Coal auctions: irrational exuberance or strategic buys?

Most the successful bidders seem to have prioritised long-term fuel security over short-term profitability

The success so far of coal auctions being conducted by the government raises more questions than answers. The government has taken the stand that its opposition to coal allocations has been vindicated. Commerce and Industry Minister Nirmala Sitharaman told reporters that “… CAG's position has been vindicated but I am underlining the larger issue here ... our position has been vindicated."

Even CAG’s estimate of Rs 1.86 lakh crore in lost revenue seems small in comparison with the expected Rs 15 lakh crore that these auctions are expected to fetch the government over the life of these mines.

The aggressiveness of bidders for coal mines and the revenue likely to accrue to the government highlights the faulty allocation policies followed by all governments till date. There was clearly a good market for coal mines which were being given at throwaway prices by earlier governments.

But is the current policy of allocation correct?

From the government’s point of view, it might seem so since it is collecting more money now than at any point of time in the past. From the companies’ point of view, however, the impact is not as simple.

Edelweiss says in a report that the objective for the power sector bids has been mainly to achieve fuel security and retain the mines, while the benchmark for non-power sector bids seem to be landed cost of imported coal costs.

Financial impact for power developers from the current bids is expected to be cushioned as most of them (except CESC) have some open/merchant capacity. For non-power developers the prospect of ramping up the output, higher utilisation of end-use plant due to assured fuel supply and lack of volatility in coal costs are the key mitigating factors.

The bidding for coal mines by the power developers have been overly aggressive with every bid being in negative (additional premium being offered). Securing/retaining fuel seems to be the predominant reason, even if it calls for foregoing some profit/incurring marginal loss. However, Edelweiss feels that developers are confident that due to the potential merchant sale (as coal cost would be only around Rs 500/tonne as against the earlier assumed Rs 2,800-3,000/tonne) as well as tying up the spare/open capacity with better rates, losses will minimise.

Rating agency Crisil, however, says that auction participants for both regulated and unregulated sectors are facing difficult choices, as outcomes will redefine their cost structures and profitability in the short term, even as they ensure fuel security and sourcing flexibility over the long term. For the regulated power sector, the allocation of blocks will lead to a four-fold increase in captive coal availability to around 100 million tonne over the medium term. Crisil feels that aggressive bidding will be credit negative.

This view is shared by Macquarie Research, which questions the irrational exuberance shown by bidders. Bids between $15-50 per tonne is well beyond the economic range of $1-3 per tonne. Macquarie feels that the economic returns for the winners will be extremely muted and, in some cases, worse than buying coal under e-auction/imports.

Crisil feels that initial bids indicate long-term strategic fuel security is getting precedence over short term profitability  as underscored by multiple bids at zero cost and additional premiums per tonne that will be paid to state governments and cannot be passed on to consumers.

The real impact on power producing companies will be felt only after they sign their PPAs. Even at current levels of aggressive bids cost of power generating companies is not expected to be more than Rs 2.5 per unit. Analysts expect bids from discoms to be in the range of Rs 3-3.5 per unit, which is much lower than what they are paying currently. Finance minister Arun Jaitley is already on record saying that common man will have access to cheaper electricity.

Non-power developers have seen more aggressive bids with the mantra being securing coal assets. Most of the blocks were auctioned at much higher prices than expected, with only a few blocks getting auctioned almost at par with the landed cost of imported coal. Edelweiss says that the key reasons for bids are to hedge themselves from the risks of future rise in international coal prices, secure fuel supply for thirty years at a price lower/at par than the landed price of currently subdued international coal prices and greater control in operating the end use plant.

Though it might seem that bids are aggressive given historical rates, companies are taking calculated decisions to secure steady supply of a key raw material at a fixed price.