking coal (used by the power sector) production in the country has not grown as per the demand. As per the 11Plan (2007-12) projections, we expect the imported coking coal demand for the power sector to go up to 40 mtpa by 2012.”
The government would not be able to meet the projected demand for about 730mt of coal by 2012, unless 100mt of the fuel is imported.
According to India’s economic survey for 2007-08, growth in coal production has dropped from a high of 6.2% between April and December 2006 to 4.9% in the same period in 2007.
On 9 September, Mint had reported that power projects capable of generating a combined 68,000MW were being put at risk because of the government’s failure to assure coal supplies.
“Inevitability of coal imports may not be synonymous to CIL being the facilitator since such canalizations may mean additional cost to the consumer in terms of CIL’s administration charges. However, such options of imports that exist for most power producers may be well exercised by developing bargaining power in the international markets through demand consolidation, which CIL can assist with. There is a need to look at import markets with a long-term view, rather than resorting to ad hoc spot purchases, which may be expensive and uncertain,” said Dipesh Dipu, principal consultant (mining) with audit and consulting firm PricewaterhouseCoopers.

(http://www.livemint.com/2008/08/28004717/2008/11/09231250/Coal-power-ministries-agree-o.html?d=2)