Indian steel producers have faced a torrid spell on the margins front over the past year. Soaring coking coal prices and limited pricing power have squeezed players such as JSW Steel and SAIL.

A silver lining for several Indian steel producers was iron ore pricing. Domestic miners such as NMDC sell their ore at prices far below international prices. Better still, Tata Steel and SAIL have their entire requirement of iron ore met by captive mines. This is a substantial competitive advantage.

However with the introduction of the new Mines and Minerals Development and Regulation (MMDR), things could get a lot tighter.

India's top three domestic steel producers — SAIL, JSW Steel and Tata Steel - will see varying impact of the MMDR Bill.

Tata Steel is the most integrated domestic player with captive mines in Orissa and Jharkhand to meet its entire requirement of iron ore and 65 per cent of its coal needs.

The least integrated of the top three is JSW Steel whose sole domestic mine is a stake in an iron ore mine in Karnataka which caters to 10-15 per cent of its requirement. SAIL lies between the two with captive mines meeting its entire requirement of iron ore and 25 per cent of its coal requirements.

Why captive mines?

Indian steel producers sell steel at prices which largely hover around international prices while their reported cost per tonne of iron ore range between Rs 760 and Rs 2,800.

This is an advantage over international producers who procure iron ore at international spot prices which averaged at Rs 6,750 between March 2010 and April 2011.

Taking a closer look at the cost structure of a SAIL or Tata Steel gives us an idea on why captive mining is such a coveted business model.

Almost every large steel producer wanting to set up shop in India targets the iron-ore belt in Jharkhand, Chhattisgarh, Orissa or Karnataka. The promise of building a large plant also comes with the demand for a mining concession.

Tata Steel's Indian operation is among the most profitable globally. In FY11 the company's standalone EBIDTA margins stood at 43 per cent. As a percentage of sales, the company's spend on iron ore and coal accounted for 30 per cent of sales.

This figure is remarkably low compared to peers such as SAIL and JSW which shelled out 43 and 52 per cent of their net sales for their iron ore and coal requirements during the same period. Consequently both the companies' operating margins hover around 21 per cent.

So now that miners will have to shell out a large sum as royalty, how will that shake things up?

The MMDR knock

In FY11, iron ore miners across India, including captive miners, paid a royalty of 10 per cent on the sale price of the iron ore mined (as listed by the Indian Bureau of Mines). Depending on the steel producer in question, this worked out to Rs 200 - 460 a tonne of iron ore sold.

SAIL, whose mining division is critical for lowering costs, will lose out the most. SAIL paid out Rs 580 crore in royalties on both coal and iron ore (a good chunk of which is towards iron ore).

SAIL shelled out 1.5 per cent of its total spending (excluding depreciation) on royalties. The new charges could take six per cent off SAIL's operating profit. Tata Steel's royalty outgo was Rs 615 crore. However Tata Steel's royalty includes the outgo for its seven million tonnes of mined coal. In case of steel producers, the ‘new' payment equivalent to royalty applies to every mineral utilised except coal.

Captive coal miners are required to pay 26 per cent on the notional value of their output excluding mining and transportation costs.

Companies with sizable coal operations such as Tata Steel could find themselves paying out a considerable sum which could be roughly in the same range as their per-tonne iron ore royalty rates.

Royalties accounted for 3.4 per cent of Tata Steel's stand-alone expenses last year. The souped-up charges could account for nine per cent of their total expenditure and cost them 5-6 per cent of their operating profits.

Passing it on

The impact on JSW Steel will be harder to quantify with certainty. NMDC is one of JSW's largest suppliers. NMDC's royalties accounted for a third of its total spending. The additional payout amounted to nine per cent of the company's operating profit last year.

With 86 per cent operating margins, NMDC can afford the payout while maintaining its enviable margins. How much of this burden will NMDC and other miners pass through to steel producers such as JSW, Essar and RINL is the big question.

NMDC prices its wares at half the levels of international peers. So the company has a good case to pass through some of the added burden. However steel producers find themselves between a rock and a hard place when it comes to passing on hikes given the challenging global climate for commodities.

This is likely to remain the case over the near term which spells further margin pressure for steel producers.

For Sesa Goa, which exports a significant portion of its output, this Bill could spell further trouble. Hikes in export duty earlier this year and the Karnataka iron ore export ban have crimped output.

Sesa paid out Rs 330 crore in royalties during the last fiscal. This was just under seven per cent of its total spending. The levy could take a 6-7 per cent bite out of Sesa's operating margins of 62 per cent.

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