The first iron ore mine auction won by Essar Steel Limited with the bidding price at a premium of 44.35% over the base price, paves the way for the auctioning of the mines. Leasing will ensure raw material security for steel players which were hitherto relying on iron ore procurement from domestic merchant miners like NMDC Limited. The successful bidder can be partially self-reliant on one of the key raw materials used in the manufacturing process of steel.
Seven steel companies, including Tata Steel ('IND AA'/Negative), Jindal Steel & Power, Bhushan Power and Steel, JSW Steel ('IND AA'/Stable)and Rashtriya Ispat Nigam ('IND AA-'/Stable), participated in the auction. The iron ore price to be paid by the successful bidder for the mine works out to be higher by 20% compared to the average sale price set by the Indian Bureau of Mines (IBM) at INR1860/(tonnes) t, assuming an extraction cost of INR1000/t-1100/t and loading the premium (44.35%), Royalty (15%), district mineral foundation contribution (10%) and NMET contribution (2%), the iron ore price to be paid by the successful bidder for the mine would be around INR2237/t. However, the situation will change if the prices of iron ore reverses to INR3800/t the average price as notified by the IBM over FY15. In such a scenario, the price to be paid by the successful bidder would be INR3424/t, a discount of 10%. The discount reflects the extraction costs which tend to remain fixed even when the prices of the IBM increase. Higher the price increase of iron ore, greater the benefit enjoyed by the successful winner.
Based on Ind-Ra's calculation, at a 44.35% of a premium to royalty and extraction cost of INR1100/t, the successful winner will be better off having the mine at IBM prices greater than INR2800/t. However, if the players through the use of highly mechanised methods of extraction are able to lower their extraction cost, the benefit of owning the mine despite the aggressive bidding over the long term can be healthy.
Ind-Ra notes that post the successful commencement of production from the mines and auctions in the future, the volume off-take from NMDC Limited and imported iron ore volumes may decline, if most of the large steel players who currently rely on merchant iron-ore procurement are successful in winning the mines. India produced 127mt in FY15 and imported 7.5mt in FY15, with NMDC's production at 30.5mt in FY15 and 25.9mt in 11mFY16.
In line with the Mines and Minerals (Development and Regulation) (MMDR) Act 2015, the successful bidder is required to make an upfront payment equal to 0.5% of the product of quantity to be mined and average price per unit. The first instalment is to be paid is 10% of the upfront payment to be made within 15 days of being declared the winner. The second instalment of 10% is to be provided on the day the mining lease is granted and the balance 80% is to be granted after 50 days from the date of signing the mining lease.
Ind-Ra additionally notes, the quantum of upfront payment in case of iron ore would not be substantial and it will work out to be nearly INR920m, which Ind-Ra believes is unlikely to stress the leverage profiles of the steel producers materially.
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