Coal Sector Chaos – Genesis to Revelation - And my views on the way forward

“Let there be light”, intends the government of India but the fuel side of the story paints a blackout. The recent Supreme Court judgement about illegality of coal block allocation has put a question mark on the sustainability of growth in capacity addition in power generation. The trouble however is not a black swan event; it had been brewing for years.

When coal mines were nationalized in 1971-73 in two phases, the provision for captive coal mining was retained to allow for continuation of coking coal mines of then called TISCO, IISCO and DVC. This one provision led to a series of measures that shaped the coal sector landscape. In 1993, the captive route was opened up for steel, power generation and coal washing for allocations of blocks for public and private sector companies. This was extended for cement sector in 1996 and then for coal gasification and liquefaction 2007. The definition of captive was enhanced further to allow companies that had long term coal supply contracts for the approved end users also to be considered eligible for allocation. The ownership of government owned companies was considered complaint with the Coal Mines Nationalization Act for government dispensation route for commercial mining, which allowed these government owned agencies to mine coal and sell in the market, which no private company was allowed to do. 

The number of coal blocks allocated between 1993 and 2004 reveals that there was not much of demand for coal blocks. The international prices of coal had been range bound from 1977 till 2003 around US Dollar 25-30 in nominal terms, which meant that prices fell in real terms taking into account inflation over the period. Prices in India could not have been higher than global prices, and hence, the CIL prices were low too. As a result, coal input costs were not significant parts of the cost structures for steel or cements manufacturing or power generation. The spur in demand from 2003 onwards led to the international prices to peak, analysts failed again and again in their assessment of coal prices cooling off and stabilizing at much lower prices than they were trading. Coal miners globally became price makers. This boom was also reflected in the demand for coal in domestic market as the economic growth engines needed more and more electricity and power generation capacities were to be added at brisk pace. Domestic prices rose up too leading to coal accounting for 40 to 60% of the final cost of manufacturing or power generation. Now it began to make strategic sense to acquire coal assets for price advantages and supply securities.

Evidence of the rush to acquire coal assets became evident in 2007 round of coal block allocation when for 16 coal blocks identified for power sector in private sector route received 748 applications. The “beauty parade” methodology for allocation was not geared up for handling this situation. The applications focused on the development stages of end use plants, degree of preparedness, size of plant, a few financial parameters of the project developer and on the extraction plans for the mine. These were to be evaluated by a Screening Committee with memberships from a large number of stakeholders. The degree of competition was so high that it became fairly evident that process would fail and there were questions raised in the aftermath of allocations from all quarters.

The methodology of evaluation was sought to be improved. The economics of captive power generation for the manufacturing of metals like aluminium, copper, lead and zinc which are totally market driven were seen to less favoured just as those merchant power plants which purported to keep a larger portion of their generation capacities free and not tied up with long term PPAs. The called in applications for allocation of coal blocks for merchant power plants were not considered with the realization that such could open up a potential for profiteering.

In the subsequent rounds of allocation, the marking scales were devised for quantifying merits. However, as the Supreme Court order of 1st September 2014 observes, the breaches were many for consideration as higher in merit for allocation.

The letters of allocation were evolving too. The earlier ones did not mention the risk of de-allocation and did not require furnishing of any bank guarantees which the later allocations of 2008 onwards did. The earlier ones did not specify the usage of coal middling and washery rejects and the ownership question of these were left unanswered. While the transfer of ownership of coal block or its leasehold was not permitted, the transfer of equity in the holding company with the power generation asset was not covered. Given these, there were chances that coal blocks could be packaged in some form along with the respective end use plant and spun off and sold in the market. As consultants would call these, value could be unlocked.

The challenges of operationalizing these coal blocks began to surface soon enough. Most companies had no experience and expertise in coal mining. They required consultants even for filing in application forms for prospecting licenses and prior approvals for mining leases. Procuring environmental and forest clearances became tougher. Land acquisition turned out to be the most critical milestone, which could not be done phase-wise in view of the new realities and all the land needed to be acquired and possessed at the beginning. Most stakeholders stoked their greed as coal mining projects began to be considered bonanza. 

A whole new industry for mine developer and operators (MDO) evolved, and the contractors that were engaged in overburden removal earlier saw this as the natural extension in their evolution. Since these were newer concepts, risks were not well understood by the owners and the MDOs, leading to unbalanced risk sharing. Due to limited market depth, the MDO agreements appeared to be a good business even with such formulations of project responsibilities and risk sharing. Lot of consulting opportunities were created as well but consultants of several hues mushroomed to compete on lowest-price basis.

The doubts over providing competitive advantages to those allocated with coal blocks and unrestricted potential for profits led the government to make a series of rules. Coal produced from the coal blocks needed regulatory oversight and the power so generated needed to regulate fuel charges. Long term PPAs with state distribution companies were necessitated. These were in view of the electricity market moving largely to tariff based competitive bidding models of Case 1 and Case 2 defined by the Electricity Act, 2003, which obviated the role of electricity regulators in the electricity so procured.

There were flip flops on the front of captive coal blocks having the potential to produce surplus coal, which was expressly restricted but in view of widening gap in the demand and supply of coal, largely due to state-owned CIL not being able to augment capacities quickly, required some measures to tap the reserves in the allocated coal blocks. The proposals ranged from allowing CIL to buy the surplus coal so produced at notified price minus a certain commission to forming a kind of coal-bank where a surplus coal supplied to another project could create a credit in coal and could be redeemed later when coal for the project was available from its own sources.

This was when the CAG report was published.

The analysis can be summed up by saying that labyrinthine policy measures were taken and rules and regulations that added to the layers of complexity were made to fix the problems of the coal sector. The pending Coal Mines Nationalization (Amendment) Bill 2000 that sought to impact the fundamental of coal mining business in India languished.           

Now the Supreme Court has ruled that all the coal blocks allocated except for those for tariff based competitive bidding done for Ultra Mega Power Projects (UMPPs) are illegal. The findings of the Supreme Court have been anticipated and hence, in the last year there was little progress in investments in the coal blocks. The lack of objectivity and transparency in process of allocation has been accepted and the Government of India formulated a policy and mechanism for auction in 2012 through amendment in the MMRD Act and notification of Auction by Competitive Bidding of Coal Mines Rules, 2012. The three coal blocks that were placed for auction in the 2013-14, one each for steel, sponge iron and cement sector received lukewarm response. 

So, now the concerns are primarily on the future of so called illegal allocations done in the past and if the Supreme Court would cancel all allocations as was done for telecom sector 2G spectrum allocations. This looks highly probable since the continuation of coal block allocations done on an illegal framework may not be justifiable, and even if attempted, it would have to be done on the basis of project development, dependence of power plants, investment done and such others, which are similar to the criteria used by the erstwhile Screening Committee and objected to by the Court. The Government of India’s proposal of levying Rupees 295 per tonne for the already mined out coal from the 40 operational mines, in lieu of continued allocation has found favour with the stock markets. The proposal has muted a total of 46 coal blocks that may be favourably considered for their status as operating mines and the 6 others that are likely to start production sooner.

The cancellations will have a telling impact on Indian coal imports and power generation in the near term as this additional shortfall in coal availability will have to be made good by imports. Imports are expensive even though coal prices are lower now than in 2012 but these may rise in view of the additional demand from India. The imports will also add to the misery of already congested infrastructure facilities of ports and railways. For calming the impact of high cost imports on those power plants affected by coal block de-allocation, demand for price pooling is being raised, which may be bring in its own set of challenges. The idea was muted earlier in view of difficulties in apportioning physical high grade imported coal and financial costs over power plants that get entire supply from domestic sources.

It may be admitted that there may be economic sense in allowing the operating mines to continue but legal justification may be tough. But need of the hour is to look beyond the imminent and take corrective measures that can lead to a stable, investor-friendly, innovative and sustainable coal mining sector as it is likely to fuel energy needs of the country for foreseeable future. From that point of view, the Supreme Court ruling, when and if it comes, cancelling all allocations may be considered God sent.

Need to restructure coal industry is critical, essential and also urgent so that power sector may meet the expectation of electricity generation and supplies. The immediate priority for the Government of India should be to ensure that coal supplies are enhanced from domestic production and that the investment environment in power sector improves. The roadmap for opening of coal sector for greater private and foreign participation needs to be drawn, which may include de-nationalization and also creating independent subsidiaries out of Coal India Limited monolith.

The best way forward will be to remove the entry barriers to coal mining and auction the coal blocks through transparent and objective process to independent miners or end users if they desire. Increasing the number of suppliers in the market will not only improve supplies but also make pricing transparent and market driven. It is time that the Coal Mines Nationalization Act is repealed.

The other mechanism for enhancing competition in coal sector that has been mooted is to split Coal India Limited into independent companies. The newspapers report that CIL unions may not resist such a move. However, looking at the fact that the subsidiaries are still monopolies in their geographies and these subsidiaries were created based on coalfields, and also that these may still be controlled by the Ministry, the mechanism of competition may not help. It is also noteworthy that marketing function of Coal India Limited and its subsidiaries are restricted and coal linkages are provided by Standing Linkage Committee, which is a multi-ministerial and multi-stakeholder body constitute by the Ministry of Coal. Under these circumstances, competitive forces in the proposed liberated subsidiaries will still be dormant and negligible. To make splitting of CIL effective, it needs to be supplemented with large scale stake sale of each of these subsidiaries; mostly to the public should outright privatization be politically unpalatable. Government may still be in control but large floating public shareholding will enhance accountability of the Boards of Directors and help competition.  

Through the transition of coal sector from the current state to market oriented with private and foreign participation state, the Coal Regulator may play a crucial role. The framework for the regulator is already in place but needs to be strengthened in scope.

Short term challenges of the domestic supply of coal will persist since the projects that CIL has planned may need quicker permissions and development of infrastructure for coal evacuation.  But with strategic roadmap laid for the turnaround of the sector will pave the way for reducing import dependence and create a vibrant domestic market.