IS COAL INDIA THE NEXT MILCH COW

http://www.mudraa.com/trading/95135/0/is-coal-india-the-next-milch-cow-or-next-basket-case.html Over the last four years, Coal India, Indias monopoly producer of the Black Diamond, has been quietly sending you an annual virtual gift cheque for Rs 500-and-odd. Dont check your bank account, though. We said virtual gift cheque, not real. But whats real is that Coal India has been selling coal at deep discounts to the world price keeping your energy costs low and manageable. Lets put it differently: if Coal India had sold its stuff at world prices, it would have earned Rs 2,45,000 crore more over 2007-11, according to Firstposts back-of-the-envelope calculations. Thats Rs 2,000-and-odd lost on every man, woman and child in India over four years. Similar cheques have been sent by the government and the oil companies by selling diesel, cooking gas and kerosene prices below cost, ruining the fiscal situation. Firstpost estimates the oil fuel subsidies over the seven-year period from 2004 to 2011 at a whopping Rs 3,60,000 crore borne either by the government or the oil companies. Thats another Rs 420 per head annually per capita. Its not sustainable any more. This is why the government has been gritting its teeth to raise oil prices, never mind the public outcry. Similar things may happen in coal, though the situation is somewhat different here for one main reason: Coal India is a monopoly, and its cost of production is one of the lowest in the world. This is why even though it sells its coal at 2080% discount to world prices depending on its calorific quality it still makes money. But all that is about to change. For three reasons. First, as a listed company, Coal India cannot endlessly keep consumer interest above shareholder interest. And with the increased involvement of private sector players, who will anyway demand world parity prices, it would not be possible to deny the same to Coal India. Second, environmental, land acquisition and resettlement costs are rising. This means Coal India cannot raise output fast enough to meet rising demand. Already, there is talk of coal imports rising to 30% of power demand by 2017. Third, the jholawalas in Sonia Gandhis National Advisory Council (NAC) have hearts of gold. They bleed for the tribals and people who lose their lands to coal mining and other projects. This is why they have pressured the government to give 26% of profits from coal and other mining projects to local and tribal communities, according to the new Mining Bill cleared by the Cabinets Group of Ministers. This will again push up costs tremendously. Protecting the interests of the poor is a national duty, but so is protection of our energy security. The government tends to fall into the trap of believing that keeping energy prices low and subsidised at the producer level somehow benefits the country. It doesnt as the prolonged subsidies in the oil sector show. Now we have no alternative but to boost prices when inflation is soaring. And the oil marketing companies are financial wrecks, living off quarterly doles of compensation from the government which is often wayward in its payments. Five years from now, this is what could happen to the coal sector, as low domestic prices, environmental concerns, and the entry of private players with their own agendas complicates the picture. According to a BusinessLine report, by 2017, the country could be facing a domestic shortage of over 215 million tonnes of coal, necessitating imports. As demand rises to 742 million tonnes, the projected production is only 527 million tonnes. This means nearly 30% of our needs will have to be met from costly, imported coal. Will the government then operate differential pricing, one for Coal Indias coal, and the other for private players and importers? This is exactly the situation which sent public sector oil companies into a tailspin, sparing the private sector players. So whats the remedy? What are the arguments, or counter-arguments? What are the pros and cons? First, Coal India must be allowed to gradually raise its prices to world levels maybe over five years. If the government wants to keep domestic prices low, it must have a transparent subsidy/compensation policy that is financed directly by the budget.

According to Firstpost calculations, if Coal India were to price its coal at import-parity prices according to the relevant grades it produces, it would have earned around Rs 62,500 crore more in 2010-11, Rs 62,500 crore in 2009-10, Rs 79,500 crore in 2008-09 and Rs 40,500 crore in 2007-08. This comes to a whopping Rs 2,45,000 crore (or thereabouts) for the four years taken together. (Which is why we said Coal India has sent you that virtual cheque with the notional profits forgone being divided by the countrys 120 crore population). Second, how will the government finance the compensation if coal prices have to be kept low? There are two answers to this: it already is. Only, Coal India is paying the amount on its behalf. Just like ONGC and other oil and gas exploration and pipeline companies partially subsidise the marketing companies, as producer and marketer Coal India subsidises the consumer directly. What would happen after it moves to world pricing is that the subsidy would be shown on the governments books. If the government wants to continue subsidising the consumer, it can do so. So while the consumer would still pay the same price, Coal Indias profits would swell, which it could invest in expanding coal production or buying mines abroad. A deterioration in the fiscal situation means the government will have to find the resources to plug this gap. A third of it would come automatically from the higher taxes Coal India would pay on its higher income. The remaining two-thirds would have to come from sales of Coal India equity (currently it holds 90%), which will soar when all the higher incomes are reflected in share prices. At current earnings per share of Rs 17.20 (2010-11), the companys market value is Rs 2,28,000 crore. If net profits rise five-fold, its market value would increase at least three times at a conservative estimate. This means a wealth boost of over Rs 4,50,000 crore. Disinvestment of even 40% of Coal India would bring in enough to finance the fiscal deficit resulting from any Coal India subsidy for five years. Third,there is the question of inflation. If coal prices are raised, inflation would rise as is the case with oil. But inflation would rise anyway if the country depends on world coal for a third of its needs. And the coal deficit would only widen if coal prices are kept artificially low as is the case now with oil. It is also a fallacy to believe that endless subsidies help tame inflation. They dont. Subsidies that show up as fiscal deficit create their own inflationary pressures. The only real choice is this: one can take cost-plus inflation by raising coal prices or demand-pull inflation by inflating the fiscal deficit. There are advantages and disadvantages to both: when costs rise, they serve as a spur to energy conservation. When energy costs are kept artificially low, they lead to waste and ultimately to higher subsidies and fiscal deficits. Both lead to inflation. So take your pick. Fourth, there would still remain the bigger problem of power costs and the enormously loss-making state electricity boards. What would happen to them? Thats a tough one. But, remember, the subsidies are already accounted for in the Union governments books. As for the current losses of SEBs, which added up to over Rs 1,10,000 crore in 2010-11, the only answers are to improve their functioning, write off past debts, raise farm power prices steadily, and bring them back to at least a cashneutral situation. The alternative is to allow them to bleed and ultimately create a power-starved country as investments in the power sector evaporate. It is worth noting that most of the new private sector power plants will have to depend partly on imported coal, as there may not be enough of Coal Indias notified price coal available. This will push up power costs anyway. The government has to bite the bullet sooner or later, or end up in the same situation as it did with the oil companies. Heres how we calculated the notional subsidy provided by Coal India Let us take the financial year 2007-08. The price per million kilocalories (kcal) of Indian coal is Rs 206, versus Rs 466 for an equivalent variety of Indonesian coal. We need to go for a per kcal calculation as Indian coal differs from international coal in terms of ash content, which is quantified by calorific value. Calorific value is the amount of heat generated by burning one kilo coal measured in terms of kilocalories/kg. The calorific value of coal is taken as a weighted average of the values of the two major categories of Indian coal, E and F, which comes to 4,050 kcal/kg. Now when Coal India gets 83 paise per kg on its total output of 379 million tonnes in 2007-08, we get one revenue figure. For the same total value, if we multiply it with the value of Indonesian coal (Rs 1.9 per kcal/kg), we get another revenue figure. The difference between the two gives us a revenue loss of Rs Rs 40,553 crore for Coal India which we have rounded off to Rs 40,500 crore. We did the same for the other three years.

A caveat: these are rough calculations, and are intended to provide ballpark figures rather than actual projections. Hence they should be taken with a pinch of salt. But they help give you the broad picture.