Less than a month after chief executives from the power sector met Prime Minister Manmohan Singh, a solution to their coal woes came from the Prime Minister’s Office (PMO) on February 15. The speed of actual gains from the decision may, however, not necessarily match the urgency with which the solution was found. That’s because the onus of fixing the problem is on Coal India Ltd (CIL), which was perceived to be at the root of the problem in the first place.
In its first sitting, a secretary-level committee headed by Principal Secretary to the Prime Minister Pulok Chaterjee decided that CIL would sign fuel supply agreements (FSAs) with power plants that have tied up long-term purchase agreements with power distribution companies and have been or would be commissioned on or before March 31, 2015. For power plants that have been commissioned till December 31, 2011, the FSAs will be signed before March 31, 2012.
The decision is expected to provide relief to power plants with a prospective cumulative generating capacity of 50,000 Mw. But CIL’s management can be forgiven if it feels unhappy. What is the issue at hand?
Some 18 CEOs from private sector power companies – including heavyweights like Tata Power’s Cyrus Mistry, Reliance Power’s Anil Ambani and Adani Power’s Gautam Adani – had informed the prime minister that CIL has been insisting on signing FSAs with a supply assurance of only 50 per cent of the required quantity; as a result, no FSAs had been signed since April 2009.
The February 15 order stipulated that FSAs will be signed for the full quantity of coal mentioned in the Letters of Assurance (LoAs) for 20 years. CIL will be penalised for supply below 80 per cent of the committed quantity and incentivised for supplying above 90 per cent. If CIL is unable to fulfill its commitment from its own production, it would have to arrange for supplies via imports or through arrangements with state or central public sector units that have been allotted coal blocks.
CIL’s initial decision to limit supplies stemmed from a mismatch between growth in production, at six per cent, and growth in demand, at 9 per cent. Added to that was the lack of environmental clearances that stalled the development of about 660 million tonnes (mt) of coal reserves with potential to generate 130,000 Mw.
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The PMO’s February 15 diktat came just 15 days after Coal India was made to roll back a new global pricing system to absorb a wage increase for its 363,000 workers. The diktat certainly blew the lid off the illusion of public sector autonomy for navaratna companies. The impact of the price rollback was immediate; but what about the FSA directive?
An analysis by Emkay Global Financial Services Ltd suggests that CIL will have to increasingly rely on imports. Considering a minimum 80 per cent supply requirement for new FSAs, CIL needs about 123 mt. Of this, 30 mt can be supplied at CIL’s current level of production of about 450 mt. A further production increase of five per cent will bring in about 20 mt more. The balance, 73 mt, will need to be imported, the price of which is linked to the global market. Imported coal is currently Rs 4,300 a tonne compared with the domestic price of around Rs 1,120 a tonne.
Much, therefore, hinges on who picks up the bill for these costly imports. According to Dhananjay Sinha, co-head, Institutional Research, Economist and Strategist, Emkay Global Financial Services, CIL could end up bearing losses if it is not passed on entirely to its customers.
CIL may also have to restrict the quantity of coal it sells through e-auctions in order to increase supply to power plants. Currently, it sells around 43 mt, or about 10 per cent of current production. Any diversion from e-auctions to the power sector will mean CIL forfeits some revenue. This is because e-auction prices are 60 to 70 per cent higher than sales based on the notified price.
“There is a potential downside for CIL in this whole affair,” says Sinha, adding, “the ideal thing would have been if production were increased and approvals, including environment and other clearances, from the government had come faster.”
The additional point is that private sector producers have clearly leveraged CIL’s public sector ownership in lobbying the prime minister. Had CIL not been a government company, it could not have been made the sole arranger for imports; the power companies would have had to import coal themselves. The spillover effect, Sinha points out, has to be borne by other shareholders as well since CIL is a listed company.
Exacerbating current coal shortages (and, therefore, fuelling imports) is the development of related infrastructure. Sinha points out that “even in the first two years, investment in related infrastructure would need to be made first”. Even if all the “no-go” coal blocks were given environmental clearance en masse, there would be a significant time lag before production begins on this account.
The PMO has certainly set a precedent and, not surprisingly, questions are being raised about the fuel supply arrangements of power plants that are due to be commissioned after March 2015 and are, therefore, outside the purview of the directive.
Seshan Balakrishnan, director-Infrastructure Practice, Ernst & Young, says given that it takes three to four years to develop a power project, many of them would be in the fund-raising phase at present. Unless they have captive coal blocks, it may become even more difficult to achieve financial closure.
Also, power generation companies will be hard put to pass on the increased cost through tariff hikes. Electricity prices are a highly politicised issue and power is distributed free to farmers in most states, so the cash-strapped distribution companies will be left with more losses if tariffs are raised.
Much depends on the pricing system that is followed. If imported coal is distributed through price pooling of domestic and imported coal, then private power producers will gain since they will not be bearing the cost of more expensive coal alone. If a weighted average price mechanism is adopted, there would be a significant increase in coal prices, which will impact existing power players and eventually the state electricity boards.
As a result, Balakrishnan says, the valuations of power projects will go haywire. The returns associated with power projects would fall substantially, reducing the interest of developers in setting up power plants and of equity investors in funding the power sector.
Though the PMO’s attempt may have been to deal with coal shortage in one stroke, it has left related questions on pricing and infrastructure bottlenecks unaddressed. The answers to them are critical for not only CIL’s financial health but the future of the power sector too.