The challenges with imported coal based power generation in India - My article in the Power Watch India magazine

The gap in the demand and supply of domestic thermal coal is widening and is expected to reach a level of more than 100 million tonnes this year and the government sources estimate the gap to rise to nearly 434 million tonnes by end of the next five year plan (2012-17). It is therefore certain that Indian dependence on imported coal is only going to intensify. But there is a need to assess the scenario and step back before formulating an imported coal based power generation strategy.


The reason coal has been and is likely to remain the mainstay of Indian power generation sector is due to two key factors in its favor – accessibility and affordability. The domestic resource base stands close to 285 billion tonnes of which the proven reserves are about 114 billion tonnes. Although these are gross resources and do not account for depletion, including those through production, it is sufficient to assume that resources-to-production ratio is more than comfortable. Similarly, the cost of production of coal, mostly through open cast mining methods; have been lower to enable affordable power generation. Now while the domestic coal availability has become a constraint and that cost pressures have also been felt, it is required to examine the case of imported coal based generation on the similar framework.

Accessibility: Coal reserves are geographically well distributed and Indian location makes choice of importing thermal coal wide to include Australia, Southeast Asia and Africa. Several transactions in coal assets have indicated the preference to Indonesia, South Africa, Mozambique and Australia for thermal coal. Of these countries, Mozambique is still to prove its credentials and it is likely that a larger proportion of production will be that of metallurgical coal. Mozambique also has to grapple with laying of rail tracks between Tete coalfields and ports of Ncala, Beira and Maputo, while the ports have to create facilities for coal evacuation. Given these, the contribution of Mozambique in the thermal coal imports to India appears less than certain for now.

Considering Indonesia, South Africa and Australia, the exports of thermal coal from these countries have been high. Indonesia has quadrupled its exports in the last decade. While the growth rates in exports in the past are also reflective of lower base effect, it can be safely asserted that future growth cannot match the past. However, according to Indonesian Coal Mining Association estimates Indonesia may produce as much as 390 million tons of the fuel in 2012, with a domestic consumption of around 70 million tonnes, which then allows the exports of nearly 320 million tonnes possible. At this rate Indonesia will likely remain the focus for Indian thermal coal exports. But Indonesia has a proven reserves of only around 21 billion tonnes which may make large scale exports growth a challenge for future strategic planning.

Exports out of South Africa have been stagnant around 70 million tonnes per annum and the same is likely to continue since the country itself faces shortage of coal for power generation and has domestic market obligations to be met.

Exports out of Australia to India of thermal coal have been low, mainly due to logistics issues. But Australia has vast reserves and can hold forth in offering coal supply options for India for long term. There are however challenges around rail networks and port capacities, which have dragged the exports of coal from east coast. There have been severe weather conditions also in the past leading to floods leading to invoking force majure conditions and impacting coal exports.

Then there is competition likely on the supply side, given China’s significant share in global coal production and consumption, a minor imbalance in the domestic Chinese market would impact the rest of the world. China has already become a net importer of coal and there tilt in imports can make supplies grossly uncertain for India.

While Indonesia and Australia do have the potential but these may not grow at a pace the gap between demand and supply is rising in India. Hence, imported supplies may be still uncertain for the quantum India purports.

Affordability: This rapid growth in coal demand in the internationally traded coal has impacted pricing substantially. Even though suppliers, such as Australia and Indonesia, ramped‐up production quickly, a strong increase in demand caused an unprecedented spike in the price of coal since 2003-04. Although the prices eased a bit during 2008-09 on account of financial crisis, but it recovered soon.

With such pricing the landed costs at Indian ports are likely to remain high, and cost of power generation may breach the levels of affordability. For illustration, a coal procured at US$ 110 with a freight and insurance charge of US$ 15 and a port handling charge of US$ 10 will have a landed price at exchange rate of Rupees 50/US$ of Rupees 6750 per tonne. If the calorific value of coal is around 5500 kCal/kg and station heat rate of 2300 kCal/kWh and an auxillary consumption of 8.5%, the resultant variable cost of generation at the bus bar will be Rupees 3.08 per unit (kWh). This when compared to domestic coal based power at pithead looks expensive.

This also has to be considered in the light of the fact that distribution utilities in India have had large accumulated losses and due to political pricing of energy, they accumulate more losses when they sell power. As a result they prefer load shedding over purchasing relatively expensive power. Hence, imported coal based power may not find easy buyers even while a section of consumers resort to still more expensive power using diesel generator sets. The manifestation of this anomaly in the system is reflected in the reported 10 million tonnes of imported coal stockpiled at Indian ports unable to find buyers while the power shortages in India are worsening by the day.

The Challenges: The investments in Indonesia used to focus on low-cost procurements of coal to be fed into power plants in India. This was strategic and companies invested in acquiring assets and equity, even minority stakes, to ensure cost-plus coal transfers from Indonesia. But this caused severe revenue leakage for Indonesia in the forms of price-linked royalties and lower taxable income of Indonesian coal mining subsidiaries on India power companies. The government therefore promulgated regulations for benchmarked coal transactions, which seems to have been a spanner in the wheels on Indian power companies.

Resource nationalism is on the rise and so is the rent seeking behavior. The Australian government also imposed Mineral Resources Rent Tax on coal which can make procurement of coal from Australia more expensive. Apart from taxes, the host countries have been demanding greater social development expenses, higher royalties, investments in value additions within the country, support for philanthropic initiatives and such others, while trying to capture much of the wealth creation from coal mining chain. This may make investments abroad a challenge, while with no investments, there will be greater degree of uncertainty in coal supplies.

Import dependence for energy has only increased in degree for India. While there does not seem to be an option in oil and gas sourcing, domestic coal can be optimally be developed to check dependence on imports. Inability to develop available resources can only lead to enhanced dependence and that can distort demand and supply scenario of the international markets and keep prices stiff. With concerns around availability of coal even from imported sources and the affordability of imported coal based power, the scenario looks like a perplexing equation.

Indian Mining Sector Investment Climate Needs Overhaul - My article in the Mining India magazine

Mining industry as the prime mover


Growth in the Indian industry as reflected by the recent Index of Industrial Production is being pulled down by poorer than expected growth rates in mining sector. The year-on-year industrial growth for October 2011 has been reported as negative 5.1%, which has mining sector growth pegged at negative 7.1%. Coal production has fallen for the third month in a row while the iron ore mining has been in doldrums since the ban on Karnataka mining. While the optimism for the economic growth of India on a medium to long term still persists, there are serious concerns about how those targets would be achieved without each of the components of the economy performing to expectation.

Mining industry in India is likely to remain the prime mover. For example, coal sector is still to contribute to 70% of power generation capacity addition being planned for the 12th Five Year Plan. Targets of large capacity addition in steel sector, similarly, will depend on development of iron ore mines. With such leverage on mining sector, it is about time that the sector is assessed for investment climate.


The typical framework for assessment of mining sector investment climate in India will include review of political environment; social environment; statutory and regulatory environment; and economic and fiscal regime for mining.

Political Environment for Mining

The political system in India has been stable form of democracy but the influence of parochial interest groups have led to several regressive measures being taken that may have significant impacts on mining sector investments. Politics of mining has been raising its influence in the mineral rich States such as Karnataka and Goa. Karnataka witnessed a change in the leadership of the government due to forces of iron ore mining from Bellary that found allegations of large scale illegal mining and exports surfacing. That there are growing number of miners in the political arena and growing number of political interests in mining is given due to commodity prices seeing rising trends leading to windfall cash flows for commodities like iron ore. For the same reasons, there has been maddening competition for new mining licenses. Such has been the competition that it has become difficult for the agencies to decide in favor of one and rejecting others without raising challenges and potential litigations. Even for coal block allocations, where the union government plays a larger role, 2006 allocation saw 748 applications for 16 coal blocks for power generation end use. Political influence in such cases makes the process abysmally slow and, in some instances, has stalled issue of new licenses altogether.

Political environment also has to concern the state and union government relations. Mining industry being subject to several union and state laws, rules and regulations are likely to be affected by the relationship between the state and union governments. It has been observed that the mineral rich states have tended to have government from parties that are in the opposition at the union level. These have sometimes led to delays in approvals and clearances to mining and end-use projects in the state. These do not support the investment climate in mining.

Corruption has been another major concern in the political, regulatory, and legal systems, and India needs to take this issue head-on by instituting new controls, such as Lokpal, to improve the investment environment in mining sector.

Social environment

Social issues concerning land acquisition, forest clearances and rehabilitation & resettlement, which have seen several mining projects delayed and some even shelved altogether. Delay in iron ore lease to Korean steel manufacturer along with delays in land acquisition for the steel plant itself has seen potentially one of the largest foreign direct investments in abeyance for more than 7 years. Land acquisition issues have also affected several bauxite mining projects in the states of Andhra Pradesh and Orissa. Several coal mining projects across the country has been delayed due to social concerns, these include expansion of existing mines as well.

The social issues have been of the nature of manifestation of ‘resource curse’ for the states and regions that have seen the mining projects not benefitting the project affected people. The watchwords in the mining industry such as sustainable development, social license to operate and such others have gained currency, the mining industry one hand is still to adopt and implement in letter and spirit, and on the other the same principles have often been used by opponents to delay or completely halt mining projects.

These get compounded by issues such as Naxalism and Maoist terrorism, which have resulted in strong negative perception about investment potential in certain regions of the country, which are mineral rich. While the politics of the state and the union determines the degree of support for the development of mining projects in such areas, suffice it to say that the investments fall in low priority zone for such regions.

The union government has been working on the new land acquisition bill that is likely to have a far reaching impact on how mining business will be done in India. The provisions for high initial payments are appended with annual payments which create future liabilities on the project. There has not been a political consensus on the subject, and this has also fuelled uncertainty in investments.

Statutory and Regulatory Environment

Indian statutory and regulatory environment has been in a flux for long. The Coal Mines nationalization (Amendment) Bill has been pending with the Parliament for more than a decade. The Mines and Minerals (Development & Regulation) Act (MMDR) has been amended once and then several other amendments have been debated for long with no consensus in sight. These statutory pieces have significant potential for impacting the mining sector investment scenario in India.

Positives of the new bill are the provisions for making investments in exploration and prospecting attract risk capital and have exit options. These will help private sector investments in much needed exploration and also allow specialized firms to invest in various stages in the life of a mine. By removing restrictions in transactions of licenses, the objectives of creating better investment environment can be achieved. This will build upon the other positive move made earlier of the inclusion of competitive bidding for allocation of mineral resources. This has set the platform for efficient and transparent mechanism for allocation of resources to deserving players. While the details of the processes for various minerals are still emerging, this provision has the potential to instill confidence in the process of allocation.

The negative seems to emanate from the concerns regarding the 26% profit share for coal and one-time royalty equivalent payment for other minerals aimed at social development. The benefits of adopting sustainable development approach to mining are manifolds, which are the reasons why the Indian mining industry is willing to invest in the societies around their operations and obtain their social license to mine. Risks of antagonizing the social set up can manifest in projects being shelved or substantial cost overruns. In view of these making a mandated payment for the same, while there are challenges in effective delivery of these social goods through government-owned mechanisms has been a drawback.

Speedy implementation of projects depends upon land acquisition, rehabilitation & resettlement and several clearances & approvals. The profit share for social development may help to a certain extent as the project affected people may see reasons to believe that their long term interests are likely to be protected. However, degree of its effectiveness will largely depend on the expectation of government machinery to deliver. On the clearances and approvals, whose process are labyrinthine and involve both central and state agencies, the Bill may not have provided a relief. The long standing demand from the industry for a single-window clearance system remains unmet.

For the captive coal miners, in particular, the cost of power generation or any other approved end use will increase. Although in the scenario of competitive electricity procurements by the utilities, it will remain to be seen how much of the additional cost can be passed on to the consumer. This may have an impact on the attractiveness of investments in coal mining as well as power generation industries. On the operational side, the issues of determination of optimum cost of coal mining and appropriate transfer price will arise soon, which will typically determine the extent of profit share.

There is a need to make process of clearances and approvals of mining and prospecting licenses predictable and time bound. The process needs objectivity and must have a defined measurable parameters for an application to be evaluated. The procedure also needs to have close coordination between the central and state agencies, which could be institutionalized through appropriate provisions in the Bill.

On the Policy Potential Index (PPI) of the Fraser Institute’s annual survey of mining companies for 2010-11, India ranks among the bottom 10 along with Indonesia, Zimbabwe, Wisconsin, Madagascar, Guatemala, Bolivia, DRC (Congo), Venezuela, and Honduras. The Institute defines the PPI as a composite index that measures the effects on exploration of government policies including uncertainty concerning the administration, interpretation, and enforcement of existing regulations; environmental regulations; regulatory duplication and inconsistencies; taxation; uncertainty concerning native land claims and protected areas; infrastructure; socioeconomic agreements; political stability; labor issues; geological data base; and security. The low score of India on the PPI shows that the statutory and regulatory environment in India may not be attractive for investments. The cause of concern is also the fact that between 2009-10 and 2010-11, the score on this account for India has fallen, indicating a deteriorating investment environment.

Economic and Fiscal Environment

The economic environment for mining has been challenging in the recent past due to cost push and shortage of equipment and labor. The talent pool for mining management has also been shallow and there are competition from other industries such as information technology for hiring talent that are trained in mining and geosciences. Cost push has come from higher costs of labor and talent; expensive power and higher consumables costs. The capital costs have also gone up due to higher costs of steel and other manufacturing inputs. The working capital investments are higher too since the lead times for procurement of spares have increased substantially; and their availability and quality have been concerns to. According to an estimate the lead time for procurement of dump truck tyres has increased to nearly two years and there are no availabilities guaranteed. While the Chinese manufacturers have gained market share in tyres, there are some questions regarding their quality.

Another input for mining, namely explosives, has become expensive as well due to their fuel oil component (typically diesel) whose prices are higher due to higher crude oil prices in the international markets.

In India, public sector companies typically do not resort to loans and borrowings for capital expenses. However, with greater participation of private sector in mining, debts will be a major source of funding mining projects, and their costs will be a component of cost of mining. In the recent past, the borrowings from banks and domestic financial institutions have become expensive. The Reserve Bank of India has revised the policy rates several times in the last year to tighten inflationary situation in India which has in turn increased the borrowing costs for mining projects and have had squeezing impact on cash flows for equity holders and profit potential of the projects.

On fiscal front, there are uncertainties pertaining to direct tax code and Goods and Services Tax, which have been hanging in the balance for quite some time now. Royalties have been now ad valorem based which link in most cases to international prices of metals. The provision for 26% profit share for coal mining and one-time-royalty-equivalent payment for social development, although not strictly a fiscal measure, also have created uncertainties on the financial viabilities of marginal mining projects.

Conclusion

The investment environment in mining sector in India requires substantive measures to improve the perceptions. The key challenges will be to contain corruption and negative political influences through improving transparency in allocation of mineral resources and all transactions of minerals. Information technology enabled governance can help this cause. Social issues need to be addressed with a balanced approach so that project affected people are duly compensated and the projects are economically viable and do not the risk of time and cost overruns. On statutory and regulatory front, there is clearly a need for streamlining the clearances and approval processes, a joint coordination committee from the union and state governments with empowerment may be a way out. On economic and fiscal issues there is a need to maintain stability and create facilities to fund mining projects. These put together can help improve Indian mining sector investment climate and help develop new projects that can help meet the growing demand for minerals.

Impact of cut in customs duty on imported coal based power generation - My views in the Power Line magazine

• Do you think the power ministry’s proposal to waive the custom duty on imported coal will bring the needed relief to power developers?


Customs duty waiver will certainly bring relief and make imported coal based generation a little less expensive. Although for the past 3-4 months, internationally traded thermal coal prices have remained stable, but these are high by any standards. This at a time when the distribution utilities have refrained from buying expensive power. Hence, the resultant is that there are shipments of imported coal available at Indian ports with no takers. The depreciation of Indian Rupee has also further compounded the challenges and made import of coal seemingly un-affordable. Hence, the waiver of customs duty may bring in some relief in view of its relatively smaller proportion in the total cost of imported coal based power generation.


• What else do you think can the government do to resolve the crisis in the short term?

There does not seem to be many short term measures that can help the crisis in power generation and coal mining sectors. Widening gap between demand and supply of coal has had impacts on bank disbursements to power generation sector, which from the other side of the value chain faces issues of credit worthiness of the distribution companies. This is the scenario when there are consumers who may have affordability, since several of them run diesel generation sets for substantial parts of the days and weeks. The structural distortions in the market cannot be fixed by short term measures. The sectors need overhauls, for which appropriate mechanisms have been debated for a long time. Reforming coal sector through enhanced and scalable participation of independent private and foreign mining companies; restructuring and degrees of privatization through franchisee models and increased private sector participation in distribution sector; and better implementation of open access through phased elimination of cross-subsidies (although already mandated by the Electricity Act 2003) would go a long way to help the electricity sector. On these accounts, which are the primary reasons of the crisis in the sector, there does not seem much of effective options for short term measures.

Coal India's profit earning strategy turns aggressive - Quoted in the Business Standard

Coal India’s new strategy to save margins in a production-constrained market by capitalising on the quantum jump in spot prices of the dry fuel, has turned more aggressive.
The contribution of spot sales, or e-auction, to the state-owned miner’s total revenue saw a rise of 17 per cent in the first half of this financial year, compared to less than 10 per cent in the same period last year. This was even as the share of e-auction in the overall volume of coal sold remained stagnant at 10 per cent.
While the world’s largest coal producer adopted the strategy in 2010-11, the first half of this financial year was marked by a decline in production for the first time in the company’s history and an increase in the notified price in February. Both factors, experts say, should have made e-auction less attractive. However, that did not happen.
In the first half of 2011-12, revenue from e-auction rose 68 per cent to Rs 6,134 crore, from Rs 3,664 crore. This was a result of the skyrocketing average sale price at e-auction, which doubled from Rs 1,808 a tonne to Rs 2,693, thanks to historic coal shortages, forcing more buyers to opt for the costly e-auction coal.
Coal India’s production remained flat at 431 mt last financial year. During the first half of last year, the company sold 199 mt of coal. Of this, 20.2 mt was sold through e-auction. Total sales stood at Rs 27,495 crore, of which Rs 3,664 crore was contributed by e-auction. Coal through e-auction was sold at a 73 per cent premium to the notified price of Rs 920 a tonne.
Between April and September this year, the company sold 176 mt coal, an 11.5 per cent decline compared with the same period last year. Of this, 22 mt was sold through e-auction. Total sales stood at Rs 35,499 crore, of which Rs 6,134 crore came from e-auction. E-auction coal was sold at a price of 68 per cent over the notified price. Notably, the notified price itself was increased in February to Rs 1,600 per tonne from Rs 920 last year.
Experts believe with coal shortage unlikely to subside soon, the boost to Coal India’s profitability as a result of increased realisation from e-auction sales is here to stay. While there has been substantial power capacity addition, coal production has risen only marginally, leading to a shortfall in linkage realisation, they say.
“The greater reliance of coal consumers on e-auction may have led to higher prices. Even on e-auction, some coal available has not been picked by the consumers for reasons such as availability of transport facilities and to some extent, concerns about quality. So, the quantum of coal available through e-auction has also been limited, which may reflect higher prices,” says Dipesh Dipu, director - consulting for mining at Deloitte Touche Tohmatsu India Pvt Ltd.
He says heavy reliance on e-auction sales for profitability may not be a concern, as “the coal market is likely to remain a sellers’ market for some time”. Globally, coal miners have moved from annual price contracts to quarterly ones and many have balanced their portfolios with a higher proportion of spot sales.
On the Bombay Stock Exchange, Coal India shares closed 1.1 per cent higher at Rs 334.4.

Bloomberg UTV Power Summit 2011 - Quoted from this conference

THE POWER SUMMIT 2011, organised by BloombergUTV, India’s premier business channel, opened the second day with the inaugural address by Chief Guest, Shri. Sriprakash Jaiswal - Hon’ble Union Minister of Coal at the Taj Mansingh in New Delhi. The theme of the three day summit is “Future Power, Future Strategies – A New Paradigm.”

Shri Sriprakash Jaiswal in his inaugural address, asking coal companies to fast track the production mechanisation, said “Coal companies have been slow in appropriate mechanization. They need to fast track the mechanization process. Coal sector in India is yet to be opened for private investments in commercial coal-mining. Coal Production is a big challenge. India has to be dependent for few more years for import of coal.”

Shri Sriprakash Jaiswal, speaking about the challenges in the sector, further added, “The energy issues with environmental concerns are more challenging. Proper maintenance of system for transportation is required. Critical areas in enhancing coal production are road infrastructure, railways, timely acquisition of land, large scale import, handling imports carefully”. He also asked the Ministry of Power to target for higher growth of energy to minimise the gap between demand and supply.

Shri Dipesh Dipu, Director – Energy and Resources, Deloitte, speaking at the Summit said, “A serious problem that plagues the industry is the availability of coal as well as the facility to transport whatever is available. There are a large number of coal blocks in the country which have not been tapped primarily due to rail connectivity. The Government should look at auctioning these coal blocks and provide them with appropriate connectivity to railway networks.”

Shri Pradeep Singh, VC and MD, IDFC Project, speaking in a panel discussion on ‘Challenges faced by Independent Coal Power Producers’ said, “There is enough coal for your and my lifetime; point is to get it out. Private sector should not be given the right to handle the natural resources. It is the right of the government and the private sector should be given the right to refine and supply them”

Shri R T Agarwal, Director - Finance, Power Grid Corporation of India said “There are certain areas where there is availability of coal, but distribution companies are not willing to buy it. There is affordability in the market but not connectivity in the buyer and seller.”


Dr. Rahul Walwalkar - VP (Emerging Technologies), Customized Energy Solutions, said ‘’Successful reforms have taken place on the generation side, but the problem lies in distribution reforms. Open access is the most possible solution for the distribution and transmission issues faced by the industry’’
Shri Anil Daulani – Business Head – Utilities, HCL Infosystems Ltd. said, “India is a large country and reaching all its corners has its own challenges and, in most cases, the problems are very local. These can be addressed through PPP and franchise models and there is enough technology available in the country to support this. What also is critical is that the Government puts in place appropriate regulatory framework before allowing any of these models to be implemented.”
The POWER SUMMIT 2011 has been conceptualized and executed by BloombergUTV PULSE Conferences & Summits, a division of BloombergUTV that specializes in customized solutions for client brands and as an extension of its services to offer specialized conferencing & exhibitions solutions to clients.

Impact of MMDR Amendment propositions - My interview with Power Line magazine

• What are the key positives and negatives of the MMDR Bill?


Positives of the new bill are the provisions for making investments in exploration and prospecting attract risk capital and have exit options. These will help private sector investments in much needed exploration and also allow specialized firms to invest in various stages in the life of a mine. By removing restrictions in transactions of licenses, the objectives of creating better investment environment can be achieved. This will build upon the other positive move made earlier of the inclusion of competitive bidding for allocation of mineral resources. This has set the platform for efficient and transparent mechanism for allocation of resources to deserving players. While the details of the processes for various minerals are still emerging, this provision has the potential to instill confidence in the process of allocation.

The negative seems to emanate from the concerns regarding the 26% profit share for coal and one-time royalty equivalent payment for other minerals aimed at social development. The benefits of adopting sustainable development approach to mining are manifolds, which are the reasons why the Indian mining industry is willing to invest in the societies around their operations and obtain their social license to mine. Risks of antagonizing the social set up can manifest in projects being shelved or substantial cost overruns. In view of these making a mandated payment for the same, while there are challenges in effective delivery of these social goods through government-owned mechanisms has been a drawback.

• Do you think the Bill will enable speedy implementation of coal mining projects?

Speedy implementation of projects depend upon land acquisition, rehabilitation & resettlement and several clearances & approvals. The profit share for social development may help to a certain extent as the project affected people may see reasons to believe that their long term interests are likely to be protected. However, degree of its effectiveness will largely depend on the expectation of government machinery to deliver. On the clearances and approvals, whose process are labyrinthine and involve both central and state agencies, the Bill may not have provided a relief. The long standing demand from the industry for a single-window clearance system remains unmet.

• What will be the impact of the Bill on captive miners?

For the captive coal miners, in particular, the cost of power generation or any other approved end use will increase. Although in the scenario of competitive electricity procurements by the utilities, it will remain to be seen how much of the additional cost can be passed on to the consumer. This may have an impact on the attractiveness of investments in coal mining as well as power generation industries. On the operational side, the issues of determination of optimum cost of coal mining and appropriate transfer price will arise soon, which will typically determine the extent of profit share.

• What aspects, in your view, need modification or are missing?

There is a need to make process of clearances and approvals of mining and prospecting licenses predictable and time bound. The process needs objectivity and must have a defined measurable parameters for an application to be evaluated. The procedure also needs to have close coordination between the central and state agencies, which could be institutionalized through appropriate provisions in the Bill.