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Auctioning coal mining licenses can lead to lower power prices

Auctioning coal mining licenses can lead to lower power prices. Possible policy directions to ensure low cost power and fuel to Indian consumers. Coal Summit 2012. Presented by: Girish Shirodkar , Global Partner and Managing Director. November 20, 2012.

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Auctioning coal mining licenses can lead to lower power prices

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  1. Auctioning coal mining licenses can lead to lower power prices Possible policy directions to ensure low cost power and fuel to Indian consumers Coal Summit 2012 Presented by: GirishShirodkar, Global Partner and Managing Director November 20, 2012

  2. Based on the current policy framework, marginal power prices are expected to be around Rs. 4 per kWh • Past efforts at maintaining low tariffs • Nationalisation of Coal and Control of pricing • Captive mining with sectoral allocation • Outcome • Shortage of coal availability (e-auction coal being sold at 60-70% premium) • Increasing dependence on imported coal (Rs 5,500 per tonne for 6,000 GCV) • Marginal tariffs of close to Rs. 4 / unit • Mental block against denationalisation of coal mining and transparent auctioning system, in belief that it will raise prices. 3.8 3.1 Imported coal: 6,000 GCV at Rs. 5,500 per tonne E-auction coal: 4,000 GCV at Rs. 2,200 per tonne It is possible to auction coal production licenses while also ensuring lower power tariffs, using the dynamics of a competitive market

  3. Over the long run, tariffs stabilize towards the cost of generating power from the marginal power source • Globally, short term tariffs are based on demand-supply matching at the marginal cost of production • From a longer term perspective, tariffs stabilize towards cost of electricity from a new plant using the cheapest available power source Market Demand Competitive Market Price Marginal Cost of Power Marginal Power Source Capacity from each power source Applying the same principle to India, we see that merchant power tariffs are in line with the cost of generating power using imported coal

  4. With increasing dependence on imported coal, power production costs will soar over the next 10 years. • CEA projects imported coal requirements of 164 million tonnes in 2016-17, in addition to the 54 million tonnes for plants designed for imported coal • If we want to overcome the entire shortfall through domestic supply, indigenous coal availability for power needs to grow by 14.4%, for which there is no clear plan 115.8 13th Plan 7% CAGR Shortfall Plants using imported coal 12th Plan Captive Mines SCCL Presumptive loss to the tune of Rs. 50000 crores / year CIL Total Case I bids are clearly reflecting this trend toward high prices. Sources: CEA, CIL, MoC

  5. Low power tariffs can result if the marginal power source is cheap & available in sufficient quantities: Coal in Australia Like India, Australia depends on coal for power generation 436 329 Exports are a significant part of the production Total = 242 TWh …wholesale power tariffs have remained low (~ Rs 1.6 per kWh in 2011-12) Sources: Energy in Australia 2012 (BREE), Resources & Energy Statistics 2011 (BREE), Average Electricity prices calculated from AEMO data ; 1A$ = Rs 55 in 2012;

  6. However, this is not a natural outcome but is a result of policies that encourage a free market for coal • Existence of large resources of high quality coal: Australia has 42 billion tonnes of reserves of high quality coal • Private players were allowed to prospect, acquire mining leases and were allowed to export, providing a natural incentive to increase production • The top 5 coal producers in Australia (BHP-Mitsubishi, Xstrata, Rio Tinto, Peabody and Anglo American) account for over half the total production and the bulk of the exports • Low cost pit-head power plants come up despite a lucrative export market: • Low quality coal cannot be exported. • Many high quality mines are in the interiors. “Transporting” electricity is more efficient than creating rail and port infrastructure to transport coal

  7. Indonesia and China have rapidly ramped up production to meet domestic and export demand. • Despite having an R/P ratio of 17, as compared to 199 for India, Indonesia has rapidly increased coal production over the last 6 years • It overtook Australia in 2011 to become the largest exporter of coal Annual ramp up of 200MT 16% CAGR • China is the largest producer of coal in the world, and has ramped up production over the last 6 years • Its R/P at 33 is also much lower than India’s Sources: APBI-ICMA, BP Statistical Review of World Energy

  8. India has the coal resources to replicate this, but policy action is required to enable an increase in production • With 118 billion tonnes of proven reserves, India has a higher R/P than many coal exporting countries • Despite this, coal production has grown at 5.5% from 2005-06 to 2010-11 • Hence, there is a need for policy action to free up coal mining: • De-nationalise coal mining: Coal production licence without linkage to captive use • Move away from sector based allocation of coal • Give out mining licences through auctions, in an open and fair manner Are we are conserving our coal for future generations? With necessary policy measures, it should be possible to ramp up production to achieve self-sufficiency over the next 7 to 10 years Sources: BP Statistical Review of World Energy, World Coal Association; *Indian R/P is calculated using figures from MoC for 2011 Indian reserves of 118 billion tonnes as of 1.4.2012 per Geological Survey of India data

  9. Once supply ramps up sufficiently, domestic coal would be the marginal power source • We assume an EBIT margin of 20% • With current production cost for CIL for open cast mines at Rs 650 per tonne* and overhead costs at Rs 150 per tonne**, we can expect coal to sell at about Rs 1,000 per tonne • The power tariffs based on this coal price, would be Rs. 2 per kWh 2 Sources: Reuters; **Calculated from CIL Annual Report 2012 Power tariff calculated using 5,000 GCV at Rs 1,000 per tonne

  10. However, if supply is not ramped up enough, imported coal would remain the marginal power source. • The key risks to an inadequate supply ramp up: • Mine development plans not being executed fast enough • Subtle cartelization • Imported coal remains the marginal power source, resulting in high power tariffs • Lead to abnormal profits being captured by the licensee holders 3.8 2 • Sufficient incentives should be in place for license owners to expand production as fast as possible Allowing export of coal would be the right incentive framework. Note: Power tariff for domestic coal calculated using 5,000 GCV at Rs 1,000 per tonne, imported coal at Rs. 5,500 per tonne for 6,000 GCV coal

  11. Allowing exports would provide an incentive to private players to ramp up supply • “Export equivalent” prices allows miners significantly higher profit (EBIT margins of 51%) • Still, the price is much lower than that of imported coal prices (and part of this margin will be captured by the government as royalty) • Miners will be motivated to create ample supply at the ‘export-equivalent’ price. • Power tariffs will be Rs 2.4 per unit 3.8 Freight & InsuranceIndonesiato Japan Freight & InsuranceIndia to Japan Port Handling 2.4 Inland Movement 2 Export Equivalent Price (Rs. 1,650) FOB Indonesia CIF Japan We need to prevent this presumptive loss of Rs. 50000 crores / year Note: FOB Indonesia prices for 5,000 GCV coal, Power tariff for domestic coal calculated using 5,000 GCV at Rs 1,000 per tonne and 1,650 per tonne respectively, imported coal at Rs. 5,500 per tonne for 6,000 GCV coal; 1 US$ = Rs. 55

  12. Devising appropriate policies for the mining license auctions would be key to enable the supply ramp up • The Government needs to give out enough licensees such that the eventual coal production from these mines will be higher than the demand • Transparency on the number of licences and the timeframe over which they would be given is essential • This will help the bidders keep this eventual supply scenario in mind, promoting rational bids and reducing winner’s curse • The licence policy should be such that any initial over-bidding does not affect the supply in the long run – high royalty levels leading to total costs being higher than market price • One possible solution is having a combination of a fixed annual licence fee for production up to a certain level, say 50% of mine capacity, to be paid at the start of the year. For any further production, a variable fee would be paid • This would help get back and re-auction any mines that see overbidding

  13. Comprehensive policy interventions are required for production to ramp up and enable market dynamics to dominate. • Amend the Coal Mines (Nationalisation) Act, 1973 to allow for private mining and selling • Create an open market for coal, facilitating growth of big private mining players • A lot of India’s current reserves are not surveyed well enough: Detailed surveys need to be done before giving out licences • Ensure that land acquisition, forest and environmental clearances are expedited for these projects so that the licensees can be turned into real production • The rail network would also need to expand in step – appropriate policy measures to support this would also be required

  14. Thank You

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