Economic case for coal sector reforms - My article for ICC's Monthly Economic Review

The case for augmenting competition and market participation in Indian coal sector has never been stronger. The nation faces shortage of coal and the shortages are likely to only worsen. The commodity is likely to dominate the Indian energy landscape, and hence, the need for development of the sector through reforms is paramount.

Free market versus control

In Indian coal sector, debate on the legal framework revolves around the efficacy of free markets. Historically, when coal sector was nationalized, the circumstances appeared to indicate that private enterprises were too profit focused to channelize their resources for safety and occupational health issues in the sector. The government ownership was viewed as a tool to improve safety records and provide appropriate work environment for the miners. Hence, the Coal Mines Nationalization Act, 1973 was promulgated and the sector came under the government ownership. Another reason cited for the nationalization of coal mines was to provide government funding for development of coal mines for meeting the energy needs of the nation, which was not sees as forthcoming from the private owners.

The circumstances have changed now. The private sector participation is being encouraged even though the degree of participation is still limited. The reason for this change in the policy outlook is that the gap in demand and supply seems to be rising by the day and the government-owned companies find themselves unable to match the expectations. Pricing policies seem distorted and make comparisons with the international markets irrelevant.

From the economic perspective the debate over free markets and control has been long and often non-conclusive. It has been observed that in free market postulation of equilibrium is itself open to question. In several circumstances, free markets tend towards excesses, which become unsustainable with time and eventually head for correction. Such correction processes, like the recent financial meltdown, can be devastating. Hence, with such evidences, the very argument in favour of free markets to establish equilibrium of demand and supply and hence, pricing, tend to lose validity.

However, the merit of free markets may be appreciated when the alternative of planned mechanism is evaluated. The centrally planned demand and supply for coal has eschewed its pricing mechanism and distortions may be considered worse than free market excesses. The lower than required investments in new projects, acute shortage of capital and physical resources for exploration and burgeoning gap in demand and supply and hence, inevitability to depend on international markets that seem to plateau are manifestations of the ills of planning processes. Part of these issues may also be attributed to the process of planning itself but the arguments in favour of free markets certainly get a boost.

Monopoly versus perfect competition

Indian coal sector is not just faced with the question of free markets and regulation but also with that of monopoly versus competition. Nearly 82% of production comes from the government owned entities and planning process indicates the continued dominance of these entities in times to come, although with reduced market share. The definition of monopoly may loosely fit the Indian players but the characteristics of high entry barrier and lack of substitutes make it evident. For market participation in coal sector in India, there is a legal barrier of captive consumption, along with other barriers of high risk clearances and approvals, land acquisition, rehabilitation and resettlement, lack of geo-technical certainties of acceptable levels, lack of institutional financing options and several others. There are even legal exit barriers since coal mining assets can not be sub-let and leased out. The lack of substitute for coal is evident from the planning process itself where coal is planned to continue to be the mainstay of Indian energy portfolio.

As a result of this market structure, there is a limitation on the options available to the consumers. There also exist allocative inefficiencies. Consumers have been less able to direct coal suppliers to serve their interests. Government supported and perpetuated monopoly may encourage rent seeking and profit protection even when there may be scope for efficiency improvements and productivity enhancements.

To restructure the coal sector, number of rival complies in coal mining and the supply chain has to be increased through reduction in barriers. For this purpose the Coal Mines Nationalization Amendment Bill 2000 may help. Till the time there is established a market with large number of suppliers, that may resemble perfect competition, there may be regulation of prices and outputs through a coal regulator.

Rationing behaviour

The existence of monopoly market mechanism with a large demand and supply gap has obviously resulted in a rationing behaviour by the government. The rationing is manifested in two ways – rationing of coal resources and rationing of coal products.

The rationing of coal resources is done through the coal block allocation process. On the macro level, there are a large number of applications for coal blocks and rationing is done through a mechanism of establishing credentials of the applicants. The process of establishing the right of coal block allocation is in itself subject to questions, but the underlying issue is the dichotomy of large resource pool and inability to meet the demand for coal blocks. In 2007-08 round of coal block allocation, 748 applications were received for 18 coal blocks reserved for power generation purposes, while the national coal inventory indicated a total coal resource of 265 billion tonnes.

Rationing of coal output is done through linkages. The linkages have to be converted into fuel supply agreements with coal suppliers after the end-users meet the project milestones. These end-users have to provide bank guarantees to comfort the coal supplier about the progress of the end-use project while the supplier may commit to only close to half of the contracted quantity and still not be liable to any commercial punitive payments. The calculation of the contracted quantity itself being done on obsolete normative principles does not seem to cause concerns when these extremes of rationing behaviour are assessed.

A relatively smaller proportion of the national coal output is sold through e-auction and the results of trades through e-auction mode further indicate that the concerns of supply shortages can force the consumers to resort to procurements irrespective of prices. It may appear that revulsions of free markets may not be as deep as those perpetuated by the government owned, controlled and regulated monopoly.

Competition

The market mechanism may be the worst form of coal mining sector regulation except all other forms may then be a safe conclusion to make. Infusion of competition in the market therefore needs to done quickly. A comprehensive approach to competition in coal sector has to encompass the structure, conduct and performance. Structure will reflect in technical and economic characteristics, including capital intensity, demand conditions, technology innovation and product substitutes; entry conditions including assessment and removal of barriers; number of participants and review of their outputs; imports and barriers to international trade and such other factors. Conduct will reflect the production, distribution and pricing mechanisms of the market participants, degree of information dissemination and arrangements between market participants and their trade practices. Performance will reflect efficiency and productivity.

Regulation of the coal markets and participants must complement competition. The role of coal regulator in the transition state from monopoly to free markets can never be overemphasized. It should facilitate removal of entry barriers, inflow of capital and investments, creation of commercially prudent trade arrangements and a check on exercise of market powers by the existing players.

For the short run, creation of competition in coal sector is possible through seeding competitive spirit among the Coal India Limited’s subsidiaries. An effective way for the same may be public listing of these subsidiaries in place of the holding company that portrays a picture of monopoly. Indian Chamber of Commerce in the second Coal Summit 2009 has proposed this approach in light of government’s intent to allow public listing of Coal India Limited’s shares. Competition through this route may still be only a part of the potential that can be targeted in long term, but it may still be a good beginning.