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Coal India’s profits may dip if coal is sold at fixed rate for 5 years

Coal India's (CIL) profits may take a dip if the company has to sell coal at a price that is determined through auctions every five years, according to a former executive of the state-run miner.

It is estimated that while cost of production will go up by about 60% by the end of the five-year period, the company's margin for every tonne of coal sold will decline each year, the executive told ET. Last week, the coal ministry released a draft document which proposes that CIL should sell coal to the non-regulated sector at a price determined through auctions every five years. The draft document also proposes that the floor price for coal will be the notified prices of coal - the prices at which CIL sells coal to the non-regulated sector.

The coal ministry has suggested adopting the supplier controlled ascending market clearing auction model for determining the supply price to the sector. Under this model, if the total volume bid is more than what is on offer in the auction, the price of the coal offered will be increased by certain percentage. Following the increase in the price of coal, some bidders may opt out of the bidding process. This raising of price would continue till the bid volume is the same as the volume on offer. This price would be the contract price at which CIL will have to sell for the next five years to the final bidders.

"Auction determined prices take away Coal India's ability to raise or decline prices during these five years  in which price will be fixed only once - at the beginning," a former CIL executive said on condition of anonymity.

According to the executive, during this period, salaries, which account for 53% of CIL's total cost of production, will be renegotiated with unions and are likely to go up by at least 20% in that year. In any other year, salaries go up by at least 10%-15%. Other input costs, including diesel, are also expected to rise on an average between 7% and 8%. The overall rise in cost of coal production each year would thus be at least 10%. "The overall effect of rise in production cost would be at least 60% over this five-year term. If bid prices are higher than 60% of the notified price, Coal India will continue to maintain margins over the period, if not, it will incur losses," the executive said.

As per the draft document, Coal India must sell at auction determined prices to the non-regulated sector. During 2014-15, the company sold 12% of its production (60 million tonne) to this sector and earned 14% of its revenue from it. The company charges a premium of 30-25% for coal sold to this sector and, hence, the increased revenue from 12% coal offtake.

Asenior vice president of a rating firm said, "The effect on profits would depend on the prices that are determined at the auction. Coal India is likely to get a premium over the spot e-auction prices that it gets now for the coal that is being proposed for the five-year auction. At present, e-auction prices are about 50% more than the notified price of coal sold to the regulated sector. Given the rate at which costs are expected to rise every year a 50% premium over notified prices is not likely to cover the total costs of producing coal during this five year period."

The average price that CIL earns from the power sector is about Rs 1,600 per tonne. During the quarter ended March, Coal India realised Rs 2,386 per tonne through e-auctions against  Rs 2,140 per tonne in the previous corresponding period. For the whole year, however, the miner earned on an average Rs 2,450 per tonne of coal sold through auctions against Rs 2,182 per tonne on the previous year.

source: http://economictimes.indiatimes.com