Contractual Issues: Long-pending problems of MDOs still to be addressed

Long-pending problems of MDOs still to be addressed

The experience with mine developer-cum-operators (MDOs) has been mixed in the coal mining segment, the largest part of the domestic mining industry. In the past, when Coal India Limited (CIL) faced resource constraints which impacted its production levels, subcontracting arrangements were a capital-efficient way of increasing production. Since 1993, the government has introduced many policies that have been conducive to increasing private sector participation; however, many projects did not progress. Meanwhile, the coal industry grew strongly after nationalisation on the back of strong performance of state-owned coal companies.

The government has experimented with involving heavy earth moving machinery contractors and MDOs as partners and stakeholders. MDOs have submitted competitive bids to win contracts, but factors such as unfamiliarity with the mining norms have prevented even serious, cash-rich captive block owners from making significant progress. This was a major factor behind the cancellation of coal block allocations in 2014.

Prior to the coal block deallocations by the Supreme Court in September 2014, a total of 17 MDO contracts had been awarded, of which 14 were awarded under bid model I (where the cost of land acquisition and rehabilitation and resettlement [R&R] is borne by the MDO) and three were awarded under bid model II (land acquisition and R&R are the responsibility of the mine owner). Of the 14 MDO contracts, 11 were awarded to the EMTA Group, a key player in the MDO market (before the deallocation of coal blocks). After the reallocation of coal blocks, coal block owners are already in the process of appointing MDOs for their respective blocks or will do so soon.

Issues and challenges

There are a number of factors that have impeded growth in the MDO space. As the entire process of developing a mine, following the award of the development contract, is carried out by the MDO, there are a host of risks that it has to bear. From securing regulatory clearances to acquiring land, many of the risks to which an MDO is exposed are beyond its control, and these result in huge cost and time overruns.

MDOs faces uncertainties related to legal aspects too. The legality of the concept of an MDO is yet to be properly established in India. This is despite the fact that all coal block owners had adopted this route for development of their blocks prior to the deallocations. Given the large-scale presence of public sector entities (in terms of production), this issue negatively affects private sector interest, unless it is standardised legally.

MDO contracts are also fraught with problems regarding clarity of clauses. Clauses related to land acquisition, R&R and labour are not well structured, and are thus open to interpretation. For instance, MDOs are required to provide employment to the landowners. However, there is no clarity on the duration of the obligation. Lack of standardisation and transparency in bidding documents is thus a major issue.

In several cases, the onus of building project-related infrastructure is on MDOs, for which they is compensated only partially. The absence of an escalation clause in contractual agreements also hurts MDOs financially. In the event of a delay in project completion, there is no escalation in payments to them. Unrealistic assessment of costs during bid submission adds to the financial woes of MDOs.

A shortage of skilled manpower to carry out operations is another major issue faced by MDOs. While the availability of low-skilled labour is not an issue (supported by local employment), lack of skilled manpower to operate high-tech machinery and equipment affects MDOs’ overall performance.

Procurement restrictions, domestic unavailability of spares and internal processing delays have forced mining companies to work with smaller or less efficient machinery. This is another area which requires improvement.

Developments beyond the control of the MDOs/mining companies such as local muscle power, political interference, local unrest, and resistance to vacating project land also affect MDOs’ operations. Insufficient information about the block also brings with it a host of other risks and unforeseen operational challenges.

Industry recommendations

Some of the key recommendations based on consultations with various stakeholders in the mining sector 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. The preparation of model contract documents as done by the National Highways Authority of India can be considered.
  • Faster clearances: The government must set legally binding time limits to accelerate the long-drawn-out process of securing the requisite approvals. It would be even better if only those blocks that have completed R&R and have been given environmental and forestry clearances are auctioned. Global mining giants such as Rio Tinto and Posco have put their plans regarding India on the back burner due to such hurdles.
  • Appointing independent agencies: In a bid to ensure reliability of exploration activities, the government should consider 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 will be utilised to set up domestic manufacturing units for mining equipment (in joint ventures with foreign players), the programme’s success will depend on appropriate designing of intellectual property rights.
  • Plug and play: One of the major impediments to MDOs’ operations is land acquisition. MDOs must be relieved of this burden, as it significantly increases risk exposure. The government could consider awarding mine blocks via the plug-and-play model, where all clearances are put in place before they are awarded to private developers.

In such a scenario, the bids are more likely to be reasonable, or else speculative bidders would win and projects will face execution issues later.

  • Market creation for OEMs: Unless there is sufficient demand and a critical market size is attained, no reputable original equipment manufacturer (OEM) is likely to make investments for producing equipment in the country. All the major OEMs have factories in countries such as China, the US, etc. Steps must be taken to phase out manual mining and encourage automation and mechanisation. Also, it must be ensured that appropriate incentives are given to encourage greater technology deployment. In composite engineering, procurement and construction (EPC) and operations and maintenance (O&M) contracts, the liabilities of the EPC phase do not end until the O&M phase is completed. In such a scenario, no major OEM is willing to enter due to the high risk element.

In sum

There is a need to adopt international best practices of contractual management for mining. Within the country, lessons for standardisation of contracts must be learnt from sectors such as roads. Besides, judicial and institutional capabilities must be enhanced to support the sector. Such steps will not only increase mining output, but will also ensure fair and greater participation by the private sector.

After more than a year of deliberation, the centre’s decision to auction coal mines to private companies for commercial mining in 2017-18 bodes well for the private sector. Besides providing a boost to technology-aided private investments, the decision to open coal mining to private players is also expected to bring in competition in the government-dominated coal sector. For decades, CIL has dominated the country’s coal industry, becoming the largest coal miner in the world (by production).

There are opportunities in the mining sector for EPC players with a demonstrated track record in mining and moderate levels of cash flows. The Punjab State Power Corporation’s recent award of an MDO contract for the Pachhwara central coal block to Dilip Buildcon underpins this fact. The Ministry of Coal is considering offering more coal blocks with large reserves to MDOs. Further, CIL’s plans of augmenting coal production via the MDO route will also be a key opportunity for contractors.

The government has introduced many policies that have been conducive to increasing private sector participation. However, factors such as unfamiliarity with the mining norms have prevented even serious, cash-rich captive block owners from making significant progress.