More power to commercial coal mining

For a policy that is a game-changer, commercial coal mining has had the most unassuming debut. Although the press release on the Cabinet decision positions it as “the most ambitious coal sector reform since the nationalisation of the sector”, follow-up messages have been subdued.

The move from “an era of monopoly to competition” holds many strategic implications for an entire set of industries and companies. Already, large global and local mining majors have expressed interest in this landmark deregulation which, in essence, allow mining and sale of coal without curbs on quantity, end-use or pricing.

The expectation is that the mining majors will set new benchmarks in terms of mechanisation, automation, mining practices, etc, and drive up productivity. So, even when only a handful are auctioned, the comparison will spur improvements across the industry. The productivity of our coal sector has improved over the years, but remains below global standards.

This can be achieved if the assets auctioned are large (say, 35 MTPA), accessible, and ready for development.

Inefficient, so far

The Government’s move to commercial coal mining is tacit recognition that developing coal blocks on end-use basis is inefficient. The output of Schedule II mines is barely half of the pre-auction levels (only 15 of 35 mines produce currently), and none of the Schedule I and III mines (total 49) are operational. There are challenges in design and handover but, mainly, the end-user industries lacked the expertise, scale and incentive to do anything more than source their own needs.

This changes entirely with commercial mining where real productivity gains can be achieved and passed on to consumers. The immediate beneficiaries are power generators who can improve utilisation and margins by sourcing commercial coal selectively. Power generators are assured of only 75 per cent of their annual contracted quantity under the Fuel Supply Agreements. These contracts, drafted in a period of scarcity, offer ample room for a competitive coal supply, and one can reasonably expect power generators to make the best use of it.

Distressed assets, in particular, will use this option to draw up a plan for turnaround after the debt recast. It is estimated that power plants totalling 26-28 GW do not have fuel tie-ups. The recent government scheme (SHAKTI) for such stranded power plants could satisfy only 9 GW (27 MTPA coal), leaving 17-19 GW capacity unmet. This translates to about 52-58 million tonnes per annum of coal demand, which makes a ready case for 3-4 large commercial blocks.

The opportunity gets larger as new commercial miners take full advantage of deregulation. They can offer short-term contracts for seasonal needs (to serve utility demand or via the merchant market), adopt more flexible pricing, and supply higher quality blends to substitute imports. It should be expected that the current coal producers too will respond with innovation and customer orientation.

There will be competition

The downstream power utilities will gain from this, but are simultaneously faced with a major competitive threat. As the output from commercial coal mines comes on line, it will have a sustained, moderating influence on energy prices. This means the manufacturing sector which is already diversifying its power procurement by buying from third-party sources and on the power exchange, will have access to lower cost electricity with limited price volatility. Similarly, as commercial miners target large energy users with captive power plants, discoms will lose the advantage of cross-subsidy.

Electricity regulators, for this reason, have to implement tariff reforms and rationalise cross-subsidy to levels at which discoms can still hold on to large energy users. This may not impact the smaller and lifeline consumers as the State governments will channel the premium earned from auction of commercial coal to extend direct subsidy. These actions are in line with the power ministry’s proposed changes to the tariff policy, namely, as rationalisation of cross-subsidies and direct transfer of subsidy benefit.

Private investment in commercial coal mining, in many ways, will thus transform the structure of the electricity industry. It makes it possible for new vertically integrated companies to own coal mining to power generation to distribution and retail supply. Customer choice can be truly offered now, as all segments of the value chain are competitive with multiple suppliers.

The success of this new policy will depend on incorporating lessons from the previous auctions, and deregulating it fully to allow efficiency and competition in the primary energy sector. If the Government gets the design right, there is good reason to expect these commercial coal auctions to become a mega hit and the poster boy for sector reforms.

The writer is Partner and Leader, Energy, Utilities and Mining, PwC India

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