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Feature | February 2015

The genesis of coal mining

The bidding framework needs to have adequate risk mitigation measures in place for the bidders as well as procurers. None of us want to see another failed effort leading to cascading failure of assets from mines to power plants.

The Indian power sector is witnessing a robust growth as investments made in the past are materialising now. In power generation, 21 GW of generation capacity has been added in the last 11 months. During the last financial year, per capita consumption of electricity has grown from 884 kWh to 917.18 kWh and nearly 9,730 new villages have been electrified. Implementation of Financial Restructuring Plan (FRP) across select distribution utilities has improved the short term liquidity position of these utilities. Tariff reforms across majority States are in progress.

This year brought to light significant challenges in fuel availability. De-allocation of captive mines rendered projects unviable. There have been regulatory uncertainties over compensatory tariff for change in international mining law and prices, increased NPAs and debt restructuring due to additional stress on new assets. The power sector witnessed tightening of norms for competitive bidding, tariff discovery under the new MYTO framework and allocation of fuel linkage.

Among the wide gamut of challenges, fuel availability, especially for coal, has turned out to be a real concern for the sector´s long term growth expectations. The genesis of coal mining in India, unlike in other coal rich countries such as Indonesia, South Africa, US and Australia, is primarily rooted to meeting domestic needs. Private sector companies were allowed to pursue coal mining for the first two decades post-Independence, but the government was concerned over the working conditions in mines and low production in mines. The government decided to nationalise the mines in early 1970s. The nationalisation of coal mines were implemented in two phases. The first phase was nationalisation of mines with coking coal and second phase was for mines with non-coking coal. This was followed by a Coal Nationalisation Act (1973). However, during this period, some private companies such as Tata Steel and Indian Iron and Steel Company were allowed to retain their mines. Over the next two decades, the coal sector was dominated by the government-owned monopoly CIL and its subsidiaries.

In the early 1990s, with growing pressure on the government for investment in energy resources, dismal performance of PSUs, advent of globalisation and the rise of India Inc., the government of India decided to allocate mines on a case-to-case basis to private players. The basis of coal allocation was however always linked to end use which implies that a private sector company intending to use coal for manufacturing or power generation would be allocated coal blocks, but the company may not use the mine for commercial use such as sale of coal. Over the next 15-20 years, the government identified 328 blocks for allocation of which 218 blocks were allocated to government and private companies. 80 of these blocks were later cancelled for variety of reasons. In August this year, the Honourable Supreme Court cancelled all the blocks allocated since 1993 which included 33 coal blocks already producing coal. The court held that the coal mine allocation was done on an arbitrary basis and no transparent mechanism such as competitive bidding was adopted.

The government has already come out with a Cabinet-approved ordinance to address the immediate crisis arising out of de-allocation of captive mines. The ordinance was imperative to address the complexity and process of the assets and a liability arising out of the de-allocation of mines, however, the ordinance also focusses beyond this theme and lays down broad guidelines for auctioning of coal mines. The ordinance contains the entire list of 204 mines, de-allocated by the order of Supreme Court under three schedules.

The first schedule contains the entire list of 204 mines which were cancelled by the Supreme Court in September 2014. The second schedule contains the list of 42 mines which were operational prior to the de-allocation. The Supreme Court has allowed a six-month grace period to the allottees before transferring the assets to the government. The third and final schedule contains a list of 32 mines which are in various stages of development.

The ordinance clearly states that allocation of all mines under Schedule I will be through a public auction. The operational mines, which are listed under Schedule II and III, shall be auctioned to players who already have an end use in place. This will imply that players with operating assets whose mines were de-allocated can also bid for the project but the government has also opened its doors for generators with coal linkage from CIL to also bid for the mines. This increases the possibility for existing generators to replace their coal linkage with captive coal, in which case the coal linkage would be freed up for further allocation. The ordinance however bars any company convicted for an offence related to the coal block allocation. Adding further flavour the government has also reserved the right to allocate the coal mines to a company which has secured project under competitive bidding route (such as Case 2 or UMPP).

The Ministry of Coal also come out with captive mining rules which has laid down detailed provisions for appointment of bidding authority, its powers and process.

However the detailed framework on the auction process including bidding documents has not been made public. It will be interesting to note the qualification and commercial bid criteria which need to be balanced to address a number of objectives which includes:

  • Adequate participation from sector players
  • Post-bid implication on power purchase contracts and pricing under different scenarios such as regulatory route, sale of power under the Case 1, Case 2, DBFOO and DBFOT route
  • Benefit-sharing formula
  • Upfront price for mines
  • Floor price determination.

The bidding framework needs to have adequate risk mitigation measures are in place for the bidders as well as procurers. None of us want to see another failed effort leading to cascading failure of assets from mines to power plants.

Another significant issue which needs to be addressed to ensure viability of the coal auction process is to prevent irrational bids. This requires understanding from the bidders as well the controls from the bid process managers. The bid process managers may have to internally set a ceiling price considering the ground realities beyond which bidders should be asked to justify the bid in front of the bid committee. There have to be clear quantitative targets in terms of production and investment based on our learnings in the oil & gas sector which has seen similar bidding models for quite some time.

Finally, there are discussions on a benefit-sharing model where benefits accruing to generators from captive mines will be shared with the end consumer. This is in line with government policy on preventing any gaming situation but there are a lot of uncertainties surrounding the regulatory provision and power sale contracts under the older bidding framework which would need to be addressed.

In our view, the immediate steps to re-allocate captive mines through a competitive bidding process will be a good tactical step. This process will help relieve the distressed assets in the manufacturing and power sectors. The existing bidding process is likely to be focussed on and is likely to attract players having assets at advanced stage of commissioning/operations. The existing process will also help in freeing up some of the long term linkage commitments from CIL thereby improving the supply scenario to existing power plants and allowing some leeway to CIL for new tie-ups.

However in what could be termed as a strategic decision, apart from the mines under the Schedule II and III, other mines under Schedule I can be used for commercial mining. Promoting commercial coal mining and development of competitive coal markets which is envisaged as the final leg of the ordinance seems to be the long term strategic solution to revive the sector.

There have been a lot of technological innovations in the mining sector which has not found its way into the Indian mining sector. Allowing commercial coal mining would attract global coal majors who can bring in new technology to enhance production and reduce lifecycle costs.

The design of the coal market may still be focussed on meeting domestic needs with allocation for individual sectors such as steel, power and cement. The design of the coal market for commercial miners may be divided into long term and short term contracts. The ceiling price for coal price or trading margin in short term may be fixed by an independent regulatory body, allowing commercial coal miners to hedge their exposure. This would also allow power plants selling power through merchant/open access route to meet their requirements from the open markets. Coal markets with the possibility of trading will help bring in more competition and reduce prices. This is visible in power markets where power is traded at prices much below the long-term prices. Also, the bidding framework for commercial mining can draw heavily from the NELP regime. Development and design of coal markets can be done in lines with experiences in Indonesia, Australia and SA where commercial mining has been successful and further tailored to suit our own requirements.

However, to augment this, we need to strengthen mining data availability in line with global practices. This has been in an abysmal state in India.

We have to perceive the long term plans of the government of India on coal mining. It is pertinent to relook at the Coal Mine Nationalisation Act which was passed 40 years ago. This may not gel well with the changing business and economic environment as the sector would move into a transition state. We must understand that our country is targeting a growth rate of 7-8 per cent on sustained basis and securing the basic energy needs for the country is the most significant step towards achieving the goal. It is important for policy makers to shed their inhibitions on private sector participation. Businesses are driven with intent of profit but so are efficiencies, technology and innovation. Already we have allowed private participation in other critical sectors such as defence, electricity generation and the private sector is latching on to the opportunity.

There exists an interesting theory on monopolistic, State-owned companies which says, ¨Monopoly PSUs similar to socialist government are like a single centre of gravity for the sector, if they fail the entire sector fails.¨ Hence it is important for the country to diversify and not place all its eggs in just one market.

Authored by Umesh Agrawal, Associate Director - Energy, Utilities & Mining, PwC and co-authored by Sandeep Mohanty, Principal Consultant - Power and Utilities, PwC.

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