Coal auction policy: New start, old fears

Last week, the Government announced a new coal block auction policy for the captive use of private companies. The policy aims to bring more transparency by auctioning coal blocks instead of allocating them on the much-criticised discretionary basis. It is expected that six explored blocks with reserves of over 2,000 million tonnes will be auctioned in the first phase, within the next four months.

Higher transparency and user-friendly terms of the auction process are likely to attract bidders. Vedanta, which operates captive power plants, has expressed its interest in bidding.

Beneficiaries

Coal demand in the country runs ahead of supply, with a shortfall of around 98 million tonnes as of 2012. This necessitates costly imports of the fuel, hurting companies in large coal consuming sectors — power, cement and steel. Companies in these sectors are likely to see relief with the new policy.

Fuel is a big-ticket cost for power companies, and may account for as much as 80 per cent of their expenses. The new policy would allow power companies that agree to sell power under purchase power agreements to bid. They can also avail significant cost concessions on the coal blocks.

The block will be awarded to the power company that offers the lowest power tariff in the auction; this should help ensure that the lower fuel cost benefits end users. Stocks of private power companies such as Reliance Power, Tata Power and Adani Power rose slightly after the announcement but gave up the gains to end the week mostly flat. The cement sector uses coal both as fuel and as raw material. Coal accounts for around 30 per cent of the total cost of cement companies, and the sector was adversely hit when local coal prices were hiked by 10 per cent this May. The auction process may help cement companies get captive mines and lower their costs. Cement stocks, however, did not react to the news.

In the case of steel producers, coal accounts for a relatively smaller 5 per cent of costs. Companies such as Bhushan Steel and JSW Steel, which do not have captive coal mines, could benefit from the new policy. The stock reaction though was muted to the policy.

Lower risk

The new policy has many positive features. Lease winners in the past had to face the risk of capital being locked for long periods. For instance, none of the ten blocks allotted between 2008 and January 2013 in Chhattisgarh, have so far achieved production.

The new policy requires the lease winner to make an upfront payment of 10 per cent of the estimated reserves in the block. The remaining payment will be linked to coal production, with the price set on the basis of international rates available from public indices such as Argus/Platts. This is unlike in the past, when 25 per cent of the bid amount was paid upfront and another 25 per cent after mine plan approval.

To ensure progress, the policy requires that the block winner perform an agreed minimum work programme at all stages and meet time limits for various milestones. The company is allowed five years to get to production in a fully explored block. The winning bidder is allowed to relinquish a block at a later date, without penalty, if minimum work has been carried out. This provides flexibility to exit and reduces the risk of being locked in.

Troubled past

On the flip side, fears that past troubles could recur may have contributed to the muted stock reaction. Block de-allocations, trouble with environmental clearances, and regulatory scrutiny in the past seem to be weighing on sentiment.

Many mining leases have had to be de-allocated due to lack of progress. For instance, coal mines allotted to Grasim Industries, Gujarat Ambuja Cement, Lafarge, Electrotherm and Kesoram Industries were de-allocated in November 2012.

ACC Cement could not get environmental and forest clearance to start production and its allocation was cancelled in early 2013.

Regulatory scrutiny has also intensified after the CAG report earlier this year on coal block allocations. This has been a drag on stocks such as Jindal Steel and Power which is down 47 per cent for the year.