Mining financial markets for coal - My article published in the Financial Express

Coal mining industry is poised to play the pivotal rote in providing energy security for the economy. With expected demand of close to 2.34 billion tonnes per annum by 2031-32, which is about five times the current rate of production, private sector participation is inevitable. However, for this to happen, the financial markets need to evolve as well. Traditionally, coal mining by Coal India Limited has been equity financed, with a large proportion of the funding coming in from the accumulated profits or government’s budgetary allocations. A look at the typical tangible asset based coal mining process will indicate that such resource allocation strategy can hardly be called prudent. The tangible assets can easily be securitized and hence, debt at lower costs of funding may be utilized substituting equity. But the industry leaders have tended to compare the cost savings of debt funding with the post-tax income generated from the cash reserves that they tend to keep in banks’ fixed deposits. Such comparisons completely miss the concept of opportunity costs, where the same source of funding, adequately leveraged, could help open new mines.

However, the equation can not be solved that easily. For debt funding to flow, the banks and financial institutions need to comprehend the unique dynamics of coal mining sector. Bankers are observed to struggle even with the concept of stripping ratio in open cast mining, since the applications for funding have come their way only now when a few private sector entities have begun to make their presence felt.

For better equity markets, the coal mining companies need to be open to investments by public and their listing process itself is likely to educate the investors. CIL has proposed an initial public offer of its shares. With not many comparable stocks listed, there are likely to be issues in benchmarking multiples and arriving at prudent valuations. CIL may be expected to rank among the largest in the world in terms of market capitalization. However, to add greater depth to the equity market, the nine subsidiaries of CIL, which are mini-ratna companies, may instead be listed. This suggestion from the Indian Chamber of Commerce expressed at the Coal Summit 2009 may be examined in detail as this could lead to other benefits as well such as enhanced competition in the industry. There could be public float of Singareni Collieries Company Limited as well. The public shareholding of Neyveli Lignite Corporation, the only listed lignite mining and power generation company, can be enhanced. The private sector companies with coal mines and contract miners may also be encouraged to tap the equity market. All these put together can improve the visibility of the coal mining companies in the market, provide them with much needed funds, develop investor confidence including those of the lenders, and help accountability and transparency in the public policies pertaining to the sector.

Development of alternate investment markets, as those existing in the UK, Australia and Canada, may help financing of prospecting and exploration activities in the sector. A large number of coal blocks that are proposed for development are only partially and regionally explored, which, therefore, have the risk of delayed and subdued investments. The alternate investment markets can provide risk capital for activities such as exploration, resource investigation and proving reserves. This may also add to the market specialized participants whose business model involve risk taking, proving reserves and exiting at attractive valuations. With the National Mineral Policy proposing to add marketability to the prospecting licenses, this new dimension to the financial market seems closer to reality but for the creation of an alternate investment markets.

The coal mining companies need to improve their financial reporting to assist development of both debt and equity markets. The current format for financial reports leaves a lot to be desired and often times is no different from financial statement of a typical manufacturing company. Key assets of mining companies are the reserves which are depleting with production and may sometimes rise due to new discoveries or acquisitions. But the reserves and reserves-to-production ratios go unreported. These make fundamental analyses handicapped and largely dependent on trends in revenues and costs. Such analyses then tend to use greater discount rates to the assessed cash flows and hence, may result in lower than expected valuations.

Sustainability reporting can also help development of markets for coal mining industry. Although not mandated, the companies may produce these reports as a compilation of their efforts to meet governance, environmental and social expectations. These reports can be used to communicate with the stakeholders, including those providing sources of finance, and help in aligning risk perceptions. These efforts by the industry are likely to bear fruits and help the market participants securing finances to mine more coal to feed the growth engines of the economy.