CIL penalty brings focus back on coal regulator - Quoted in the Financial Chronicle

The recent imposition of Rs 1,773 crore penalty on Coal India (CIL) by the competition commission of India (CCI) has bought the focus back on setting up a regulator for the coal sector on priority basis. The sector that is facing surfeit of issues including the inability to meet the growing demand is also leading to compromises wherever accountability can be evaded, according to industry experts.

Dipesh Dipu, a professor of energy and mining at Administrative Staff College, Hyderabad, says, “The demand and supply gap for thermal coal has been rising and questions have been raised about CIL’s capacity to meet the demand as the peak shortage has risen to more than 200 million tonne. This has translated into production pressures at coalmine level leading to compromises wherever the accountability can be evaded with weak system for checks and balances. It urgently calls for a central regulatory mechanism to address market excesses.”

This viewpoint has been seconded by company officials as well from NTPC, Mahagenco and Gujarat State Electricity Corporation, who believe a regulator is the need of hour and it can be executed better if monopoly related issues are addressed. Opening up the sector to competition from both public and private sectors should be taken up immediately to tackle the demand supply imbalance.

A senior NTPC official who has also approached CCI on discrepancy of coal supply issue believes, “Having a regulator is a must but that would work only if there are many more players in mine production, both public and private, of good credentials which would give people more options and not be driven by the whims of one player.”

The monopoly also restricts supply substitution where private players cannot provide any horizontal challenge or competitive pressure to a company like CIL due to the entry barrier imposed by the policy measures of the government and the Coal Mines (Nationalisation) Act, 1973.

Maharashtra Generation Company (Mahagenco) that filed two petitions against the bad quality coal received by CIL at its generation plants for the past two years and which led to penalising of CIL, states, the directorate general (DG) was of the view that CIL and its subsidiaries enjoy a dominant position in the relevant market and the company is vested with absolute monopoly in production and distribution of coking and non-coking coal besides having a monopolistic control on of the terms and conditions of fuel supply agreement.

The DG concluded that CIL and its subsidiaries had violated the provisions of the act by imposing unfair or discriminatory conditions in the relevant market. CIL has been penalised around Rs 1,773 crore or 3 per cent of the average turnover of CIL for the past three years.

Experts say the dilution of coal quality happens due to technological challenges as well as where Vitrinites and inertinites in coal molecular structure of the Indian coal due to drift origins cannot be helped. “However, use of surface mining technologies with limited capacities to segregate waste bands may results into avoidable compromises in quality. It may be agreed that technology and management may have a limitation owing to complex geology of Indian coalfields there must not be any tolerance of quality compromises due to production pressures,” said professor Dipu.

The role of coal regulator in the transition state from monopoly to free markets can never be overemphasised. 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, the experts believe.

Anti-trust ruling juices India's power companies - Quoted in the Monitor Frontier Markets

ON-THE-GROUND

"Better certainty of supply of high-quality coal could make power generation sector attractive for foreign investors and the Competition Commission's ruling helps." - Dipesh Dipu, energy sector analyst

The anti-trust ruling Monday against Coal India Ltd. marks the first time in India that a public sector company has been fined for abusing its state-sanctioned monopoly.

The Competition Commission of India has fined this week the state-owned Coal India Ltd. nearly $288 million for monopolistic practices. The curbing of such practices – along with the easing of rules governing import of coal, the pricing of electricity based on the high cost of imported coal, and the passage of a new land acquisition law – should make power generation in India more attractive for investors. 

“There are only two-three independent foreign players in power generation in India and the ones who have come in through Joint Ventures basically supply equipment and not run plants. Better certainty of supply of high-quality coal could make power generation sector attractive for foreign investors and the Competition Commission’s ruling helps,” leading energy sector analyst Dipesh Dipu tells the Monitor.

The world’s largest coal mining company faced the anti-trust ruling for supplying low-quality coal at high prices; retaining the right to unilaterally terminate contracts with buyers; not providing a fair dispute redressal mechanism; and preferring other state-owned companies over private buyers of coal.

The case was filed by two state-owned power companies from Gujarat and Maharashtra. Coal India is a monopoly coal miner and despite being the world’s largest, invariably falls short of the needed supply. It also imports some coal.

“Much of the issues between Coal India and power companies have been resolved with the new pricing mechanism introduced last year. That mechanism has less scope for manipulation.”

The issue of getting enough quantity of coal to power generation companies is slowly getting revolved. But the quality of the coal that the power companies get remains a big concern, says Mr. Dipu. 

What's behind Coal India's missing profits? - Quoted in the Business Standard

Coal India, the world's largest coal miner, has upped output prices as many as three times in the current financial year so far - a record of sorts. This, coupled with 5 per cent higher production, should have expanded margins and boosted profits like never before. On the contrary, the company posted a 10 per cent dip in net profit at Rs 6,783 crore in the first half of the current fiscal (Apr-Sep 2013) - its first loss in several years. Net profit had jumped 12 per cent during the same period previous year (Apr-Sep 2012). So, what went wrong?

An analysis of the company's month-wise performance reveals how the electronic spot sales, which have acted as the company's safeguard against declining margins and stagnant efficiency levels for years, ditched the miner this year. Data shows that while Coal India is selling significantly higher volume of coal through e-auctions this year, its price has remained stagnant despite a jump in notified prices, pulling down the net realisations on the back of rising fuel and employee costs.

Around a tenth of Coal India's annual 452 million tonne (MT) output is sold through e-auction at market rates largely to non-core consumers. These prices have historically been 50-80 per cent higher than the notified price at which the rest of the produce is sold. Between April and November this year, e-auction volumes grew 32 per cent to 34.8 million tonne. However, the price remained stagnant at around Rs 2,220 per tonne. To add to the problem, Coal India's premium in e-auction over the notified price has dropped significantly both on a sequential and year-on-year basis (see table). In other words, consumers are buying more e-auction coal but paying less. This naturally impacts the company's bottom line.

The developments in the two months of May and June highlight the new trend. While Coal India raised notified prices on May 28, making coal dearer by an average 10 per cent, e-auction volumes jumped 28 per cent in June. On the other hand, the price remained largely unchanged (see table). In the quarter ended September, Coal India's e-auction sales volume jumped 25 per cent -in stark contrast to a meagre 4 per cent growth in overall sales. Yet, realisation dropped by Rs 19 to Rs 1,418 a tonne.

The company accepts the dampening impact of declining e-auction realisations on overall performance. "In the second quarter, despite the growth in sales, our average realisation came down to Rs 1,418 per tonne, as compared to Rs 1,437 per tonne last year, largely due to the reduction in e-auction realisation," Coal India Chairman and Managing Director S Narsing Rao says. He attributes the dip in realisation to demand slump in the manufacturing sectors of cement and sponge iron, the non-core sectors which consume a large chunk of e-auction volumes. "Because of the dip in demand, buyers are not bidding aggressively, impacting realisations," he says. However, the overall volumes are still higher as core sector consumers in the power and steel sectors have started lifting more coal because of the domestic demand-supply mismatch that widened to 135 MT last fiscal.

Rising costs
The net realisations came under pressure also because of higher fuel bill and rising contractual expenses. Coal India's average cost of production per tonne rose from Rs 1,037 in 2011-12 to Rs 1,049 in 2012-13. In the quarter ended September this year, the company spent Rs 13,112 crore to mine coal against Rs 12,098 crore in the same period last year.

The stagnant e-auction prices may be threatening Coal India's profitability but it has corrected a major anomaly in the utility of the electronic trading platform. While e-auction was introduced by the government in 2005 to meet the short-term requirement of non-core sector consumers (cement and sponge iron companies), it gradually developed into a cushion for Coal India against near-stagnant efficiency. This trend has now been reversed.

What is worrisome for the company is that the dip in demand from the sponge iron sector is likely to continue. This means Coal India will have to grapple with lower spot realisations over the coming months. "The sponge iron manufacturers are not buying coal because their plants are running at below capacity. This is because, thanks to the illegal mining scam, there is no availability of iron ore. All the iron ore mines are either shut or restricted," Purushottam Kandoi, president of Odisha Steel Federation, which represents the sponge iron manufacturing companies in the eastern state, says. Odisha is one of the three sponge iron hubs in India, apart from Chhattisgarh and Bellary in Karnataka. The state has 104 dedicated sponge iron plants in addition to 30-odd integrated units that process sponge iron into steel. All of them are working at 10-20 per cent capacity. In Chhattisgarh too, a majority of sponge iron manufacturers have already closed shop. No wonder Coal India's spot sales are losing profitability.

Weak prices
Apart from the dip in demand, another reason for the hit to e-auction realisations is subdued global prices, particularly of high-grade metallurgical and thermal coal. "The price premium in the spot market is determined by global rates. The consumers, therefore, take the international prices as benchmark in the spot e-auction market. As the global rates are currently subdued, the bid price has been low as compared to last year's prices. The prices fetched by high-grade coal account for a significant portion of the profits," says Dipesh Dipu, energy specialist and associate professor-energy at the Administrative Staff College of India.

Benchmark prices of free-on-board Australian metallurgical or coking coal have come down from an all-time high of around $250-300 per tonne in January 2012 to $180 per tonne currently. Thermal or non-coking coal prices, too, have tumbled from $130 per tonne to $75 per tonne during the period. The historic price crash is a result of an ongoing industrial slowdown in China coupled with an oversupply in the Asian market due to increased shipment of high- grade US coal as new shale gas discoveries have displaced coal usage in that nation.

Dipu says these causes of the decline may not subsidise soon because global prices are expected to remain depressed over the next year. That factor, coupled with the demand slump from sponge iron sector, would continue to pull e-auction rates and hurt Coal India's profitability. However, he says the miner should look at the erosion of e-auction cushion as an opportunity to start focusing on internal efficiency. "Coal India must focus on improving efficiency levels if it wants to remain profitable now. It can begin with ensuring better availability of heavy earth moving machinery and streamlining human resources," he says.

Coal India's employee expenses rose 5 per cent to Rs 13,786 crore in the half-year ended September. Fuel bill increased 3 per cent to Rs 1,102 crore in the same period. Overall expenses rose 7.3 per cent to Rs 26,102 crore. The growth in expenses came along with a minuscule 2.6 per cent growth in earnings. Coal India's production grew 3.9 per cent to 452 MT last financial year. The company is likely to see its production growing at 5 per cent, a four-year high, in the current financial year. The expected annual production of 475 MT would still be short of the target by 7 MT.

Coal India and Coal Quality Conundrum

The key issue that the Competition Commission of India’s order on Coal India Limited pertains to is the discrepancies in coal quality received at the power stations of Mahagenco and GSECL and the prices charged. The power companies filed the petition in view of the prices charged for higher grades of coal while they received inferior coal; and due to alleged dominance of Coal India Limited, their grievances were not resolved.

Some of the reasons for coal quality issues are historical in nature. Earlier while the coal produced were graded on the basis of Useful Heat Value (UHV), a formula-driven measure of heat content, it dis-incentivised quality control. The UHV bands were wide, their pricing structures were skewed and the additive nature of ash content distorted the economics. Following illustration helps better comprehension:

Grade	UHV Band (kCal/kg)	Price (Rupees/Tonne)
F	>2400 to ≤ 3360	630
G	> 1300 to ≤ 2400	450

When 1 tonne of F grade coal was produced, say, with a UHV of 3200 kCal/kg, it would fetch revenue of Rs. 630. But if 1 tonne of dirt was added to it, the resultant was 2 tonnes of coal with UHV of 1600 kCal/kg which would fetch revenue of Rs. 900. Such distortions eclipsed the motive to produce good quality coal. CIL has since 2012 moved to GCV based pricing with relatively narrower range of quality parameters but persistence of the earlier practice for long may have led to a work culture of negligence if not wilful contamination of coal with ash.

The dilution of coal quality happens due to technological challenges as well. Vitrinites and inertinites in coal molecular structure due to drift origins of Indian coal cannot be helped. However, use of surface mining technologies with limited capacities to segregate waste bands may results into avoidable compromises in quality. Larger sized equipment help productivity but result in loss of thinner seams of coal available in a mine and also result in dilution of coal quality. Use of surface miners may be helpful but this technology has its own set of geotechnical parameters for suitability of application. These apart, there cannot be a substitute for active mine quality management. This necessitates high degree of exploration, predictive geological model and accuracy in technological selection.

While it may be agreed that technology and management may have a limitation owing to complex geology of Indian coalfields, there must not be any tolerance of quality compromises due to production pressures. The demand and supply gap for thermal coal has been rising and questions have been raised about CIL’s capacity to meet the demand, which translates into production pressures at coalmine level, leading to compromises wherever accountability can be evaded.

There are also the issues of management of sampling and assaying. The practices of sampling and quality measurements have been disputed and sometimes the facilities to precisely determine the run-of-mine quality of coal are found wanting. Use of independent agencies is favoured but when stakes are large these agencies may not be truly independent and quality reports may be “managed” leading to serious mismatches between recorded qualities of coal delivered at mine mouth and that at receiving end at the power station.  Use of global firms with digital online analyser technologies may be expensive but can such eliminate disputes and build trust.

While investments in technology are easier, the much needed organizational focus on quality assurance at the working faces and mine-mouths are challenging and need cultural shift. CIL leadership has shown commitment to customers in the recent past and the CCI’s decision to impose penalty will only go on to reinforce the need to translate that commitment into practices.

The other larger issues of competitiveness in the sector are tied to the legislative framework. 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.

Under the current circumstances, opening the sector may be better suited since continuing with the legacy system that has not been able to perform to expectations will not bridge the demand and supply gap and will add to imports. These can be done through the stepped approach such as 1) Creation of open and vibrant market with large number of suppliers; 2) Market based pricing mechanism – in the transition period and supply constrained market, regulatory mechanism to address market excesses; 3) Enabling the safety and environmental regulations to be efficient and effective in continuous monitoring and remedial measures; and 4) Enabling investment environment such that market participants and stakeholders form a cohesive eco-system.

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. 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.

(*The writer is an Associate Professor in the Energy Area of Administrative Staff College of India. Views are personal.)