The Coo(a)l Auction is Getting Hot

Both the Central Government as well as State Governments which are rich in coal must be more than happy as corporates threw up some crazy bids (time will tell!) to bag coal blocks in the on-going e-auction of coal blocks. According to the Coal Secretary Anil Swarup, the first two rounds of coal block auctions for 31 mines are likely to fetch the government over INR 2000 Bn (USD 33 Bn) which includes e-auction proceeds, royalty proceeds and upfront payment. This is already surpassing the INR 1800 Bn (USD 30 Bn) loss to the exchequer that the Comptroller and Auditor General had estimated due to arbitrary mine allocations.

Apart from above, around INR 97,000 crore of additional tariff benefit will accrue to the consumers of power through reverse auction of coal blocks, the upbeat Coal Secretary says.

Time will tell whether this benefit will percolate down to the end consumer.

In the first round (Schedule II coal blocks), 18 blocks having 1,527 Mt of geological reserves have been auctioned, while in the second round (Schedule III coal blocks) auction for another 14 blocks comprising of 1,346 Mt is being conducted. Another 9 blocks which were put up for auction, were eliminated from these two rounds either due to legal issues or insufficient number of bids in the technical round of e-auction.

So far 31 coal blocks have been auctioned and the largest chunk has been gobbled up by the power sector taking up 11 blocks followed by sponge iron (9), aluminium (6) and cement (5). Company wise, Aditya Birla Group has been the most successful bidder bagging 5 coal blocks (Gare Palma IV/4, Gare Palma IV/5, Kathautia and Dumri by Hindalco Industries and Bicharpur by Ultraech Cement), followed by Jaypee Group 3). Only five companies could retain their coal blocks. Mining method-wise, 18 coal blocks are opencast, 8 underground and 5 mixed mines. These 31 mines is expected to produce around 65 Mt coal each year.

Source: MSTC, Geovale

The first round of auction which comprised of the operating coal blocks listed as Schedule II mines witnessed fierce competition amongst the bidders. In some coal blocks which were earmarked for non-power sectors like Bicharpur and Gare Palma IV/7 where the floor price was set at INR 150/t and INR 206/t were sold at prices as high as INR 3,003/t and INR 2,619/t. For power sector also very aggressive bidding was observed for Amelia North and Trans Damodar blocks where forward bidding occurred following the initial reverse auction.

Geovale believes such aggressive bidding strategy will make a number of power projects become unviable. Power plants which have not signed the Power Purchase Agreement (PPA) will have comparative advantage since they can now have better risk assessment for their Case 1 bidding for power tariff. For the non-power sector, although the producers may offset the issue of volatility in international coal price and e-auction price, the cost of production plus high bid price will squeeze their margins substantially. As Coal India Ltd is targeting a coal production of 1 Bt by 2019-20 and international coal price is expected to continue to be benign such aggressive bid winning may prove to be a losing proposition.

Also, being a consultant for a number of coal blocks in the bidding process, it is observed that the prospective bidders are not well prepared for taking such huge financial risks. Lots of ad-hocism and last minute decisions are taking place in terms of selecting the mines for bidding, calculating the cost benefit analysis and ultimate bid price. We have found a few cases where the bid prices are not justifiable considering the geological complexities, mineable reserves and mining constraints. Some of the mine plans which are already prepared and companies have bid on the basis of those plans are full of drawbacks and loop holes.

As the coal blocks are acquired at a very high cost, the owners will now try to keep the cost of production as low as possible. As large chunk of money will be blocked in upfront payment and fixed payment, it will be prudent to outsource the mine development and operation activities to the MDOs (Mine Developer and Operator). The MDOs bring in expertise in mine operation, finances the project and has the onus of meeting the target production at a competitive cost allowing the mine owners to focus on other managerial issues.