Challenges of Disinvestment in Mineral Sector

Disinvestment in mineral sector is not a new phenomenon. Even in developing countries with fair degree of dependence on mineral resources, governments have been making way for private sector players. The reasons for disinvestment vary from enhancing productivity and efficiency to providing financial and strategic inputs. It is generally considered that private ownership may optimize mineral resource utilization in view of the profit motives. Also, in many cases, disinvestment leads to reduction in the flow of public subsidies where mining companies under government ownership and management accumulate perpetual losses. However, the question is not fully settled yet. Disinvestment needs to be assessed in the light of complex relationship between privatization and allocative efficiency. This relationship comes into play in cases where the subject of disinvestment operates in near monopoly. In such cases, the losses due to allocative inefficiency arising from higher mark-up on prices of minerals overweigh gains from giving up public (through government) ownership that cause operational inefficiency. Government may do well to create a competitive environment in the mineral sector to mitigate such risk.

Considering disinvestment decision as given, governments tend to look for alternate ways of generating revenues from mining operations and seek commitments that go beyond the commercial and business imperatives, more so in the light of political compulsions. These activities sometimes cause disinvestment to fail in meeting the objectives. Additional fiscal burdens in terms of royalty and taxes may make mining business unviable. While windfall taxes may fetch higher revenues to the government for brief periods, these may not allow mining companies to cushion their positions when the cycle turns. Case in the point is Zambia’s recent decision to retract windfall taxes in copper and other base metals to attract investments when one of the strategic investors withdrew.

Although not specific to disinvestment, Indonesian coal contracts of work (CCOW) have lex specialis provisions that ensure continuity of fiscal terms and conditions for mining for specified periods and shield the mining companies from future unfavorable legislative changes. Stability provided through such measures may help disinvestment become successful. There can not be an argument against governments aiming to maximize their gains in the process of disinvestment – through negotiating value, ensuring price participation and rationalizing private returns – but any post-facto changes in the playing field may be disastrous.

There are three basic steps that need to be followed for the effective disinvestment process - legislative and administrative arrangements; company preparedness; and determination and implementation of methods of sale. The legislative and administrative arrangements need to be made to authorize and facilitate the processes of restructuring and eventual privatization of government assets. Once the appropriate legislative approval is given, the government may make appropriate institutional arrangements for the administration of privatization process. These may include un-reserving the shares, establishing ownerships on assets, organizational restructuring, financial restructuring, contingent liabilities audit, and fair market valuations.

In the audit of one of the divested companies, the Indian government auditors (the Comptroller & Auditor General of India or CAG) discovered that land deeds did not clearly establish the ownership of the asset with the company, resulting in lower value realization from disinvestment. Thorough technical, legal and financial due diligence should be a part of disinvestment process that may help close issues that impact the valuations.

Mining companies subject to disinvestment may be financially restructured to clean up the balance sheets. The debts and other liabilities which may have been on the books due to poor performances in the past and governmental compulsions may be written off. Not writing off such debts may result in bankruptcy risks post privatization and may render privatization process less attractive to investors. Such outstanding liabilities could also make the private player hamstrung for raising funds.

Before the government companies are privatized, their fair market values must be assessed. This may set the floor price for privatization. In their 2006 report to the parliament, the CAG of India lamented lack of coherence in and, in one case absence of, valuation exercise. The CAG stated that discounted cash flow approach was used with revenue projections based upon historical performances of an ailing company, which could not possibly reflect the potential of the company. A way to mitigate valuation risks is to hire competent and independent advisers for reserve assessments and business valuations. Due care should also be taken to include intangible assets in valuation matrices.

There are methods of privatization for government ownership in mining companies that include the following methods - joint ventures; private placement, typically with institutional investors, by negotiation and buyouts by management and/or employees; public tendering where prospective purchasers in response to a tender provide the best written price and investment proposal. Public tenders are generally followed by negotiations to improve the offered conditions. However, the negotiations have risks how much ever small or large the size of the negotiation committee. CAG of India in 2006 report mentioned that the negotiation team failed to realize better value for the company even while it gave away concessions.
Risk of public perception is one of the key challenges in mineral sector disinvestment. Resource nationalism plays a dominant role in public perception and governments tend be blamed for disinvestment at throw away prices. However, a higher degree of preparedness coupled with transparent process can help allay such risks. Governments may as well conduct stakeholder consultations and, wherever needed, education so the disinvestment process concludes with goodwill prevailing all around.

Reform Policy Framework to Unearth the Mineral Wealth - My article in the Financial Express

Mining sector needs structural overhaul to attract investments that can help the sector meet growing needs for raw materials. The sector, including coal mining, has been traditionally dominated by the government-owned companies and with limited participation from the private sector. In the current financial crisis this may have been a boon as the government-owned companies have healthier cash positions to keep their capital expenditure plans intact. But to support the growth expectations of the long term as indicates inevitability of private investments. For this the capital markets appear less than prepared. Disinvestment through IPO routes and enhancing public floats in listed companies may enhance the market depth for mining sector investments.

Government through the budget may provide roadmap for implementation of National Mineral Policy 2008. The amendment to MMDR Act to ascribe marketability to prospecting and mining licenses will help the sector reap risk capital and will make exploration a sustainable business for private investment. Government may also facilitate creation of alternate investment market that will provide much needed funds to support prospecting and exploration activities.

Incentive may be provided to encourage innovation and adoption of cutting edge technologies, more so in coal mining sector where the cut-off depth is likely to require capacity additions in underground mining. Duties on capital equipment for both surface mining and underground mining may be revisited.

Competitive bidding for mining license allocations has its pros and cons. The method will enhance transparency and objectivity and may have inherent commercial mechanism to hasten project implementation. Depending upon how these are structured (initial bullet payment, production sharing, revenue sharing or profit sharing) there may be cost implications. But looking at the bigger picture and the urgency to develop new mines, the pros certainly overweigh the cons. Government also needs to then de-risk the mining projects from delays due to approvals and clearances required to make the assets lucrative investment targets.

Proposed coal regulatory mechanism is unique to India which has its roots in the coal market structure and energy affordability. Pricing of coal by the government owned coal producing companies have thus far been opaque, even though prices have been lower than the international prices on energy-equivalence basis. The absence of a vibrant market with large number of buyers and sellers coupled with supply constraints have made fair pricing a difficult proposition in the Indian context. The policies framework should aim at a market driven pricing mechanism, however, till the time it is established, coal regulator may be required.

New mines, better efficiency raise coal production in April - Quoted in the Business Standard

Commissioning of new projects and better mining efficiency pushed up the coal sector’s growth in April to 13 per cent, compared with 10.4 per cent growth in the same month last year, according to the Index of Industrial Production (IIP) figures released on Tuesday.

The sector carries a weight of 3.2 per cent in the IIP.

This, according to experts, led to higher output at thermal power stations. Electricity generation, which has a weight of 10 per cent in the IIP, registered 6 per cent growth in April 2009, compared with 1.4 per cent in April last year. About 75 per cent of the country’s coal production is used to fire power plants.

“We have been able to procure land for some new mines. The output has increased due to these new mines,” said a senior official from Coal India Ltd (CIL), India’s largest coal producer.
India’s total production in April this year — 39.6 million tonnes — was 4.6 million tonnes higher than in the same month last year. For the financial year ended March 2009, the production grew 7.7 per cent, compared with 6.3 per cent growth in the previous year. Higher production is also a result of improved mining efficiency. “The time taken for physical measurement of coal stocks at mines was reduced to seven days in April from 45 days earlier. Mine officials are able to concentrate better on production activities,” said CIL Chairman Partha Bhattacharyya.

State-owned CIL, along with its seven subsidiaries, accounts for a major chunk of the country’s overall coal production.

“Our own production in April this year was 12.2 per cent higher than in April last year,” said Bhattacharyya. For April and May together, CIL’s production rose over 10 per cent.
According to Bhattacharyya, another major factor that has given a boost to production at the mines is the capital investment made by the company. “We invested in replacement of mine equipment last year, which yielded results in April,” he said.

Experts believe the spurt in the sector’s growth is likely to continue as demand for the dry fuel, especially from sectors like power, is not likely to dip in the long term.

“New mines are coming up and existing ones are being stretched to their limits as demand for electricity has not come down even in the current slowdown,” said Dipesh Dipu, principal consultant, PricewaterhouseCoopers. “Coal and electricity are the sectors where we expect a revival.”