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Coal Auctions Impact On 'Make In India'

Published on Thu, Aug 27,2015 | 18:40, Updated at Thu, Aug 27 at 18:40Source : Moneycontrol.com 

By: Santosh Kamath, Partner, Infrastructure & Government Services, KPMG India

The government showed remarkable speed and good intent in carrying out the coal block auctions in February and March this year. By all means, the process seems to have been conducted transparently. But at the end of it, a serious question arises: would the outcome be healthy for our industry?

For the non-power sectors (the ‘unregulated’ sectors), the auction prices have led to a rise in the cost of coal, comparable to that of the landed cost of imported coal (90 per cent of landed import coal price[i]), thus undermining India’s natural advantage of abundant domestic coal reserves, and causing a handicap of INR1100/ton to the industry in China. The point we make here is that while auctions may be good, the conditions in which they occur also need to be right to healthy results.

It is tempting to say that a market determined price through auction is always fair and reflective of the true value of the resource. But this argument would require a deeper introspection in the current context. Are the demand-supply conditions ripe for auctions to determine a fair price? Are bidders placed in a situation of extreme despair that prevents rational economic behaviour?

A person who has been starving for a few days would perhaps pay an unreasonably high price, possibly a large part of his disposable income, for a meal if food was in short supply. Though this would signal a fair value for food at the time of shortage; it leaves the individual with little resources to nurture and grow his wealth and prosperity. If this situation is transposed to wealth creating industries, the impact could cascade down to overall investment and economic growth. The Indian industry could lose its competitiveness compared to its global peers. Our analysis suggests that the net result of these auctions has led to an increase in the cost of energy to certain industries by 30 to 40 per cent[ii] and impacted their cash flows by 5 to 10 per cent[iii]. Further, this is likely to hit the banking system as many of the users are financially stressed; for example, the iron and steel sector where over 50 per cent of the advances may be stressed.

Auctions are good; however, certain pre-conditions should be met:
1.    A reasonable equilibrium between demand and supply should exist when the goods under auction are core to economic output. In a scenario where demand significantly exceeds supply such as up to five times in the recent auctions, then bidding behaviour could become irrational.
2.    The financial soundness of end use sectors need to be assessed and the possibility of significant asset stranding for unsuccessful auction participants should be reduced.
3.    Users need to have credible alternatives; these could be other suppliers within India or abroad. In the last round of auctions, this was not the case. Even import of coal was not a reliable alternative due to logistical constraints from the port to the plant.

What then could be the alternative? Reforms in pricing of natural resources should be done in a step-wise manner:
1.    Supply side improvements should be brought about before auctions are carried out in cases where the resource is considered as an essential one and is in very short supply.
2.    Till the supply side position improves, a minimum level of supply should be assured for all potentially stranded investments. For such minimum levels, a benchmark price should be set to reflect a reasonable market price of the resource. Natural gas pricing in India has been set on such benchmark basis. Auctions can be carried out for quantities above this level.
3.    The security of supply through logistics feasibility needs to be ensured to make alternate options such as imports reliable.


There should be serious introspection on how the ‘Make in India’ vision of the government can be carried out in respect of energy intensive industries. For an energy intensive industry, India presents handicaps because of the regulatory structure. A reason many industries shifted to captive power was because public utility tariffs were loaded with cross-subsidies and inefficiencies – a situation which industries in developed markets do not face. Further, the reliability of supply was a major concern. To avoid this situation, large energy intensive industry switched over to captive power and the cost of such power has now increased substantially owing to the market auction of coal. The cost of such power now exceeds the price paid for utility supplied power in industrialised countries such as Germany, Norway[iv] and the USA[v], which are in the range of USc4-6/kwh for energy intensive industries, and the cost of captive power in China by 15-20 per cent[vi]. Apart from the higher cost of power, it has consumed valuable senior management bandwidth for developing and managing mines and power plants which are not core business activities for such industries. It is time for to reform energy supply to the industry in a holistic manner, if we truly wish to achieve the vision of ‘Make in India’.

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[i] Weighted average for all Schedule II coal mines for non-regulated sector
[ii] Compared to domestic coal at  INR700 per mn Kcal, landed basis)  
[iii] Assuming cost of energy as 10 per cent - 20 per cent of overall cost structure of end use industries
[iv] For customers in energy intensive manufacturing
[v] For industrial states such as Pennsylvania, Texas, Alabama with presence of iron and steel companies
[vi] Compared to cost of power in China for a CPP with a standalone captive coal block which avoids distribution fees
 
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