Contract Benefits: Capital-efficient arrangement for increasing production

Capital-efficient arrangement for increasing production

The experience with the mine developer-cum-operator (MDO)/contracting/private sector has been mixed in the coal segment, which is the largest segment of the mining industry. In the past, when Coal India Limited (CIL) faced resource constraints which impacted its production levels, subcontracting was a capital-efficient way of increasing production. Since 1993, the government has introduced several policies that have been conducive to increasing private sector participation. Further, CIL has managed to outperform privately run mines in the country.

Scope and advantages

The scope of MDOs differs across mining projects. In some contract agreements, MDOs have total responsibility, while in others they are required to render selected services. In the former agreement, the appointed MDO is responsible for all the works – from securing statutory clearances, acquiring project land and constructing infrastructure facilities, to developing and operating the mine. In the other contract type, the MDO/contractor company is responsible for only some works in the operations chain, such as removing overburden, transporting the mined output, reclaiming land, executing the environmental management plan, undertaking mine closure, etc.

The MDO model has a number of advantages. For instance, these players are not only well equipped to handle operational risks, but also bring with them advanced technologies. Being assured of production quality and quantity from the MDO, the mine owner can focus on end-use projects, regulatory clearances, business development, marketing and logistics.

The long duration of MDO contracts also provides an incentive to mining companies to invest in measures to ensure safety and environmental sustainability, and implement the mine closure plan properly. MDO contracts also hedge block owners from forex fluctuations and unanticipated cost risks.

Key trends

Varied extent of participation: The extent of responsibility of the private sector/MDO/contracting firm in the mining sector has varied according to the type and size of mines. In small mines, for instance, contracting firms have typically had larger roles, that is, all the mining operations have come under their ambit.

However, in the case of large mines, their roles have been restricted to the removal of overburden and the transportation of the mined resource. This is the case with several CIL subsidiaries. For instance, at Western Coalfields Limited, “hired” overburden removal increased from 53.42 million cubic metres (mcum) (46 per cent of total overburden removed) in 2010-11 to 68 mcum (52 per cent of total overburden removed) in 2014-15.

Formation of joint ventures (JVs): State-held companies that were allocated coal blocks formed JVs with private entities wherein they held 51 per cent and the private entity held the remaining 49 per cent. The private entity was then responsible for mining operations. These JV companies also entered into MDO agreements with either the private JV partner or its parent concern. At present, several Indian companies are collaborating with their overseas counterparts in carrying out contractual mining works, especially after the coal sector was thrown open to private participation. For instance, Gayatri Projects Limited, a key player in the space, has entered into a partnership with the China Coal Overseas Development Company, a Beijing-based subsidiary of China Coal, to offer longwall technology for mining.

Building expertise: Factors such as collaborations with overseas players and the need to reduce costs in the long run have aided private sector players who are beginning to develop a robust pool of skilled personnel. It is well known that private companies present in the mining space bring in the best technology solutions for carrying out operations. However, a crucial component of deploying new technology is the effective training of manpower to operate the systems. While the paucity of skilled personnel is still a challenge for the whole industry, contracting companies are addressing the issue by investing in manpower skill development.

Issues and challenges

In cases where the entire process of developing a mine is carried out by the MDO (following the award of the development contract), there are a host of risks borne by it. From securing regulatory clearances to acquiring land, the MDO is exposed to several risks, some of which are beyond its control and cannot be mitigated beforehand.

On the legal side too, the MDO faces uncertainty. The legality of the concept of an MDO” is yet to be established in India. This is despite the fact that coal block owners had adopted this route prior to the deallocations. The absence of a legal framework to protect the interests of MDOs can ward off private sector participation, which is already low.

Besides, MDO contracts are also fraught with problems resulting from a lack of clarity in clauses. Clauses related to land acquisition, rehabilitation and resettlement (R&R), and labour are not well structured, and are thus open to interpretation. For instance, MDOs are required to provide employment to landowners; however, there is no clarity on the extent of the obligation. This lack of standardisation and transparency in bidding documents is thus a major issue.

In several cases, while the onus of building infrastructure related to a project is on the MDO, it is compensated only partially for this cost. The absence of an escalation clause in contractual agreements also hurts the MDO financially. In the event of a delay in project completion, there is no escalation in payments to the MDO. An unrealistic assessment of costs during the bid submission also adds to its financial woes.

A shortage of skilled manpower to carry out operations is another major issue faced by MDOs. While there is adequate availability of low-skilled labour (supported by local employment), the lack of skilled manpower to operate advanced technology machinery/equipment impacts the MDOs’ overall performance.

Industry recommendations

In consultation with a number of stakeholders, some key recommendations have surfaced. These are discussed below.

  • Contractual transparency: It is widely understood that contractual transparency holds the key for the future of MDOs in India. This hinges on improving contractual clauses and removing the existing grey areas that lead to interpretation issues. Preparation of model contract documents as done by the National Highways Authority of India can also be considered.
  • Faster clearances: The government must set legally binding time limits to accelerate the long-drawn-out process of securing the re-quisite approvals. Even better would be to auction only those blocks that have completed the R&R process and have been given environmental and forestry clearances. Global mining giants such as Rio Tinto and Posco have put their plans for India on the back burner due to such hurdles.
  • Appointment of independent agencies: In a bid to ensure the reliability of exploration activities, the government is considering the appointment of independent agencies to certify geographical reports. At present, both the tasks are carried out by the government itself (that is, the government is certifying its own work). Independent auditing would help garner investor interest.
  • Leverage Make in India: While mega programmes such as Make in India are being utilised to set up domestic manufacturing units for mining equipment (in JVs with foreign players), their success will depend on appropriately assigning intellectual property rights.
  •  Plug and play: One of the major impediments to MDO operations is land acquisition, which significantly increases their risk exposure. The government could consider awarding mine blocks via the plug-and-play mode. Consequently, the bids received will be reasonable rather than speculative. In the latter case, due to the bids being untenable, bidders often face issues in project execution.
  • Market creation for original equipment manufacturers (OEMs): Unless a critical-size market is created, no reputable OEM will invest in equipment production facilities in the country. At present, all major OEMs have factories in countries such as China, the US, etc. Steps to phase out manual mining, ensure greater deployment of technologies and establish appropriate incentives must be taken.

In sum

Overall, international best practices for contractual management in mining need to be adopted. Within the country, lessons for standardisation must be learnt from sectors such as roads. Besides, judicial and institutional capabilities must be enhanced for supporting the sector. Such steps will not only increase mining output, but will also ensure greater private sector participation.