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A Coal Roadblock

| 6/28/2012 9:00 PM Thursday

There will be very few incidents in corporate history where something that is offered at a discount of over 50 per cent to the market value would have few takers. Coal as a commodity, which has been in the eye of a storm for quite some time now, has its own importance in the overall economic scenario. If you were to get it at a 50 per cent discount to the market price, why would you not want to jump at the opportunity? Before this question can be answered, it is important to put the whole discussion in the correct context.

Coal can be procured at a price that suits its quality. Largely, the quality of Indian coal is of a lower degree than what can be procured from markets abroad. This is the predominant reason why coal prices in India are lesser than those abroad. The second reason why coal in India is cheap as compared to that in the international markets is that Coal India (CIL), which controls almost 80 per cent of the reserves, does not have to pay any extra amount to the government for the prospecting of coal from the mines. For instance, against the current international market price of USD 85 per tonne, CIL’s average realisations during FY12 stood at only USD 26 per tonne, which means a discount of almost 70 per cent to the international price.

Within the Indian market, the coal prices are determined either by way of e-auctions or by way of FSAs (fuel supply agreements). Now, the government has come out with a clear directive asking CIL to sign FSAs with the power producers that have come up after April, 2009 and who will be setting up their plants till March, 2015. These FSAs must ensure that CIL supplies at least 80 per cent of the committed coal delivery. What emerges loud and clear is that the government is keen on ensuring coal supply to power producers by obliging CIL to stick to its commitment.

As it is, the price of coal in India is at a discount to the international price. Even within that, the price that is being offered through the FSAs is almost 50 per cent lower than the price of coal as determined through e-auctions. Out of a total of 48 power units that CIL needs to supply fuel to, only 27 units have signed this deal. What is preventing these companies from signing such a lucrative FSA? The devil lies in the details, which in this case is the penalty clause and the percentage at which the penalty triggers in.

 

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