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Coal Pricing: Market or Import Parity or Regulation, Shri R V Shahi, Former Secretary, Ministry of Power

India's energy profile, as we know, is heavily predominated by domestic coal. Huge coal reserves, of the order of 260 billion tonnes (though there are views that these reserves are overstated), are our greatest strengths, but they are also proving to our weaknesses on account of our heavy reliance on coal as the main source of power generation and for also other industrial usages. Under the fossil fuel category of power generation, which, as a matter of fact, characterises the power generation profile, in as much as it contributes almost 80% of total power generation, coal based generation occupies the lion's share. Gas based generation is approximately 10% of the total power generation. Therefore, anything that happens, or does not happen, with coal and gas is of extreme importance for the power sector. In the last few weeks the issues connected with pricing of gas and of coal have been discussed in different contexts. Since power sector is so directly and so greatly influenced by coal and gas prices, it is important to examine the various issues concerning pricing of these fuels. This paper deals with coal. I will write a separate piece on gas pricing.

The regulated pricing mechanism in the power sector, which is not subject to market play and which is determined keeping in view various relevant factors, is such that after the power producing assets are depreciated and loan including interest burdens are fully mitigated, it is primarily the costs of fuels which determine the cost of power generated. It is, therefore, natural that any discussion about price revisions in respect of coal or gas should attract maximum attention, not only from power generators, but also from consumers at large, who are likely to be affected by such revisions.

Coal industry in India, except for a few captive mines, is totally controlled by Government owned companies viz. Coal India Ltd. alongwith its subsidiaries, Singareni Coal Company Ltd. which is a joint venture of Government of India and Government of Andhra Pradesh and Neyveli Lignite Corporation Ltd. In the past, the price revisions used to be decided by the Government of India. Subsequently it was left to the coal companies who determine and decide prices in negotiations with major consumers. Government does have an indirect role. Since the industry has a monopolistic character, often the arguments from the consumer groups emphasise on the need for a regulatory mechanism for fixation of price.

I recall, somewhere around the year 2005, a debate cropped up about the price and pricing mechanism for domestic coal. While on the one hand there was an extreme and strong view held by the Planning Commission that the domestic coal was highly under priced and that there was a need to establish its link and parity with international coal prices, there was an equally strong view of the coal consumer group, mainly power sector including the Power Ministry, that in view of inefficiencies of operations in the coal industry, the prevailing prices themselves were on the higher side, because even with inefficiencies the coal industry was making huge profits. The debate, in fact, was between the two schools of thought - one having tremendous faith in the market mechanism and another which held the view that, in a situation of shortages, energy pricing could not be left to the market forces and that a substantial overseeing by regulatory mechanism would be essential. The belief of those who relied on market mechanism was apparently based on a principle that anything which relies on cost plus as the basis for price determination must be discouraged, interventions by any administered mechanism must be abolished and it is market which will take care of everything. The group belonging to the other school of thought suggested that unless market was matured, unless there was a general parity between demand and supply and that unless there were a number of players to produce and supply energy, it would not be only risky but also highly undesirable to leave the pricing of energy segments totally to the market forces. Finally, when the Integrated Energy Policy was formulated by the Expert Committee, this approach was accepted. It was recognised that in none of the energy segments, be it coal or gas or other petroleum products, the market was anywhere near maturity, monopolistic situations prevailed in most cases, demands were far in excess of supply, and, therefore, regulatory interventions were essential.

Following considerations appear relevant to understand and appreciate various issues involved in pricing of coal:

i.

As a dogma it cannot be anybody's case that everything that is based on cost plus is bad and everything that gets determined by the market is good. During last two years, the whole world has seen what havoc markets could create, how cruel the market forces could become leading not only to unreliable and erratic behaviour, but also to extremely adverse consequences to the detriment of consumers, and how relevant it is to provide a watch dog or a regulator to see that one group of stakeholders in the market does not put to ransom the other groups of stakeholders. Regulation does not mean taking a position in the interest of one group of stakeholders. On the contrary it means to develop strategies and formulate and implement policies and regulations in a manner that interests of all concerned groups are served in an optimal and balanced manner.

ii.

We also need to highlight how markets are made. Is it only governed by demand and supply considerations, or there are a large number of other forces including intermediaries who start influencing the market, not necessarily linked to demand and supply but through speculative practices, which shape the structure of the market? Global events and developments have demonstrated that speculative practices have started playing a much larger role in the architecture of market behaviour. The example in case is the sudden rise of crude prices from $ 45 per barrel to $ 145 per barrel in a period of about one year. Can we say that this rise was caused necessarily by the sharp increase in demands? It has been established beyond doubt that a number of intermediaries played major role in creating chaotic conditions like this. For a while, proponents of market mantra to be panacea for everything were silenced. Regulatory interventions started becoming relevant in many areas where the whole world thought that regulation had no role to play.

iii.

Indian coal industry is dependant on Indian power industry for more than 80% of its business. Similarly, Indian power industry is dependent on domestic coal industry for more than 75% of power generation. How import parity of coal price has any relevance in such a scenario? Income level of our people is different, wage and salary structure is different, labour cost component is different, purchasing power of people is entirely different. To conceive of an approach of import parity in price of coal is not only unreasonable and inconceivable but also illogical.

iv.

Even if we go along with the argument that an approach of cost plus may not be a sound approach, what about cost plus reinforced with standards of performance and efficiency? A part of cost component of the price structure flows from capital investment. There could be an efficiency element introduced in the capital cost, which may not respect the actual but a benchmarked capital cost. Similarly, there could be efficiency parameters introduced for performance. Capital invested could be allowed returns subject to these efficiency parameters. One fails to understand why this type of an approach is branded as being cost plus and, therefore, bad, and, in preference, there are advocates who argue for market driven pricing inspite of established knowledge that these markets lead to totally unreliable and erratic results.

v.

During 2005, when a view emerged from Planning Commission that Indian coal was under priced, Ministry of Power sent a delegation of Experts to study the coal mining activities, productivity, cost and price etc. in a few countries, including South Africa. Apart from a number of items of comparisons and contrasts that this delegation was able to bring out, one of the revealing facts was that in South Africa coal was being produced and priced at about $ 5 a tonne (approximately Rs. 225 per tonne) as compared to more than double the price at which coal was available in India from the public sector coal companies. It is true that if we analyse the nature of technology deployment, operations and maintenance practices, extent of contracting, in addition to departmental mining operations, there is considerable scope to reduce the cost. Hence, the co-relation that was discovered between the cost and price in case of Open Cast Mining in India and that in South Africa has considerable validity. The hypothesis that Indian coal was under priced could not be proved.

vi.

Though coal sector has not been opened up, as is the case with power sector, there are bound to be a number of players now because of the liberalisation on Captive Coal Mining Policy. Transparency will require that in all such cases transfer prices of coal to the power plants, for which these captive mines have been allocated, are determined in a fair manner. Other than Ultra Mega Projects, and similar projects being facilitated by State Governments, in all other cases the issue of transfer pricing will be relevant. Here, neither the approach of market driven prices, nor the principle of import parity will be relevant.

vii.

It is gratifying that the Minister of Coal and subsequently the Finance Minister, in his Budget speech, have stated that the institution of Coal Regulator would be put in place. We have seen that, by and large, the regulatory institutions in power sector have not only been able to stabilise but have provided a transparent method of determining tariff. There could be scope for improvement, but the larger picture is that a successful attempt has been made to synthesise the concerns and interests of not only consumers but also of investors. In the last few years, large numbers of investors have come in the power sector, their number is growing, the size and proportion of capacity additions by them is growing. And, at the same time consumer's interests are also being safeguarded. A similar approach in the coal sector may, with a difference of lead time, fetch commensurate advantages.

viii.

Competitive Bidding for development of power projects, based on tariffs, as provided in the Electricity Act 2003, has not only become an accepted and smooth process of developing power projects, but also this Scheme has demonstrated the highly attractive and competitive nature of prices at which power could be produced and supplied. Similar approach is necessary in the coal sector. To start with, Shell Company to develop initial infrastructure, to obtain statutory clearances, to acquire land and offer development of coal mines on the basis of competitive price of coal, would be an approach which will lead to similar benefits as we have witnessed in the case of power sector. Price of coal will flow from this process.

ix.

The present Captive Mining Policy will definitely need a re-oriented approach. Even though, coal industry is not opened up fully, like the power industry, it is necessary that the policy of captive coal blocks is properly analysed and implemented. So long as a coal block is allowed to be developed by a company which is made to commit the captive uses of coal produced, it should get covered under the Captive Coal Policy irrespective of the fact whether the coal mine developer is a power plant owner/operator or not. When this happens competition on price of coal, which becomes the criterion for allotment of coal blocks, will establish benchmarks of prices for different types of coal mines and different situations. These benchmarks would also enable the Coal Regulator to appropriately determine the coal prices in other cases keeping in view these benchmarks as well as other relevant factors.

x.

Under the above background, where is the need, or even a logic, to talk in terms of import parity for coal pricing? We must remind ourselves, time and again, that Indian industry needs a lot of power. But unless this power is provided to them at a competitive rate they would not only fail to compete in international market, but Indian products may fail even to compete on Indian soil in Indian market. Price of fuel holds key to price of power which, in turn, holds key to the competitiveness, or otherwise, of Indian manufacturing.

These are the issues which our policy planners, particularly those who believe in market mantra and in import parity of prices will need to confront themselves with and provide suitable answers. We need to recognise the distinction between the destination and the road map. Perhaps a matured and perfect market is the destination we should aim at. But to reach there, we also need to configure the architecture of the road map. A regulatory approach provides the road map to reach the destination. Believers of market mantra, or for that matter, of import parity, tend to confuse the issue and try to jump to the destination without going through a well structured, co-ordinated and moderated road map which is essential for a smooth transition to a perfect market.