Digging Deeper: Is commercial coal mining such a transformative idea?

Is commercial coal mining such a transformative idea?

Dipesh Dipu, Founder and Partner, Jenissi Management Consultants

The Cabinet Committee on Economic Affairs has approved the methodology for the auction of coal mines for commercial mining. Earlier, the Ministry of Coal had published a white paper for public discourse on the policy initiative that purports to bring in private participation in coal mining. The stated objectives of this reform are fourfold – efficiency in the sector through competition; transparency; ease of doing business; and the use of natural resources for national development.

Commercial coal mining is a bit of a misnomer as all coal mining activities are, by definition, commercial, but in India this has come to define the right of a coal miner to sell its products in the open market. This should ideally imply freedom to price products based on market demand and supply. The proposed reform provides this freedom and allows commercial miners to price their products. Increasing the number of suppliers in the market will not only improve supplies but will also make pricing transparent and market driven. It is agreed that in volatile circumstances when there is a severe demand-supply gap, prices may jump up, and hence, there will be a need to regulate. Yet, given that Indian coal with quality constraints does not have international markets, except in the Southeast Asian neighbourhood, greater supplies are likely to keep prices lower and may keep Coal India Limited’s (CIL) notified prices in check as well.

The cost side of the story is not easy. As the list of coal blocks for commercial coal mining has not yet been published, it may only be speculative to estimate costs. But it may well still be stated that the costs of coal mining undertaken by private players are likely to be relatively lower than CIL’s, considering private sector efficiencies in coal blocks that are similarly placed in terms of technical complexities. But the margins will have to be distributed between the miners and the government, accounting for the revenue share or an auction premium, depending upon how these coal blocks are auctioned. Will the available margins be able to justify investments in coal mining ventures that have risks of obtaining the “social licence” to operate, including land acquisition, rehabilitation and resettlement, risks of mine permissions such as environmental clearances, and infrastructure development constraints? Is commercial mining indeed a piece that fits into India’s energy security puzzle? Is the development of more coal mines (with inherent environmental and social costs) in the direction of national development?

From a pure-play margins and returns on investment perspective, a lot will depend on location, size of resources, and geotechnical features of coal blocks, which impact the costs of mining. Demand and price risks and the risks in coal supply logistics can be assessed from the location of the mine and its likely markets. To attract investors, it is therefore important that the government chooses coal blocks that promise scalability, a higher degree of geological information, lower risks of stakeholder management and shorter gestation period to get the first tonne of coal to market. These

coupled with the demand outlook and certainty of prices will dictate investor interest in coal blocks on offer for commercial mining.

Thus, the pricing flexibility proposed to be accorded to commercial miners will get restricted by the lower bound of CIL’s notified prices and the upper bound of the import parity prices, a band which is quite likely to remain narrow in the future. The auction premium that commercial miners will have to pay, depending upon the degree of competition, may also dent the flexibility in pricing their products or may lower the profitability expected as the margins will be channelled into paying these additional premiums to the government. A move to bid for commercial coal mining blocks, therefore, would have to be made keeping in view the constrained freedom to price and the impacts on margins in light of the complexities and risks of the mining business in India.

Commercial coal mining in itself is not a new concept either. Prior to the de-allocation of coal blocks by the Supreme Court, and indeed even earlier, after the Coal Mines (Special Provisions) Act, 2015, was approved by Parliament, several coal blocks were allotted to state-owned entities for commercial mining. A closer look at these entities and their strategies for coal mine development indicates that private contract miners operate the coal mines and then these state entities bargain with the potential coal buyers for a piece of rent from the price of coal that they sell. These state-owned entities, in most cases, did not have the technical or financial capabilities to mine coal themselves even though many of them were mining organisations, and thus they had to choose private contract miners for mining. They were also able to secure buyers for their products as there were severe supply gaps in the early part of this decade when CIL was unable to meet the demand. Learnings from these past experiences show that the eligibility criteria should be revised. There must be due consideration for experience of construction, development and operations and maintenance of mines. Those players who have merely been owners of coal or other mineral blocks may need to differentiated from those who have actual experience. Contract miners who have built projects may need to be given an opportunity to graduate into full-fledged mining companies with ownership and privileges associated with such ownership. It must be considered that contract miners have been playing in competitive markets for a while and have been sources of several innovative practices that have kept the costs of mining lower for the likes of CIL and Singareni Collieries Company Limited (SCCL). Given their appetite to manage risks, work within stiff time lines and be able to control costs of operations, they may be well placed for this transformation into commercial mining. Their entry must not be curtailed.

Let us examine the policy initiative in terms of the stated objectives. The first objective is bringing efficiency into the sector through competition. CIL, along with SCCL, produces more than 90 per cent of the total coal produced in the country and has plans to reach a production of 1 billion tonnes by 2020. While the target looks steep and may not be achieved, there is hardly any evidence that captive coal miners who have a three-four-year head start over commercial miners would be able to increase their share. Knowing the long gestation period in mine development, in the medium term, it is unlikely that CIL will witness any dent in its dominance. Also, given the premium that commercial miners are expected to charge their customers, CIL with its lower notified pricing may still find favour in spite of concerns about quality of service. With negligible impact on the competitive landscape and on the efficiency front, this policy initiative may have only so much impact.

On the transparency front, the auction method has proven its reliability in several rounds of auctions of coal and other mineral assets. There may not be much to complain about the process, which now is largely electronic. However, questions persist about setting the qualification criteria. There has to be coal mine-specific qualification criteria, which needs to go beyond the quantum of minerals produced and specifications of mining equipment owned, and focus on the sustainable development of coal mines. Parameters on environmental and social impact need to be adequately weighed. This would mean making inclusive development an objective of the selection process and present this process in such a transparent way that all stakeholders are confident that the objective is being met.

The other two objectives – energy security and national development – may have to be evaluated in the context of a bigger picture. There is a revolution that is sweeping across the energy sector globally and in India. The balance now seems to be conclusively tilting towards renewable energy. And this development is not entirely due to government support, but because these sources of energy are financially viable on their own. Of course, there are some concerns about the quality of supply and backup, but again, a lot of investment is being made, for example, in developing grid-size storage technologies for solar power. The next three-five years are likely to witness an epochal shift in the way energy is generated and distributed. Coupled with these developments, coal mining in India has witnessed lower-than-expected demand. CIL was struggling to meet the demand just a few years ago but now it is finding it increasingly tough to despatch the coal produced, resulting in building up stockpiles.

It is agreed that commercial coal mining is the need of the hour but the recipe needs to be altered. The coal sector needs to open up to competition, independent miners, new technologies and new business models. Yet, all said and done, the market is the place for the real test of an idea. It is, therefore, wise to wait and watch whether commercial coal mining is such a transformative idea after all.

The stated objectives of this reform are fourfold – efficiency in the sector through competition; transparency; ease of doing business; and the use of natural resources for national development.