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Coal India: Fuel supply agreement to have little impact

To meet additional coal needs through higher output, inventory drawdown

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Malini Bhupta Mumbai
Last Updated : Jan 21 2013 | 2:54 AM IST

Even as the battle between Coal India Ltd’s (CIL) largest shareholder, the government, and the second-largest shareholder, The Children’s Investment Fund, continues to brew, the market is bullish on CIL’s prospects. After a presidential fiat issued on Tuesday, CIL is expected to sign fuel supply agreements (FSAs) with power producers for plants commissioned after March 2009.

After signing FSAs, CIL would have to supply the full quantity of coal. If it supplies less than 80 per cent of the total requirement, it would be liable to pay a penalty, which could be 10-40 per cent of the price of the shortfall . However, it can charge a premium if it manages to supply more than 90 per cent of the contracted amount.

In theory, the shares of a company which is not free to price its product and has to guarantee supplies despite output issues should not have a ‘buy’ call on it. Despite the issues, the world’s largest coal producer has many takers. The market believes FSAs would change nothing for CIL. Analysts say CIL would be able to meet its additional contractual obligations in FY13 through increased output and de-stocking of its 74-million tonne inventory. They estimate the critical coal inventory to be maintained at 30 million tonnes.

In view of the recovery in coal production in Q4, CIL has raised its production guidance for FY13 to 470 million tonnes from 463 million tonnes. Explains Edelweiss Securities: “The environment ministry cleared a total of 10 CIL projects in February and March, with capacity of 19 million tonnes per annum, and is likely to further accelerate its clearances.”

This means CIL would not need to import coal to meet its obligations in FY13, as the increased output and inventory will suffice. However, over the long term, FSAs may not help power producers. Given that CIL would have to import coal if it is unable to meet its contractual obligations under FSAs, Citi Investment Research and Analysis says, “CIL will need to import long-term and we estimate 50 million tonnes in FY17. While imported coal pricing remains uncertain, we feel CIL will find a way to pass on the higher costs.” Though most believe the CIL stock may correct on this news, Citi says there is limited downside from here, with the odds in favour of a price rise, faster clearances and a high dividend payout.

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First Published: Apr 05 2012 | 12:45 AM IST

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