Short-term traders need to follow policy debate.
The market's reaction to the draft Mines and Minerals Development & Regulation Bill (MMDR) has been very negative. The fine print is difficult to understand. It’s quite possible the Bill won’t go through Parliament anyway, without major modifications.
Let’s assume it does go through. Profit margins for mining companies will drop due to sharing profits with affected people. However, no clear-cut formulae is set out for calculating this. Nor do we know what exactly happens to captive blocks. So, the devil is in the details and there’s scope for creative accounting.
The government must be hoping the draft will result in some positive outcomes. One is that it will reduce opposition to mining operations from displaced citizens by offering them some upside in the process. Second, as a corollary, it could reduce Maoist violence. Third, it could lead to increased investments in mineral exploration and production and thereby, trigger more efficient exploitation.
As a confirmed cynic, I’d say that it’s unlikely that the new MMDR will be very successful in its aims, even if it’s passed as it stands. The equitable division of profit share between affected people will also require thought and offers room for ample corruption. Plus, profit-sharing will not compensate landless rural labour, who may turn Maoist anyway.
But the MMDR makes a start in recognising that the current methods of land acquisition and compensation are unsustainable. There have been way too many agitations because those laws were written in the 19th century by an imperial power that didn’t give a damn about locals
In the current system, the government can acquire land for whatever purpose, at the stroke of a pen. The same entity that acquires the land, also calculates the compensation. By just changing designated usage from “agricultural”, the value can then be multiplied and the land sold on. It doesn’t require a rocket scientist to understand why this makes the previous owners unhappy.
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If a sufficient number of people express their unhappiness forcefully, projects are held up. Of course, the acquired land isn’t farmed either. This is a classic lose-lose situation and it’s occurred multiple times. Projects ranging across sectors such as roads, power plants, ports, mines, to factories and real estate developments have been held up for years due to this vicious cycle.
If the MMDR is followed up by changes in land acquisition laws (for other purposes) , it cannot, in the long run, be bad for business. It could, in fact, have positive outcomes for miners, as well as downstream businesses.
Mining companies could generate higher volumes because they would be able to start operations in projects currently held up by local agitations. Downstream industries such as power, cement, metal-users, etc., would all benefit from more reliable supply. But if any of this is to occur, it would be in the distant future. We’ll have to wait a minimum of a couple of years to see even initial effects of the MMDR. That’s assuming that it goes through at all, in a form that isn’t very different from the current draft.
Trying to judge forward earnings for the mining sector in the current situation is frankly, absurd. It’s difficult enough, in a stable policy environment, to gauge future mining profits because prices can vary by huge amounts within short time-frames. Any mining operation is long-gestation and that adds to the complexity. The error factors are so large that standard discounted cash flow (DCF) methods of project evaluation are more or less useless in the sector. Many miners (especially in energy specific commodities) use a methodology called real option valuation (ROV) instead of DCF to judge if a given deposit is worth developing at all.
ROV is even more complex than financial option pricing from where it adapts models. An ROV would consider the likely range of current and future prices for a given mineral deposit, given various assumptions of timeframes and volatilities, the cost of developing the project, etc. and then decide whether to hold the asset in abeyance, develop the asset or to sell/ abandon the asset.
This is all very complicated. If you’re interested in the sector fundamentals for the next two years, keep tracking prices on global commodity exchanges and ignore debates until policy settle down.
If you’re interested in short-term trading profits, follow the policy debate, and try and gauge changes in sentiment. If the Bill fails to get through, or changes in terms of provisions, there will be a relief rally. Otherwise, there will be plenty of lucrative shorts. Whatever positions you take, keep strict stop losses.