Oil and coal – a tale of two fuels

Coal, that black diamond, is currently generating more heat than light… at least that is the conclusion one reaches on reading and viewing the current debates on what is popularly referred to as “Coalgate”. At the heart of the controversy is the (apparent) failure of the government to allot coal blocks to private parties through a bidding process rather than by direct allotment, as has been done over the past decade. Unfortunately, the focus is largely on the allocations to apparently undeserving parties rather than on the issue of what is the most cost-efficient method of mining coal to meet the energy requirements of the country. Once again, we are in the uncomfortable situation of a public sector versus private sector debate rather than an assessment of how best to meet the country’s fuel requirements.
The first bogey that needs to be laid to rest is the contention that coal mining and extraction should vest entirely with the public sector. A public sector monopoly with its cumbersome processes can hardly be expected to meet the rising demand for coal. It would be interesting (and instructive) to analyse why the coal sector was not opened up to private investment at around the same time (1974) as the petroleum sector. After the first oil shock of 1973, surely India’s energy planners should have been giving serious thought to augmenting supplies of alternative fuels for the power sector, given India’s large coal reserves in relation to its petroleum reserves. There could be two possible reasons for this (in hindsight) costly oversight. The first (rather charitable) explanation could be that it was felt that the public sector could meet the coal requirements of the power sector. This explanation could probably have had credibility till 1991, when the Indian economy underwent a U-turn. By 1991, the capability of the public sector to meet crucial infrastructure needs was being seriously questioned. International agencies like the World Bank, IMF & ADB leant on the Indian government to fully open up the petroleum sector (from exploration for oil and gas to refining and marketing of petroleum products) to private (Indian and foreign) investment, when approving loans to bail out the Indian economy in a crisis situation. However, they exerted no similar pressure as far as the coal sector was concerned. It could be surmised that the clout of international oil and gas companies being significantly more than that of global coal mining companies, the pressures from the former influenced the views of international lenders to a far greater extent. But why did the Indian government not proactively go in for opening up the coal sector as well to private investment in 1991? After all, the critical balance of payments situation in 1990-91 should have awakened policy planners to the dangers of an energy crunch, which required concerted action in respect of all fuels, not just petroleum. The explanation for this policy failure will necessarily have to be not so charitable to the Indian government: it reflects the vested economic and political interests that were against giving up control over the lucrative coal sector. The major success in petroleum discovery and production post-1974 was in the offshore Bombay High field; since offshore allocation of petroleum exploration licenses lay squarely within the competence of the Indian government, it was relatively easy for the central government to offer offshore exploration blocks in successive exploration rounds between 1980 and 1995; even the offer of onshore blocks got little attention, because the production in onshore areas was located largely in the states of Assam and Gujarat and had not led to the development of powerful pressure groups as in the coal sector. In contrast all coal blocks were onland, in states like the then undivided Bihar and Madhya Pradesh, Odisha, Goa and Andhra Pradesh. Equally important was the coalition of interests that had developed in the coal sector (unlike in the limited onshore petroleum mining sector). Politicians, mining sub-contractors, transporters and labour contractors, among others, stood to gain from the many contracts that could be garnered from the operations of the public sector entity. With such an array of pressure groups opposed to any change in the existing system, it comes as no surprise that the coal sector remained a public sector monopoly.
What steps could, if taken over the past twenty years, have helped in avoiding the present brouhaha in the coal sector? This requires an examination of the possible policy framework that would not only have ensured a transparent system for entry of private players in the coal sector, but would also have enabled greater cost efficiency while also giving government a greater share in revenues generated from increased production (and value addition). The experience of a bidding process in the petroleum sector over three decades could well serve as a guide to the development of a robust allocation and management system in the coal sector.
First and foremost, there is need to shed ideological blinkers regarding private investment in the coal mining sector. It is not good economics to have an inefficient public sector that extracts lesser quantities of a mineral at costs which are higher (for given geological conditions) than the international norm. This was the logic behind the New Exploration Licensing Policy (NELP), introduced in the petroleum exploration sector since 1999, which required Indian public sector oil and gas companies to compete for oil and gas exploration blocks with domestic and international players in bidding rounds. Competition in the coal sector will improve economic efficiency by exposing all companies to best international mining practices and encourage cost reduction efforts to improve profit margins. There is, of course, the issue of how to permit companies with no previous expertise in coal mining to bid for blocks. Here, the path followed in the petroleum sector can be adopted. Indian private or public sector companies newly entering into coal mining activities could be considered if they bid jointly with Indian or foreign companies with previous experience in this sector. This was how companies like Reliance Industries, Gujarat State Petroleum Corporation and Videocon Industries were able to enter the petroleum exploration and production sector.
More importantly, there is need to lay out a specific contractual framework within which all companies (private and public sector) must carry out operations. Petroleum exploration and production activities have been carried out under the ambit of production sharing contracts. Developing similar contractual arrangements for the coal sector would not only streamline operations relating to prospecting for and extraction of coal but also enable putting in place a fiscal regime that allows companies to earn a reasonable rate of return on the capital invested by them while also giving government a share in the profits realised from the sale of coal produced. The important features that will need to be a part of such contracts are detailed in the succeeding paragraphs.
The first requirement is the specification of the duration for which the coal block will be allotted to the successful bidder and the manner in which coal resources in the block will be assessed and exploited. In case there is need for a company to carry out a geological assessment of the block, the period for such assessment should be specified, with the proviso that production plans must be prepared and approved in a specific time period. Any unreasonable delay on the part of the contracting company in commencing production should invite sanctions ranging upto termination of the contract. The specification of a contract period for the block (with provisions for extension by mutual agreement between the company and government) enables the computation of the likely revenues from the block (under different assumptions regarding future coal prices) and is crucial for determining the proportions in which revenues (net of costs) will be shared between the company and government.
The second aspect relates to the sharing of the “economic rent” from the sale of coal (and possibly coal gas) produced from the coal field. As in the petroleum sector, the company could first be required to pay a flat-rate royalty linked to the value of gross production. It would then be permitted to recover its costs of prospecting, capital investment and operation from the gross revenues less royalty. Revenue (net of royalty and cost recovery) would then be shared between the company and government based on a resource rent tax, which could, as in the petroleum sector, be based on the post-income tax return on investments in the project by the company. The company would also be liable for corporate income tax on its profits after payment of all government levies, including royalty and resource rent tax.
Profit determination is crucially linked to the pricing of coal and other by-products. Where coal is permitted to be sold in the open market, a fair third-party arm’s length sale price would have to be determined to ensure that government gets its due share of revenues. In the absence of a free market for sale of coal, prices may need to be set by an independent regulator to meet the needs of different sectors of the economy. Here, the pricing policy will have to be such as to meet the profit concerns of the private investor as well as the requirements of the economy.
Transparency and fairness in allotment of coal mining leases can be ensured through a single-stage bidding process. Once technically qualified bidders have been shortlisted, the financial packages offered by these bidders would be evaluated in terms of the net present value (NPV) of revenue streams accruing to the government over the life of the contract in the form of royalty, resource rent tax and income tax, discounted at an appropriate interest rate. The successful bidder would be the one offering the highest NPV to the government (based on assumptions regarding production over the contract period, coal price and the discount rate, applied to all the bids). This has been the approach adopted by the Indian government for award of petroleum exploration blocks in successive bidding rounds down to the present day and seems perfectly adaptable for use in the coal sector.
The introduction of such a system in the coal sector would go a long way in ensuring a transparent, rule-bound method for award of coal blocks. Of course, after the award of the blocks, a rigorous regulatory framework would be necessary to monitor production, set the price for sale of coal (and coal gas and other by-products, where produced) and approve costs incurred in extraction of coal. There is also the issue of coordination between the central and state governments, since many clearances for coal production would need to come from the state government. More significantly, there is the question of how the revenues which are to accrue to the government will be shared between the central and state governments. While royalty and a large portion of the corporate income tax will flow to the state governments in accordance with laid down financial devolution norms, a formula for sharing the resource rent tax between the central and state governments will need to be evolved, possibly through the recommendations of future Finance Commissions, by widening their terms of reference to include non-tax revenues.
What is evident is that there can be a well-defined path for allocation of a natural resource like coal, which meets the requirements of fairness and transparency while also addressing the differing concerns of the principal stakeholders – the operating companies, the state governments, the central government and local communities. Such an approach will reduce the likelihood of future controversies and will promote investment in a crucial natural resource sector, contributing crucially to the raw material requirements of a growing economy.

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