Vivek Kaul
The press note for allowing foreign direct investment (FDI) of up to 51% in multi-brand foreign retailing throws up several interesting points as well as questions.
One of the major points of the press note is that retail sales outlets may be set up only in cities with a population of more than 10 lakh as per 2011 census. There are 45 cities in India that meet this requirement.
Currently eight states, the national capital territory of Delhi and the union territories of Daman & Diu and Dadra and Nagar Haveli have agreed to allow FDI in multi-brand retailing. All these states are ruled by the Congress party.
But as the data from the 2011 census points out, only 20 of these 45 cities are in states that have currently agreed to FDI in muti-brand foreign retailing or big retail, as it is more popularly referred to as.
Interestingly, the Census of India has two classifications. One is cities having population 1 lakh and above. And another is urban agglomerations/cities having population 1 lakh and above. As per the former India has 45 cities of population which have a population of 10 lakh or more. As per the latter India has 53 cities/urban agglomerations which have a population of 10 lakh or more.
For the sake of this analysis the former has been used because the press note uses the word “cities” very clearly and not cities/urban agglomerations. But even if one works with the assumption of 53 cities, the analysis that follows doesn’t change much. Nevertheless, the government needs to clear this confusion on which version of the census applies here.
The state of Maharashtra leads the pack with 10 cities out of the 20 cities which qualify for big retail. These are Aurangabad, Kalyan-Dombivilli, Navi Mumbai, Mumbai, Pimpri-Chinchwad, Pune Nagpur, Nashik, Thane and Vasai-Virar. Hyderabad, Vijaywada and Vishakapatnam are the three cities that meet the criteria in Andhra Pradesh. Kota, Jaipur and Jodhpur are the three cities in Rajasthan. Srinagar in Jammu and Kashmir, Faridabad in Haryana (and not the fancied Gurgaon which has a population of 876,824 as per the 2011 census), New Delhi and Chandigarh are the four other cities that make the list. Chandigarh is the capital of Haryana, which has agreed to allow FDI in big retail. But it is also the capital of the state of Punjab, which hasn’t.
What is interesting is that 50% of the cities eligible for big retail are in one state i.e. Maharashtra. It also means that there are no cities in Assam, Manipur and the Union Territories of Daman & Diu and Dadra and Nagar Haveli which meet the criteria of population of more than 10 lakh.
To get around this problem the note allows companies to be set up retail sales outlets in the cities of their choice, preferably the largest city, in states/ union territories not having cities with population of more than 10 lakh as per 2011 Census.
But the most interesting part of the note is that most of the policies elucidated in the note are only enabling in nature. Hence, governments in states and union territories are free to make their own policies. This means that it is very well possible that states might allow big retail to set shop in places with a population of less than 10 lakh. What stops the state of Haryana from allowing big retail presence in the city of Gurgaon? Or Maharashtra allowing big retail in Mira Road-Bhayander which has a population of 8,14,655 as per the 2011 census. The same can be said about Secunderabad, which is Hyderabad’s twin city, and Jammu which is the second largest city in the state of Jammu and Kashmir. Another point in the note is that at least 50% of total FDI brought in shall be invested in ‘backend infrastructure’ within three years of the first tranche of FDI. The note doesn’t specify whether this investment is to be limited in states that have allowed big retail. So the conclusion is that this investment can be made all across India. But here is where practical problems might crop up.
A company like Wal-Mart to may set up backend infrastructure in a state like Himachal Pradesh to source apples. But as we know Himachal Pradesh isn’t on the list of states that have allowed FDI in big retail. So we will end up with a situation where big retail is present in a state at the backend but at the same time it’s not allowed to set up a front end retail store. That would not be an ideal situation.
Another major problem can crop up because of the decision being currently left to the states. The states that have agreed to big retail are all Congress ruled (except Kerala which is ruled by the Congress led United Democratic Front but hasn’t said yes to big retail). Now what happens if the Congress party loses the next elections in these states? Can the party or front which comes to power reverse the earlier decision?
The note also points out that the government will have the first right to procurement of agricultural products. What is implied by this? At the same time the note points out that at least 30% of the value of procurement of manufactured/processed products purchased, shall be sourced from Indian ‘small industries’ which have a total investment in plant & machinery not exceeding US $1 million. This will be a huge problem for big retail companies which play on economies of scale.
But at the same time the note is silent on international procurement of goods and products by these companies. This means that companies which invest in big retail can source their products internationally. Hence, a Wal-Mart can source products for the Indian market from China. “More than 70% of the goods sold in Wal-Mart stores around the world are made in China,” point out Garry Gereffi and Ryan Ong in a case study titled Wal-Mart in China which was published in the Harvard Asia Pacific Review. Sourcing from China has been the backbone of Wal-Mart’s everyday low pricing strategy.
The state governments that allow FDI in big retail can change any of the policies mentioned above and frame their own policies because these policies are only enabling in nature. The only part that they cannot change is retail trading by means of e-commerce.
(The article originally appeared in the Daily News and Analysis on September 24, 2012. http://www.dnaindia.com/money/report_retail-fdi-note-raises-more-questions-than-it-answers_1744390)
(Vivek Kaul is a writer. He can be reached at [email protected])
Business
Kirana vs Wal-Mart: Busting the big myths of big retail
Vivek Kaul
In a rather poignant scene in Zoya Akhtar’s Zindagi Na Milegi Dobara, the character played by Farhan Akhtar, is sitting face to face with his biological father, played by Naseeruddin Shah (in a brilliant cameo). As the story goes, Shah had abandoned Akhtar’s mother (played by Deepti Naval) after getting her pregnant and moved onto becoming a famous painter in Europe.
Akhtar finally calls up Shah, when on a holiday in Spain he and his two friends get involved in a drunken brawl and land up in jail. Shah comes and bails them out. After this, Akhtar asks Shah for the true reason behind abandoning his mother. To which Shah replies “Sach hota kya hai. . . sach ka har ek ka apna apna version hota hai!” (What is truth? Everybody has their own version of it)
This line written by Farhan Akhtar is at the heart of the current debate happening, after the decision made by the Congress led UPA government to allow foreign direct investment in multi-brand foreign retailing.
Those in favour of the decision have their own version of truth. And those against it have another version. Those in favour of the decision believe that allowing foreign investment will create jobs, build supply chains and overall help economic growth. Those against it firmly believe that it will destroy the neighbourhood kirana shop, as you, I and everybody else, hop onto Wal-Mart to buy stuff. I have my own version of truth which is somewhere between the two extremes.
The kirana store will survive: A lot of hue and cry has been made on this. Nitish Kumar the Chief Minister of Bihar believes that the aam aadmi will suffer because of FDI in retail and hence he won’t allow it in Bihar. The fact of the matter is that it is not easy to compete with the neigbourhood kirana store. My kirana guy even goes to the extent of delivering things that he does not sell, like eggs and medicines, to ensure that I keep giving him business. As Rajiv Lal a professor at the Harvard Business School told me in an interview I did for Daily News and Analysis (DNA) “Kirana stores have a lot of benefits that established retailers don’t have. First of all location. What rents do they pay versus what established companies have to pay? Employees, same story. On the consumer side they can deliver services, in terms of somebody calls them and asks can you deliver six eggs? The guy runs and delivers six eggs. That’s not something that the big established firms can provide.” (You can read the complete interview here)
No homogeneity across India: An important factor for big retail to be successful is the homogeneity of the population in consumption behaviour. This gives them economies of scale. As marketing guru V Kumar told me in a recent interview I did for DNA “Does the country as a whole consume common things or there are regional biases? In a country like Brazil people eat similar foods that every retailer can sell.” In India clearly things are different. “In India between South, East, West and the North, there is so much heterogeneity that you need localized catering and marketing .So consumption behaviour varies therefore unless you are willing to carry heterogeneous products in each of the locations it is tough,” said Kumar (You can read the complete interview here). This is a challenge that foreign retailers will have to deal with.
The real estate conundrum: A typical Wal-Mart in the United States is situated outside the city, where rents are low. But such a strategy may not work in India. “It’s not easy to open a 150,000 square feet store in India. That kind of space is not available. They can’t open these stores 50 miles away from where the population lives. People in India don’t have the conveyance to go and buy bulk goods, bring it and store it. They don’t have the conveyance and they don’t have the big houses. So it doesn’t work,” explained Lal. This is something that Kumar agreed with. “Even if Wal-Mart is there in every place, the way they are located is typically outside the city limits. So only people with time, motivation and a vehicle, will be able to go and buy things. And the combination of these three things is very rare.” The kirana stores also provide goods on interest free credit to their customers something that no big retailer can afford to do.
The fear of Wal-Mart and others of its ilk is overdone: It is widely believed that wherever Wal-Mart goes it destroys the local business. As Anthony Bianco writes in The Bully of Bentonville – How the High Cost of Wal-Mart’s Everyday Low Prices is Hurting America “It (Wal-Mart) grows by wrestling businesses away from other retailers large and small. In hundreds of towns and cities, Wal-Mart’s entry put ailing …shopping districts into intensive care and then ripped out the life-support-system.”
But that is truer for markets like Canada, Mexico and United Kingdom, which are culturally and geographically closer to the United States. The Wal-Mart formula doesn’t always work everywhere. Pankaj Ghemawat, who has the distinction of being appointed the youngest full professor at the Harvard Business School, writes about this in his book Redefining Global Strategy, “When CEO Lee Scott (who was the CEO of Wal-Mart from 2000 to 2009) was asked a few years ago about why he thought Wal-Mart could expand successfully overseas, his response was that naysayers had also questioned the company’s ability to move successfully from its home state of Arkansas to Alabama…such trivialisation of international differences greases the rails for competing exactly the same way overseas at home. This has turned out to be a recipe for losing money in markets very different from the United States: as the former head of the company’s German operations, now shut down, plaintively observed, “We didn’t realise that pillowcases are a different size in Germany.””
What is the experience from other emerging markets? Big retail has got some traction in countries like China and Brazil. As Kumar put it “If you look at evidence from China organized retailing has got more traction. That’s because they did not have many mom and pop stores to begin with. They were cultivating their own things which was locally community based. But with more cities coming up and migration of people from rural areas to cities, gives more scope for organised retailing in China. Also space is not an issue in China. In India space is a constraint. Look at China and India. China is much bigger than India but the population is pretty much similar. Look at Brazil, it is as much bigger than India but the population is maybe one sixth that of India. So they also have space.” Whereas space remains a key constraint for big retail stores like Wal-Mart, Tesco and Carrefour in India.
Also in almost all emerging markets a local company is number one. As Lal told me “There is not a single emerging market that I know where a foreign entrant is the number one retailer. In Brazil it is Pão de Açúcar, in China you have the local Beijing Bailian. In most markets even when there are foreign entrants the dominant retailer in the organised sector is still the local retailer.”
And there are several reasons for the same. The local retailers are very price competitive. “If Wal-Mart is operating in Brazil there is nothing that Wal-Mart can do in Brazil that the local Brazilian guy cannot do. If you want to procure supplies from China, you can procure supplies from China as much as Wal-Mart can procure supplies. On top of that they have local merchants that they know they can source from and Wal-Mart may not,” said Lal.
Will foreign players be able to crack the market, when most of the Indian retailers are bleeding? The biggest Indian business groups have tried to crack organized retailing over the last decade. The Tatas, the Birlas, the Ambanis, all have a significant presence in the sector. But despite that organized retailing remains a small part of the overall retail business. As Sreenivasan Jain writes in the DNA: “For starters, India has had big or organised retail for about 15 years now, not a small stretch of time. Some of the biggest Indian corporates are in this space, like Reliance, the Birlas, Godrej, RPG (Sanjeev Goenka Group) and Kishore Biyani’s Future Group. Despite this, organised retail is only 5% of the Indian retail market. The remaining 95% is still unorganised.” (You can read the complete article here).
And all these big players are losing money hand over fist. “Last year, Reliance Fresh posted a loss of Rs 247 crore, Bharti posted a loss of Rs 266 crore, and Aditya Birla group, which runs the chain of More supermarkets, posted a loss of Rs 423 crore. Some retail chains have actually shut down, like Subhiksha which at one time had almost 1,500 outlets,” writes Jain.
It is in the interest of these firms that foreign investment is allowed in the sector, so that they can sell a part of the equity to foreign firms. Those in favour are of the opinion that these firms do not have the necessary expertise which the foreigners will bring in. This argument does not really work. Bharti Enterprises which runs the Easy Day stores has a back-end and cash-and-carry partnership with Wal-Mart. Star Bazaar, run by the Tata group is offered back end support by Tesco. So the big retail giants are in a way already operating in India.
Another point put forward by those in favour of foreign investment in retail is that it will help build reliable supply chains across the country. Theoretically yes, but the trouble is supply chains cannot be built if it’s left to the states to decide whether they allow foreign retail or not. Supply chains need to be seamless, they cannot be built if one state allows foreign retail and the neighbouring state does not. Also, we must remember that despite the presence of these heavy weights in the retail sector the kirana shops still continue to function as they had before.
So what is the future going to be like? It is difficult to predict what the future of the likes of Wal-Mart, Tesco and Carrefour in India is going to be. But one thing is for sure. They won’t find it easy. As far as Wal-Mart goes Kumar had this to say “There will be a market if they are content at not being the largest retailer. If they say in India I am one among many, they will have a presence. Maybe at some point in the future, things might change, like Wal-Mart buying other retailers and that’s the way they can expand. Their specialty is supply chain and turning the inventory over multiple times than other retailers. They cannot turn it over multiples times here. Each time if they make a 1% margin they get a higher margin due to turning the inventory over multiple times. Here I don’t see them turning it over as many times as in other markets. It’s very difficult to do that.”
Kumar also predicts that over a period of time the likes of Wal-Mart will be forced to buy the smaller kiranas in order to expand. “My prediction is this that mom and pop stores or kiranas as we call them will become more and more sophisticated. Today the store owners know people by their names, as the number will grow they will have to start building a database, but they don’t have the capabilities. So organised retailing will start buying mom and pop stores individually. And then they will put all of them under one banner. It will be like how Tesco is operating in the U.K with different store formats. You have Tesco supermarket, convenience store, street corner store, express etc. So that is the way in India you will see this evolving because otherwise there is no growth for them,” said Kumar.
So my version of truth is somewhere in between those who support foreign investment in mutli brand retailing as it’s called, and those who don’t. Big retail will not be the panacea it’s being made out to be. Neither will it destroy the smaller shops as is being claimed. It will have to create its own space. And that will only happen over a period of time.
This article originally appeared on www.firstpost.com on September 18, 2012. http://www.firstpost.com/business/kirana-vs-wal-mart-busting-the-big-myths-of-big-retail-459490.html#disqus_thread
(Vivek Kaul is a writer and he can be reached at [email protected])
To be a revolutionary manager – FIRST BREAK ALL THE RULES
Curt Coffman is the New York Times bestselling author of First, Break All the Rules: What the World’s Greatest Managers Do Differently(along with Marcus Buckingham). He is also a researcher, business scientist and a consultant to Fortune 500 organisations. “Approximately 15% of organisations today are embracing the power of people within the organisation. At the same time, 95% of companies believe that they are doing so. Businesses are currently operating at only 35% of their capacity, because of obsolete people practices. There is a maxim from quantum physics that says…“When you change the way you look at things, the things you look at change,”” says Coffman. He will be touring India for ‘First, People 2012’, India’s First HR ‘Un-Conference’ in Goa on September 21 – 22 organised by SHRM India (Strategic Human Resource Management), a subsidiary of the world’s largest HR association, SHRM – The Society for Human Resource Management. In this interview he speaks to Vivek Kaul.
In your groundbreaking work First Break All the Rules you got responses from 80,000 interviews to determine that the best managers are revolutionaries. Could you discuss that in some detail?
Just in the past 5 years we have interviewed approximately 90,000 managers/leaders across the globe. Great managers have one objective and that is to facilitate unprecedented performance in every individual. They form very strong relationships with their people based on trust and friendship. This allows for high expectations that are motivational and challenging. They don’t treat everyone the same but as individuals with unique talents, gifts for contribution and specific needs. There is an opposition to the notion of changing people, as they feel one’s work should draw out the individual’s talent versus attempting to put in what was left out. Commitment to innovation is seen through embracing the differences in individuals rather than create a blanket of conformity. Yes, they are the rebels who really drive an organisation’s success – one person at a time.
If the best managers are revolutionaries who are the revolutionaries according to you in the current business scenario?
The great leaders of tomorrow will commit to one thing – making sure every individual in the enterprise has a great manager. Great managers who are close to the action will trump traditional leadership in driving world-class results. Leaders atop the organisational chart cannot effectively impact the local workplace and thus need great local managers to create ownership and commitment. The senior leaders of today’s most relevant brands know this intuitively. Brands like Google, Zappos, Apple, Tata, and Starbucks, know the power of aligning brand (how others see us) with culture (how we see ourselves). Enlightened executives know the power of each individual employee on creating success.
One of the things that comes out from First Break All the Rules is that treat employees like individuals, set specific outcomes, but not the process, and focus on employee strengths instead of calling out weaknesses. Could you discuss that in some detail with examples?
Progressive leaders who are charged with creating a better tomorrow and managers who are charged with creating a outstanding today intimately know what creates a passion for excellence within people.
| Destroy Passion | Create Passion |
| Judge me on how I conform to the “steps” of doing the job regardless of results. | Help me know the real outcomes of my job – the real reason you hired me. |
| Point out precisely who I am not and then help me get better in those deficiencies. | Help me discover who I am and then allow me to use my gifts for outstanding contribution. |
| Work should be serious and hard. | Work should be fun and full of energy. |
| Use fear to drive us. | Use hope to drive us. |
| Always highlight what you don’t want. | Create a vision around what you do want. |
Do you see many companies following this kind of process while dealing with their managers?
Ninety five percent of all organisations proclaim that people are the key to their success. Sadly, I must say that only about 15% of global organisations have adopted a 21st century vision about people and the vital role manager’s play in building value. That said, there might be a higher percentage in India. You have some great brands and enlightened leaders who are savvy enough to recognise who really owns the means of production – every employee every day. Very progressive organisations like Taj Hotels, Voltas, Piramal, Lupin and Manipal to name a few, pay sharp attention to how managers are identified, developed and rewarded.
What do they do differently?
These organisations are keenly aware that a manager’s real job is to increase the productivity and success of every individual. In the past being a manager meant organising “things” and only caring about how they are viewed by the leaders above them. This is position-ship not leadership. If there was any focus on people, it was seen as a hobby not a primary function of the role. Very talented and productive people have options and we know that ultimately they leave managers, not organisations. If you have ever had a bad manager, you know exactly what we are talking about.
What is that makes a great place to work?
When people can’t wait to come to work!
But isn’t that very idealistic?
Yes, but why should it be? Knowing what about work gives your people energy and what drains their energy is the most primary step in developing a progressive, people-centered focus. Our most current research reveals that a great place to work is based on the characteristics of relationship, growth, and purpose. Relationships are the foundation of strong culture. Without them we wither away. The connections we have with co-workers, managers and leaders are the renewable energy that drives success. Great organisations promote strong friendships and a spirit of connectedness. People contribute at exceptional levels when there is another person they trust and feel loyal to. People are most loyal to the organisations that have helped them grow and develop – that is why you will see more philantrophic money being given to colleges and universities than any other institution. Great managers help every person know themselves well and thus set people up for success. When we know our talents and then acquire the right skills and knowledge incredible things happen.
So what is the takeaway here?
We just do our work and relationships differently when we have a sense of pride in the organisation’s mission. It is the broader purpose of one’s work that makes a difference. On those days that we feel overworked and frustrated, the higher purpose of our work will pull us through.
Another thing that your research threw up was that an organisation doesn’t have one culture overriding it. It has these many little cultures what you call the “little C cultures”. Could you discuss this finding in some detail with an example preferably?
Everyone uses the word “culture” with little consistent understanding of what it really means. If culture is the new competitive advantage, we need to become really clear on what it is. The key discoveries that we have made are that there is no culture without people. Culture exists at three levels – micro (local employee), bridge (manager) and macro (leadership). Each of these cultural charges have distinct roles; Micro to ignite positive/purposeful energy in one-another, bridge is to connect people to purpose and macro is having leaders who are more “interested” than “interesting.” Once key businesses imperatives are defined, the next question should be “what kind of culture are we going to need to drive results?”
Can you explain this through an example?
Steve Jobs at Apple cast a vision for innovation that carved out markets that didn’t even exist. He was always listening and more interested than interesting (actually he was more interesting because he was interested). This macro culture is about creating a better tomorrow. Steve Jobs vision is only achievable when the right people and culture bring it to fruition. Great managers are attracted to an environment where they can connect individuals to vision. Take the Apple employee as an example – who wouldn’t want to be a “genius” versus a “help desk employee?”
Earlier in the interview you said that most people don’t leave organisations, they leave their bosses. How do you control for something like that?
The steps are rather basic. It starts with promoting people who are already the spiritual leaders of people. Great managers didn’t become that way when the official title was given. Know who these employees are. Don’t make becoming a manager a reward. Reward great managers who genuinely care about the success and potential of others and know the strengths of each person they work with. Another step is to not try and change people, but instead draw out the best within them. Don’t make becoming a manager another rung on the career leader.
Why do you say that the worst mission a manager can undertake is attempting to erase a person’s weaknesses?
Great managers will say that people don’t change that much and instead of trying to put in what was left out, let’s draw out what was left in. Neuroscience now confirms that the brain is done developing between the ages of 15 – 22 years of age. By that time all of us have a pretty well structured network. There are things that come naturally and others that don’t. Talent is about hard wiring and explains our predisposition for excellence in certain roles. Many times we feel as though we can rewire people brains. It is not possible. We have never seen a person take a weakness and transform it into a throbbing strength. There are ways to manage around our weaknesses, like having a complimentary partner who does have the talent and energy for those things in which you do not. Or, you can find a system that makes the weakness immaterial (i.e. grammar and spell check).
You also suggest that it is okay for managers to treat some people as their favourites. Again something that goes against conventional wisdom. Shouldn’t a manager try and treat everyone in his team equally?
Treating everyone the same is true discrimination. We are individuals with unique strengths, needs and styles. By legislating one way for everyone, we disconnect people’s distinctive ability to display exceptional performance.
Your latest book is called Culture Eats Strategy. So how does culture eat strategy?
Vision is what could be. Strategy is our rational plan to get there. Execution is our continual day-to-day progress toward the desired outcome. Our rational plans always require human spirit and energy to bring to fruition. The daily progress we make (or fail to make) is dependent upon our people – our culture.
So how do you define culture then?
Culture is the collision of rational with emotional. When individual motives, drives and feelings come up against strategy, plans and structure, the end result depends more on the emotion than logic. While evolving a new strategy can be difficult, executing it in the face of existing conventions, routines and ways of working together can be nearly impossible.
Could you explain through an example?
Consider a hospital we know that changed out CEOs five times in four years. The culture, comprised of long-tenured staff, resisted the new CEO and strategy de jour. As each CEO was replaced, the culture became more and more convinced they could “wait the next leader out.” Our vision is essential, our strategy critical; but however sound, they are dependent upon the culture – the people – to deliver the desired results.
(Interviewer Kaul is a writer and he can be reached at [email protected])
(The interview originally appeared in the Daily News and Analysis on September 17,2012. <http://www.dnaindia.com/money/interview_to-be-a-revolutionary-manager-first-break-all-the-rules_1741770>)
Box:
The discoveries of great organisations:
-People practices focus on building excellence (what we want), not preventing weakness (what we don’t want)
-A senior leader’s greatest impact comes from insuring that every employee has a great local manager
-No people, no culture. Finding talent is a basic to performance, managing talent is the differentiator
-Obsessing over the “right” decision is not as important as insuring that the decision is being made by the people closest to the issue
-Employee purpose is driven by a “line-of-sight” between their work and the ultimate impact it has on the customer
Why oil prices won’t come down in the foreseeable future
Vivek Kaul
It is India’s Rs 2,00,000 crore problem. And it’s called crude oil.
With the global economy in general and the Chinese economy in particular slowing down, it was widely expected that the price of crude oil will also come down.
China has been devouring commodities at a very fast rate in order to build infrastructure. As Ruchir Sharma of Morgan Stanley writes in his recent book Breakout Nations “China has been devouring raw materials at a rate way out of line with the size of its economy…In the case of oil China accounts for only 10% of total demand but is responsible for nearly half of the growth in demand, so it is the critical factor in driving up prices.”
Even though the Chinese growth rate has slowed down considerably, the price of crude oil continues to remain high. According to the Petroleum Planning and Analysis Cell (PPAC) which comes under the Ministry of Petroleum and Natural Gas, the price of the Indian basket of crude oil was at $ 113.65 per barrel (bbl) on September 11. The more popular Brent Crude is at $115.44 per barrel as I write this.
The high price of crude oil has led to huge losses for the oil marketing companies in India as they continue to sell petrol, diesel, kerosene and cooking gas at a loss. The oil minister recently said that if the situation continues the companies will end up with losses amounting to Rs 2,00,000 crore during the course of the year.
So why do oil prices continue to remain high?
The immediate reason is the tension in the Middle East and the threat of war between Iran and Israel. Hillary Clinton, the US Secretary of State, recently said that the United States would not set any deadline for the ongoing negotiations with Iran. This hasn’t gone down terribly well with Israel. Reacting to this Benjamin Netanyahu, the Prime Minister of Israel said “the world tells Israel, wait, there’s still time, and I say, ‘Wait for what, wait until when? Those in the international community who refuse to put a red line before Iran don’t have the moral right to place a red light before Israel.” (Source: www.oilprice.com)
Iran does not recognize Israel as a nation. This has led to countries buying up more oil than they need and building stocks to take care of this geopolitical risk. “In the recent period, since the start of 2012, the increase in stocks has been substantial, i.e. 2 to 3 million barrels per day. These are probably precautionary stocks linked to geopolitical risks,” writes Patrick Artus of Flash Economics in a recent report titled Why is the oil price not falling?
At the same time the United States is pushing nations across the world to not source their oil from Iran, which is the second largest producer of oil within the Organisation of Petroleum Exporting Countries (Opec).
What also is happening is that Opec which is an oil cartel, has adjusted its production as per demand. Saudi Arabia which is the biggest producer of oil within OPEC has an active role to play in this. “This adjustment in the supply of oil mainly takes place via changes in Saudi Arabian production:this country keeps its production just above 10 million barrels/day to avoid the excess supply that would appear if it produced at full capacity (13 million barrels/day,” writes Artus.
If all this wasn’t enough gradually the realisation is setting in that some of the biggest oil producing regions in the world are beyond their peaks. As Puru Saxena, a Hong Kong based hedge fund manager writes in a column “it is important to realise that several oil producing regions are already past their peak flow rates and have entered an irreversible decline. For instance, it is no secret that the North Sea, Mexico, Indonesia and a host of other areas are past their prime.”
All eyes are hence now on the Opec nations. The twelve nations in the cartel currently claim to have around 81.3% of the world’s oil reserves. The trouble is that this has never been independently verified. As Kurt Cobb, the author of Prelude, a thriller based around oil puts it in a recent column on www.oilprice.com “Opec reserves are simply self-reported by each country. Essentially, Opec’s members are asking us to take their word for it. But should we?”
Saxena clearly doesn’t believe that Opec countries, including Saudi Arabia, have the kind of reserves they claim to. “Given the fact that the vast majority of Saudi Arabia’s super-giant oil fields are extremely old, one has to wonder whether the nation is capable of boosting production…We are of the view that Saudi Arabia has grossly overstated its oil reserves and it is extremely unlikely that the nation has 270 billion barrels of petroleum. After all, the Saudi reserves have never been audited and a recent report by WikiLeaks suggests that the Saudis have inflated their oil bounty by 40%,” he writes.
This is something that Cobb backs up with more data. “Another piece of evidence that casts doubt on Opec members’ reserve claims came to light in 2005. That year Petroleum Intelligence Weekly, an industry newsletter with worldwide reach, obtained internal documents from the state-owned Kuwait Oil Co. The documents revealed that Kuwaiti reserves were only half the official number, 48 billion barrels versus 99 billion,” he writes. “In 2004 Royal Dutch Shell had to lower its reserves number by 20 percent, a huge and costly blunder for such a sophisticated company. If Shell can bungle its reserves estimate, then how much more likely are OPEC countries which are subject to virtually no public scrutiny to bungle or perhaps manipulate theirs,” adds.
Given these reasons the world cannot produce more crude oil than it is currently producing. The production of oil has remained between 71-76million barrels per day since 2005. “When you take into account the ongoing depletion in the world’s existing oil fields, it becomes clear that the world is heading into an epic energy crunch,” feels Saxena.
In these circumstances where the feeling is that the world does not have as much oil as is claimed, the price of oil is likely to continue to remain high. India’s Rs 2,00,000crore problem can only get bigger.
The article originally appeared in the Daily News and Analysis (DNA) on September 14, 2012.
(Vivek Kaul is a writer. He can be reached at [email protected])
Mute Manmohan watches as “Coalgate” engulfs Congress from all sides
Vivek Kaul
The Great Fire of Rome started on July 19, 64AD, and burnt for six days. There are several varying accounts of it in history. One of the accounts suggests that Nero the king of Rome watched the fire destroy the city, from one of Rome’s many hills, while singing and playing the lyre, a stringed musical instrument.
India these days has its own Nero, Prime Minister Manmohan Singh. As the Congress led United Progressive Alliance (UPA) government gets engulfed in the coal-gate scam, Manmohan Singh has largely been a silent spectator watching from the stands and seeing his government being engulfed by the coal fire.
And this is not the first time. Manmohan Singh has largely been a bystander at the helm of what is turning out to be probably the most corrupt government that India has ever seen. As TN Ninan, one of the most respected business editors in the country, recently wrote in the Business Standard “Corruption silenced telecom, it froze orders for defence equipment, it flared up over gas, and now it might black out the mining and power sectors. Manmohan Singh’s fatal flaw — his willingness to tolerate corruption all around him while keeping his own hands clean — has led us into a cul de sac , with the country able to neither tolerate rampant corruption nor root it out.”
Manmohan Singh like Nero before him has been watching as institutionalised corruption burns India. The biggest of these scams has been termed “coal-gate” by the Indian media. The Comptroller and the Auditor General (CAG) of India put the losses on account of this scam at a whopping Rs 1,86,000 crore.
The background
The Planning Commission of India had estimated that the raw demand for coal in the year 2011-2012 will be at around 696 million tonnes. Of this 554 million tonnes was expected to be produced in the country by Coal India, Singareni Collieries and a host of other small companies. The remaining was expected to be met through imports.
Production of coal in 2011-2012 in million tonnes
Company Target Achievement
Coal India 447 436
Singareni Collieries 51 52
Others 56 52
Total 554 540
Source: Provisional Coal Statistics 2011-2012, Coal Controller Organisation, Ministry of Coal
As can be seen from the table above the actual production of coal at 540 million tonnes was a little less than the target. This was an increase of 1.3% over the previous year. Also since the actual demand for coal was significantly higher than the actual production, India had to import a lot of coal during the course of the year. Estimates made by the Coal Controller Organisation suggest that the country imported around 99million tonnes of coal in 2011-2012. The Planning Commission had expected around 137million tonnes to be imported in the year. So the Coal Controller’s estimate for coal imports is significantly lower than that. Also the increasing iport of coal is not a one off trend.
Coal Imports In Million tonnes In Rupees crore
1999-2000 19.7 3548
2000-2001 20.9 4053
2001-2002 20.5 4536
2002-2003 23.3 5028
2003-2004 21.7 5009
2004-2005 29 10266
2005-2006 38.6 14910
2006-2007 43.1 16689
2007-2008 49.8 20738
2008-2009 59 41341
2009-2010 73.3 39180
2010-2011 68.9 41550
2011-2012 98.9 45723*
*from April-Oct 2011
Source: Provisional Coal Statistics 2011-2012, Coal Control Organisation, Ministry of Coal
As the above table suggests India has been importing more and more coal since the turn of the century. A major reason for this has been the inability of the government owned Coal India, which is the largest producer of coal in the country, to increase production at a faster rate. Between 2004-2005 and 2011-2012 the company managed to increase its production by just 65million tonnes to 436million tonnes, an absolute increase of around 17.5%. The import of coal went up by a massive 241% to around 99 million tonnes, during the same period.
In fact, to its credit, the government of India realised the inability of the country to produce enough coal in the early 1990s. The Coal Mines (Nationalisation) Act 1973 was amended with effect from June 9, 1973, to allow the government to give away coal blocks for free for captive use of coal. The Economic Survey for 1994-95 points out the reason behind the decision: “In order to encourage private sector investment in the coal sector, the Coal Mines (Nationalisation) Act, 1973 was amended with effect from June 9, 1993 for operation of captive coal mines by companies engaged in the production of iron and steel, power generation and washing of coal in the private sector.”
The total coal production in the country in 1993-94 stood at 246.04million tonnes having grown by 3.3% from 1992-93. The government understood that the production was not going to increase at a faster rate anytime soon because the newer projects were having time delays and cost overruns. As the 1994-95 economic survey put it “As on December 31,1994, out of 71 projects under implementation in the coal sector, 22 projects are bedeviled by time and cost over-runs. On an average, the time overrun per project is about 38months.There is urgent need to improve project implementation in the coal sector”.
The last few years
The idea of giving away coal blocks for free was to encourage investment in coal by companies which were dependant on coal as an input. This included companies producing power, iron and steel and cement. Since the government couldn’t produce enough coal to meet their needs, the companies would be allowed to produce coal to meet their own needs by giving them coal blocks for free.
While the policy to give away coal blocks has been in place since 1993, it didn’t really take off till the mid 2000s. Between 1993 and 2003, the government gave away 39 coal blocks free to private companies as well as government owned companies. 20 out of the 39 blocks were allocated in 2003.
In the year 2004, the government gave away four blocks. But these were big blocks with the total geological reserves of coal amounting to 2143.5million tonnes. After this the floodgates really opened up and between 2005 and 2009, 149 coal blocks were given away for free.
Year Number of mines Geological Reserves (in million tonns)
2004 4 2143.5
2005 21 3174.3
2006 47 14424.8
2007 45 10585.8
2008 21 3423.5
2009 15 6549.2
153 40301.1
Source: Provisional Coal Statistics 2011-2012, Coal Control Organisation, Ministry of Coal
The above table makes for a very interesting reading. Between 2004 and 2009, the government of India gave away 153 coal blocks with geological reserves amounting to a little more than 40billion tonnes for free. Estimates made by the Geological Survey of India suggest that India has 293.5billon tonnes of coal reserves. This implies that the government gave away 13.7% of India’s coal reserves for free in a period of just five years.
The Congress led United Progressive Alliance was in power for most of this period with Manmohan Singh having been sworn in as the Prime Minister in May 2004. Interestingly, things reached their peak between 2006 and 2009, when the Prime Minister was also the Minister for Coal. During this period 128 coal blocks with geological reserves amounting to around 35billion tonnes were given away for free. But giving away the coal blocks for free did not solve any problem. As per the report prepared the Comptroller and Auditor General of India, as on March 31, 2011, eighty six of these blocks were supposed to produce around 73million tonnes of coal. Only 28 blocks have started production and their total production has been around 34.6million tonnes, as on March 31,2011.
The CAG and the losses
As is clearly explained above the Manmohan Singh led UPA government gave away around 14% of nation’s coal reserves away for free. Nevertheless, several senior leaders of the Congress party have told the nation that there have been no losses on account of the coal blocks being given away for free, primarily because very little coal was being produced from these blocks.
P Chidamabaram, the finance minister recently said “If coal is not mined, where is the loss? The loss will only occur if coal is sold at a certain price or undervalued.” Digvijaya Singh, a senior Congress leader targeted Vinod Rai, the Comptroller and Auditor General. Singh told The Indian Express that “the way the CAG is going, it is clear he(i.e. Vinod Rai) has political ambitions like TN Chaturvedi (a former CAG who later joined the BJP). He has been giving notional and fictional figures that have no relevance to facts. How has he computed these figures? He is talking through his hat.”
This is sheer nonsense to say the least and anyone who understands how CAG arrived at the loss number of Rs 1,86,000 crore wouldn’t say so.
The CAG reasonably assumed that the coal mined from the coal blocks given away for free could have been sold at a certain price in the market. Since the government gave away the blocks for free it lost that opportunity. This lost opportunity is what CAG has tried to quantify in terms of a number.
While calculating the loss the CAG did not take into account the coal blocks given to the government companies. Only blocks given to private companies were taken into account. Further only open cast mines were included in calculating the loss. Underground mines were not taken into account.
Also, the total coal available in a block is referred to as geological reserve. Due to several reasons including those of safely, the entire geological reserve cannot be mined. The portion that can be mined is referred to as extractable reserve. The extractable reserves for the blocks (after ignoring the blocks owned by government companies and underground mines) came to 6282.5million tonnes. This is equivalent to more than 14 times the annual production of Coal India Ltd.
The government could have sold this coal at a certain price. Also mining this coal would have involved a certain cost. The CAG first calculated the average sale price for all grades of coal sold by Coal India in 2010-2011. This came to Rs 1028.42 per tonne. Then it calculated the average cost of production for all grades of coal for the same period. This came at Rs 583.01. Other than this there was a financing cost of Rs 150 per tonne which was taken into account, as advised by the Ministry of Coal. Hence a benefit of Rs 295.41 per tonne of coal was arrived at (Rs 1028.42 – Rs 583.01 – Rs 150). The losses were thus estimated to be at Rs 1,85,591.33 crore (Rs 295.41 x 6282.5million tonnes) or around Rs 1.86lakh crore, by the CAG.
Chidambaram and Singh were basically trying to confuse us by mixing two issues here. One is the fact that the government gave away the blocks for free. And another is the inability of the companies who got these blocks to start mining coal. Just because these companies haven’t been able to mine coal doesn’t mean that the government of India did not face a loss by giving away the mines for free.
What are the problems with the CAG’s loss calculation?
The problem with CAG’s loss calculation is that it doesn’t take into account the time value of money. The government wouldn’t have been able to sell all the coal all at once. It would have only been able to do so over a period of time. The CAG doesn’t take this into account. Ideally, it should have assumed that the government earns this revenue over a certain number of years and then discounted those revenues to arrive at a present value for the losses.
This goes against the government. But there are several assumptions that favour the government. The coal blocks given away free to government companies aren’t taken into account. The transaction of handing over a coal block was between two arms of the government. The ministry of coal and a government owned public sector company (like NTPC). In the past when such transactions have happened the profit earned from such transactions have been recognised. A very good example is when the government forces the Life Insurance Corporation (LIC) of India to buy shares of public sector companies to meet its disinvestment target. One arm of the government (LIC) is buying shares of another arm of the government (for eg: ONGC). And the money received by the government is recognised as revenue in the annual financial statement. So when revenues for transactions between two arms of the government are recognised so should losses. Around half of the coal blocks were given to government owned companies.
Also, the price at which Coal India sells coal to companies it has an agreement with, is the lowest in the market. It is not linked to the international price of coal. The price of coal that is auctioned by Coal India is much higher than its normal price. As the CAG points out in its report on the ultra mega power project, the average price of coal sold by Coal India through e-auction in 2010-2011 was Rs 1782 per tonne. The average price of imported coal in November 2009 was Rs 2874 per tonne (calculated by the CAG based on NTPC data). The CAG did not take into account these prices. It took into account the lowest price of Rs 1028.42 per tonne, which was the average Coal India price.
Let’s run some numbers to try and understand what kind of losses CAG could have come up with if it wanted to. At a price of Rs 1,782, the profit per tonne would have been Rs 1050 (Rs 1782-Rs 583.01- Rs 150). If this number had been used the losses would have amounted to Rs6.6lakh crore.
At a price of Rs 2874 per tonne, the profit per tonne would have been Rs 2142(Rs 2874 – Rs 583.01 – Rs 150). If this number had been used the losses would have been Rs 13.5lakh crore. This number is a little more than the Rs 13.18 lakh crore expenditure that the government of India incurred in 2011-2012.
So there are weaknesses in the CAG’s calculation of the losses on account of coal blocks being given away free. But these weaknesses work in both the directions. The bottomline though is that the country has suffered a big loss, though the quantum of the loss is debatable.
To conclude
News reports suggest that several Congress politicians have benefitted from the coal blocks being given away for free. The companies which got coal blocks haven’t been able to produce coal. The government hasn’t been able to invoke the bank guarantees of the companies for the delay in producing coal. This is because of a flaw in the allocation letters. As the Business Standard reports “There is a technical flaw in the format of the allocation letters. As per the letters, the government can invoke the bank guarantee clause only in cases of less production, and not nil production.” Some companies have started selling power in the open market. This power is being produced from the coal they mined out of the coal blocks they got free from the government.
The situation has all the facets of turning into a big mess like the previous scams under the Congress led UPA regime. And like the previous scams, it is likely to be swept under the carpet as well. Despite all this, the Prime Minister Manmohan Singh will continue to be a mute spectator to all this, keeping the chair warm till Rahul Gandhi is ready to take over. I would be glad to be proven otherwise.
(The article originally appeared in The Seasonal Magazine on September 12,2012. http://www.seasonalmagazine.com/2012/09/mute-manmohan-watches-as-coalgate.html)
(Vivek Kaul is a writer and can be reached at [email protected])