Coalgate

Firstly, the disclaimer. The contents of this blog are the personal views of mine. They are not the views of the company i work for, nor of companies in this sector, nor would they necessarily my views when i am wearing official hat and they definitely dont have an official sanction. Nevertheless.

Recent months have had more than a few "breaking news" stories about "Coalgate" and the implications. Opposition and media have gone hoarse shouting about the crores and crores of benefit  gifted away to the corporates. Personally, well the hype is sickening but let us leave the cacophony of the issue and come straight to the point. Let us start by understanding how are coal blocks allocated and the coal laws of India

historically all coal mining in India has been done by Coal india limited (and some other govt entities). The law provides that coal mining can be done by a lot of entities but trading of coal is prohibited.  So technically you can mine coal if you get a mining lease..which you wont but then theoritically if u get a mining lease you could mine coal but not sell it.

So you had coal india and its subsidiaries mining coal (and no we wont get into the efficiency debates) and selling the coal. unfortunately the demand for coal was much higher than what would be produced by Coal india. So a mechanism was created to "allocate" coal to the industries which needed it. Its a system called "Coal Linkage". Now coal linkage is a system peculiar to India (to my knowledge...though this peculiarity isnt surprising). So if you are an industrialist and you want coal, you make an application to the coal ministry (and to a coal linkage committee). the linkage committee would then "consider" the application onj subjective merits - such as the credentials of the party,. credentials of the project etc and allocate it a linkage. That would mean - x million tonnes of production from X mine of Coal India limted (or its subsidiaries) would be provided to you at the linkage prices. The linkage price is the price charged by Coal india to the industry. Now Linkage price is a tricky subject. The base linkage price makes taking coal from coal india a very economic proposition for the customer. Now that works fine if the customer is a power plant such as NTPC or MSEB who are allowed a fixed return and thereby passing on the lower cost of coal to the ultimate consumer of electricity. Now whether that is a good thing or not is a matter of seperate debate. Nevertheless for a profit oriented industry, that Linkage a source of competitive and financial advantage.
However, coal india failed to keep up the supply in line with the demand for the linkages. So the government turned to the concept of captive mining of coal.

So what is captive mining
Well, if you are an industry which needs a lot of coal. you make an application to the ministry and another committee which allocates captive coal blocks based on a very subjective "merit" of the case. Now if you get alloted a few million tonnes of coal in coal mine. you apply for mining license, environmental clearance, forest clearance and then spend capital expenditure (minign and processing equipments, railway sidings etc) to develop the mine, remove the overburden (waste material) on top of the coal seams and mine the coal. Now indian coal is a extremely bad quality so you may also wash the coal before using it.
you ofcourse cant sell it. you can use it in your power plant or steel plant.
then one needs to consider is what price does the power plant sell. if it does below the market price (in line with the cost savings from coal block allocation or linkage) like say a NTPC or MSEB would, then perhaps it is not a major issue. but if the steel output or power output is  sold at the market price well then the country of india just handed over the profit on a platter to a private steel company or a power company to the detriment of the govt of india and by corollary the tax payers.

So what we have is a situation where a company does get a financial advantage as a result of either linkage or captive coal blocks.

There is ofcourse the other side of the coin too. The quantum of the advantage however needs to be checked in each case as it would depend on the complexity of the mine, amount of coal, amount of overburden, amount of forest, resettlement issues, diversion of rivers and nullahs, capex required for the railway siding etc. all of which affect the cost and timing of the coal production. so not all coal block allocations result in supernormal profits accruing to a company.  what also needs to be considered that mining coal (or even any other mining) is an expensive business. the exploratory drilling in itself could cost millions of dollars. coupled with other expenses, the coal could turn out to be quite expensive. The CAG figures needs to be evaluated in that context. I dont know about coal numbers but when it comes to Iron ore, people tend to overestimate the value of resource. Some people argue. Iron ore price is 100$, cost is 10$ to mine , so you get a profit of 90$. Super normal profit. well, most important 100$ is for a grade., so make an adjustment for indian grade. Secondly 100$ is price at port, so you need to deduct the cost of transportation to the port. Now there in lies the catch, Cost of transportation could range from 10$ to 70$ or more depending on location etc. and that doesnt include any capex or interest expenses.
Same thing works with coal. take a poor quality coal and add to that transport cost and the cost of building railway siding, cost of punitive railway charges etc and your profit could be overestimated by a large margin. And we havent started on the export duty ifany is imposed by govt.

Ok, all those arguments apart, there is still a quantum of profit associated with the allocation of coal blocks to "endusers". but does that imply there is something hanky panky? no not really, it could only be stupid policy. or even more likely, it could be a policy which was fine in a different environment where the coal prices were not that high. and that isnt that far back actually. the commodity price boom has started post 2005. not so much into distant path.

infact what one needs to also consider is the policies of the worlds major coal producers. there you just apply for an exploration license and if you get a license you explore . if you are lucky you strike coal and if you are not well you lost your money. do it a few times and you wil average out to normal profits. india somehow seems to shy away from this concept of exploration for minerals which seems to have worked very well for australia, USA, Canada etc pretty well.

 And one needs to consider the policies applied for oil exploration and 3G. May be just look at only auctions. Agreed large upfront payments could lead to problems, so do a profit share based bid. that should work well earning profits in the future if the prices rise abnormally.
 One also needs to ensure that we have enough competition for the bids( so as to earn as much money as possible for the govt) by not keeping any restrictions. If one puts end use restrictions or any other restrictions on the sale of the output, the bids will be of smaller value and result in a low return to the GOL. Do enough market auctions and there will be enough supply in the market to cause the prices of coal and other commodities to fall.
Lets face it, minign is an industry which has historically done 10 years boom and 30 years of oversupply and depressed prices. the prices would fall eventually coz of oversupply.

and i can go on and on typing. but its enough for tonight. may be will continue with my incoherent blabbering on this topic later