In a landmark decision yesterday, the Supreme Court cancelled majority of the 218 coal blocks that were handed out free by the various governments since 1993 for captive mining.
The Coal Mines (Nationalisation) Act 1973 was amended in June 1993, allowing companies which were in the business of producing power and iron and steel, to own coal mines for their captive use. Hence, the coal that these companies produced in these mines was to be used to feed into the production of power, iron and steel etc.
This amendment was used to allot coal blocks for free to private and public sector companies to the condition that the coal produced was used for captive mining. The Supreme Court judged the process of allocation of these coal block to be suffering “from the vice of arbitrariness”. Hence, it cancelled a majority of the allocations.
But these cancellations will have several repercussions in the days and months to come. I discuss these repercussions here:
1) Currently 40 out of the 218 coal blocks that were allocated produce coal. The Supreme Court has cancelled all these allocations except one mine belonging to SAIL and two mines which feed coal into Sasan Power, which is an ultra mega power project. Data from the ministry of coal suggests that these mines are likely to produce around 52.9 million tonnes of coal during this financial year (April 1, 2014 to March 31, 2015).
Of this, the mines that have not been cancelled are likely to produce around 2.07 million tonnes of coal. This means that the cancelled coal mines will produce around 50.83 million tonnes of coal during the course of this financial year. The Supreme Court in its judgement yesterday said “we make it clear that the cancellation will take effect only after six months from today, which is with effect from 31st March, 2015.”
So what happens from April 1, 2015? As yesterday’s judgement points out “The Central Government is confident, as submitted by the learned Attorney General, that the CIL[Coal India Ltd can fill the void and take things forward.” Hence, Coal India is likely to operate these mines after the cancellation comes into effect.
This as I had explained in a previous piece has its own set of challenges. Coal India is a for profit enterprise and hence, it needs to be figured out who will bear the cost of operation during the period Coal India runs these mines. Further, will it be allowed to keep the profits it makes during the period it operates the mines?
Also, the government will have to figure out how to transfer these mines. As Ashok Khuarana, director of the Association of Independent Power Producers told The Economic Times “It is not yet clear how the operational mines would be transferred…If Coal India is taking over the mines, they ought to take over the liabilities too otherwise it would jeopardise the lenders.”
As mentioned earlier these mines are captive mines which supply to other units primarily producing coal and power. Hence, during the period Coal India takes over these mines it will have to make arrangements for transporting coal from the mine to the unit where it will be used. These arrangements need to be figured out.
Further, Coal India will have to transfer its own employees to run these mines. Again, a lot of manpower in coal-mines is statutory and cannot be just transferred overnight, until a replacement is found. Given this, it is important that the Coal Ministry and Coal India work in tandem over the next six months to have an actionable plan in place to take over the mines and continue producing coal.
2) It is very important that production in these coal mines is not stopped at any point of time. As pointed out earlier these mines are expected to produce around 50.83 million tonnes during the course of this financial year. This is around 8.6% of the total coal expected to be produced in India during this financial year. It is not an insignificant number by any stretch of imagination.
If Coal India doesn’t get around to producing coal in these mines starting from April 1, 2015, the power, iron and steel, cement and aluminium plants that these coal mines feed into, will have to import coal. There are several problems in importing coal. First and foremost imported coal is costlier. A research report brought out by Kotak Institutional Equities suggests that it costs Rs 600-800 per tonne to produce captive coal. In comparison, the e-auction price of coal sold by Coal India is Rs 2,200 per tonne. And it costs Rs 3,500 per tonne to import coal. Hence, imported coal is four to five times more expensive than captive coal.
Also, it is most likely that companies which have operational coal mines which feed into their power and iron and steel plants, will have to import coal. They may not be able to buy it from Coal India because Coal India already has prior commitments in place and may not be able to fulfil their coal needs.
As Crisil Research points out in a report titled De-allocation of operating coal mines to severely impact metal players “Players who have operational coal blocks will witness a sharp decline in profitability post 2014-15, as they would have to substitute captive coal with imported coal which is about four times more expensive (as Coal India may not supply domestic coal to these players given its FSA[Fuel Supply Agreement] commitments to the power sector).”
Further, these companies will also have to pay a fine of Rs 295 per tonne for all the coal that they have produced till date and will continue to produce until March 31, 2015. As I had explained in a piece yesterday, the cost of this fine will come to a little over Rs 10,000 crore.
3) Also, importing coal in a huge quantity will not be easy. Our ports will have a tough time handling this additional quantity of coal that will have to be imported. Over and above that, the Indian Railways is not exactly geared to be able to transport this “extra” coal from the ports to different parts of the country where it is required. The added infrastructure that will be required to handle the additional imports cannot be created overnight. Further, sourcing more than 50 million tonnes of coal from the international market will not be easy, and will push up the international price of coal. India imported nearly 171 million tonnes of coal in 2013-2014 (April 1, 2013 to March 31, 2014). This went up by around 18% in comparison to 2012-2013 (April 1, 2012 to March 31,2013).
4) Imported coal will also mean that the cost of production of power will go up for companies which had been using captive coal supply. Hence, it is important that Coal India takes over these mines smoothly and continues producing coal. A recent report in the Business Standard points out that the coal being produced in the mines already in operation was being used to produce “26,000 Mw of power output and 12 million tonnes of steel.”
5) Banks will also come under pressure because of the allocation of coal blocks being cancelled. A straight forward reason is that companies have spent money in getting these mines up and running. Now with the mines being taken away it is bound to put pressure on banks, as companies may not be able to continue servicing these loans. A report published by Enam Securities estimates that in total,n banks have loaned out about Rs 37,000 crore to the mining sector. Coal mines form around half of this lending. This amounts to around 0.6% of the total loans given by banks. Prima facie this does not sound like a big number but things could turn out to be much worse. “While this figure on [coal] mines seems low, the impact could be much greater, as it will impact power plants dependent on these mines,” Enam Securities pointed out.
A report in the Business Standard points out that “According to brokerage firm Anand Rathi Financial Services, the Supreme Court order will hit Andhra Bank the hardest, as the power sector accounts for 13.4 per cent of its total industry loan book.” This is followed by UCO Bank which has an exposure of 13.1 per cent of its total industry loan bank.
6) The government is likely to auction the coal blocks after it takes them over starting April 1, 2015. Interestingly, analysts are expecting that companies which have lost coal mines will bid aggressively in this auctions. As Crisil Research points out “We expect players whose blocks are de-allocated to bid aggressively to retain their blocks, given the operational advantages such as proximity to end-use plants, quality of coal and consequent equipment configuration. Moreover, competition from other players operating in the vicinity of these blocks will also be very high as these are operational mines and the cost of imported coal is also higher.”
This will mean a windfall for the government if the auctions are designed well.
To conclude, there will be a lot of repercussions from yesterday’s decision on coalgate by the Supreme Court. The government will have to move fast in order to limit damage.
The article appeared originally on www.Firstbiz.com on Sep 26, 2014.
(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)