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Wednesday, April 4, 2012

Coalgate: Overhaul allocation rules for coal blocks

The CAG report has argued that the government's system of coal allocation has resulted in a huge loss to the exchequer and 'windfall' gains to companies. Government's policy has been to allocate coal blocks to large actual users such as power generation companies, steel companies and so on for captive mining through a process that has evolved over the years.

Did this allocation process maximize value of the coal mines? The answer is no. The policy was to enable users to develop coal mines so that they can access coal supplies reliably and economically. Did the policy lead to windfall gains for a few? The answer again is no, given that a large number of companies, both private and government-owned, got access to the coal blocks.

Also, most blocks were allocated to power generators that sell most of the power under long-term power purchase agreements to state government distribution companies through competitive bidding process where the lowest power tariff wins.

The scope for significant gains is limited to only merchant power companies but these companies carry significant risk as well. The reality is that these 'user companies' are not allowed to sell the coal in the open market to earn windfall profits.

Can the existing policy be improved? Sure, by restricting coal allocation to power companies with long-term PPAs only and by auction of coal mines, which tends to be a more transparent process. However, if the auction of coal mines is only by value maximisation criteria, it will lead to higher price for coal and cost of power.

Also, true value maximisation will happen only if the coal industry is reformed and auctions are opened, not just to actual users, but to mining companies, including foreign ones. This will ensure greater access to technology and sustainable mining practices, as well as efficiency and competitiveness of the coal mining industry.

But this will require a change in the Coal Mines Nationalisation Act, 1973. The issue is not just allocation policy but the fact that we need to significantly enhance domestic coal production or we will need substantial increase in higher-cost imported coal and perhaps even stranded power projects for want of coal. If we are going to change the policy, why not go the whole hog.

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