In a recent report, the Comptroller and Auditor General (CAG) of India has estimated that financial gains to the tune of Rs 1.86 lakh crore (around $37 billion) were passed on to private sector players which were allotted coal blocks between 2006-09; a part of this, it is thereby implied, could have come to the Exchequer, had there been a process of competitive bidding.

The CAG has further said a transparent method was not followed by the screening committee, comprising representatives of various ministries, while allocating 57 coal blocks to such players. Rather, an arbitrary process based on the recommendations of some State governments was used.

To bring in transparency, the CAG has recommended a competitive bidding process, something that the UPA Government has allegedly not followed.

Auctions are an effective method to maximise government revenues, as mining companies bid according to how much they value the licence.

But can auctions deliver a fair value for coal to tax payers? The US, Australia, China, South Africa and Indonesia are among countries that have large reserves of coal. Their experience reveals that non-auction-based methods can be effective.

While auctions are used in the US and have recently been introduced in Indonesia, Australia and South Africa issue licenses through non-auction-based methods.

Of paramount importance is how a coal licensing regime addresses information asymmetries faced by a prospector. Asymmetries make it difficult to value the coal on a prospective tract with reasonable certainty. The source of these asymmetries could be manifold: Geology, infrastructural constraints, or demand-based.

An auction or non-auction-based system is effective only to the extent it remedies information asymmetries.

INITIAL SPADEWORK

Both Australia and the US release, at nominal cost, extensive amounts of high-quality geological, geophysical, and other technical information that is widely used by domestic and foreign companies in exploration. Both have an efficient coal transportation system run either by private operators or competent government departments. They also have well-functioning coal markets with market forces balancing supply and demand.

The US has taken the lead in using an auction-based system for coal licencing on federal land. The Bureau of Land Management (BLM), a federal agency, uses two types of competitive leasing processes: Regional leasing where the BLM selects tracts within a region after land use analysis, and leasing by application where an interested party can nominate a particular tract of coal for competitive sale, provided it has been included under BLM’s coal land use plan. In either case, a sealed bid auction with a secret reserve price is used.

The success of Australia’s non-auction coal licensing system is attributed to reasonable royalties, secure tenure of ownership rights, free entrepreneurial decisions, largely well known coal deposit locations, and supportive public geological services.

State governments have been entrusted with the management of coal resources. Licences can be obtained by filing an application with the State government, which then makes an assessment that considers a broad range of environmental issues. The mining company to which a lease is awarded pays a legislation-mandated royalty.

The experience of the US, however, suggests that auctioning coal licences could lead to the kinds of problems encountered in India, where the CAG has alleged that the Government has left too much money on the table for the coal producers.

A recent Washington Post article reports that in the US, of the 26 coal leases the federal government has awarded in south-eastern Montana and north-eastern Wyoming since 1991, 22 have gone to a single bidder. In the other four instances, there were only two bidders involved. This has led to calls that the auction process is responsible for depressing the value of the leases and taxpayers have lost as much as $28.9 billion over the past 30 years.

South Africa has followed the Australian model with the passage of the Minerals and Petroleum Resources Development (MPRD) Act in 2002, which transferred ownership right on mineral resources from private land-owners to the state. Social goals have been accommodated by evaluating mining and exploration applications.

INDONESIAN SYSTEM

Indonesia has transitioned to a US-style auction based system since 2009. While a first-price sealed-bid auction with a government-mandated secret minimum price is used as in the US, additional criteria have been imposed on companies that wish to participate in the competitive tender process.

As an example, foreign companies can bid only through a domestic affiliate; foreign firms will have to sell down stakes in mines and increase domestic ownership to at least 51 per cent by the 10th year of production; companies have to satisfy a domestic market obligation, whereby a fixed percentage of coal production has to be for domestic consumption.

However, prior to this, Indonesia spent over 40 years licensing coal to foreign companies through a non-auction based system. Given the undeveloped nature of Indonesia’s coal industry, beginning in 1969, the Government of Indonesia entered into direct, bilateral contracts with foreign coal mining companies.

The idea was to obtain their investments and expertise to develop what was then a blank slate, in exchange for fairly generous contract terms.

Thus, both auctions and non-auction based methods for licencing coal can be effective in delivering fair value to the tax payers, apart from dealing with externality issues. Since mining of coal, like most other mineral resources, is bedevilled by information asymmetries, the priority in coal licensing reform should be to mitigate them.

(Sareen is a Principal Economist at Nathan Associates Inc. Singh is Principal Economist, Nathan Economic Consulting India. The views are personal)

(This article was published on September 6, 2012)
XThese are links to The Hindu Business Line suggested by Outbrain, which may or may not be relevant to the other content on this page. You can read Outbrain's privacy and cookie policy here.