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Capital costs of coal mining project , Dipesh Dipu, Director - Consulting (Mining), , Deloitte Touche Tohmatsu India Private Limited

The coal mining sector that has been opened partially through captive mining route has seen allocation of 208 coal blocks to private sector, government-owned power generation and other downstream companies. These coal blocks, however, have had limited success in terms of operationalisation on time and at budgeted costs. These have led to serious concerns for coal supplies for power generation sector in India.

One of the key concerns for the development of the coal mines in India has been the quantum of capital required which is the determinant of expected returns from investment perspective and the viability of the project in terms of affordability of power so generated. The capital costs for coal mining projects typically include costs of land, capital equipment and infrastructure to support mining and logistics. Project costs also include capitalised expenses for clearances and approvals that help the mining project take off.

Elements of Capital Costs

Cost of land typically means the cost of acquiring surface rights for coal bearing land for which allocation has been made by the appropriate authority. The recent social concerns that have generated a lot of debate in the country centre on the cost of land which the companies are willing to pay for acquiring surface rights. The recent trends indicate that the land values head northwards since the time of announcement of a project, which makes it challenging to estimate the cost of land. In states that have vast coal resources, the land acquisition issues have been observed to be acute. In Talcher and IB Valley coalfields of Orissa, for example, there are a large number of coal blocks proposed with massive capacities. In these coalfields, it may therefore be expected that land costs will be relatively higher for the coal mining projects. Costs of mining equipment largely dominate the project costs, although due to higher costs of land acquisitions, its proportions are likely to be revised downward. The costs of equipment, typically, are functions of geological characteristics, technology, mine design and requirement of coal processing. Equipment costs also include costs of electricity supply features, drainage systems, environmental management systems, surveillance systems and several others. The costs of construction of coal handling plants and railway siding are parts of support systems for evacuation of coal and if the coal project is relatively farther from the nearest railhead, the costs will be higher. For pit-head power project, the costs include the conveying system from mine to the coal handling system of the power project.

Key Determinants of Capital Costs

Technology is a key determinant of capital cost. Underground coal mining and surface (or opencast) mining has different requirements. In the underground mining methods, there are variants such as bord and pillar, longwall, shortwall and variants for thick seam mining such as horizontal slicing and inclined slicing; sub-level caving and others. The accesses to coal seams are made either through inclines (surface drifts) or vertical shafts, each of which may have substantially different capital cost. In surface mining methods, equipment selection largely determines the project costs - shovel-dumper combinations, dragline, bucket wheel excavators are mostly used in India. The geo-technical parameters like dip and strike length, inclination of seams, thickness of overburden layer, and stripping ratio are indicators of specifications of equipment required, which, in turn, indicate the capital costs.

Equipment selection, therefore, is at the core of the determination of capital costs. In surface mining, the equipment selection takes into account the geological features such as partings between coal seams and expected bench heights. These impact the selection of size of shovels and matching dumper sizes. In such cases, the natural economies of scale need not work and hence, the capital costs per tonne of production versus capacity or size of excavators is a non-linear function.

Apart from the excavators and hauling equipment, capital cost of surface mines also depend on size and number of drilling machines, which, in turn, are dependent on the hardness of the rock. For blasting, the use of site mix slurries or site mix emulsion explosives can eliminate the need to maintain a magazine at mine project and thus, lower the capital costs. Relatively softer rock formation, such as those of lignite, the drilling blasting processes may be replaced by continuous mining system as bucket wheel excavator. Rock fragmentation and the requirement of crushing (including secondary crushing and sizing) will determine the additional equipment required that have a direct bearing on capital costs.

Hydrological characteristics of mine indicate the requirement of drainage and pump capacities. These may be significant where the water tables are high and may have large capital costs required to keep the working faces prevented from being inundated.

Estimates

According to estimates, investments needed in surface coal mining in India are in the range of INR 1500-2100 per tonne of rated capacity. For example, investment in a one million tonne per annum capacity mine is expected to be INR 210 crore. This estimation is based on a stripping ratio of 4:1 and appropriate adjustments can be made for projects that have higher or lower stripping ratios. This, however, is as good as only an estimate and for the purpose of evaluations and investment decision making purposes, nothing can substitute a detailed plan, including equipment selection and fleet size determination.

For underground mining, the estimates are in the range of INR 1900-2800 per tonne of rated capacity. These are estimated for project that are shallow (within 150 meters depth) and are worked with semi-mechanized bord and pillar mining methods.

Business models change contribution to capital costs

At a high level, project costs remain more or less unchanged, irrespective of ownerships and financing pattern. However, for the project developers, the project costs are not nearly as significant parameters as are the equity investments and returns thereof. The business models now being contemplated and implemented substantially reduces the equity investment and causes the owner of the coal mine to focus on alternative investments such as, those in power generation capacity building. Contract mining is fast catching up in India as the preferred mode for development and operations of mines. The business model of hiring contract mining companies for overburden removal and even mineral winning is not a recent innovation. There are a number of new projects being planned through contract routes. Even the traditional mining companies like, the Coal India Limited and SCCL have been contracting out their mining operations. The scope of work in many cases involves the contract mining company to use their own equipment to carry on mining activities, which reduces the capital expenditure requirement of the coal mine owner.

In a total outsourcing model, the owners contract out all the processes including statutory approvals and clearances, land acquisition, mine development and operations. The recently floated tenders of a few state government owned power utilities are proponents of this model. The prospective bidders for the contract mining projects are expected to conduct their own geo-technical assessments, study the feasibilities and bid for the long term contract. The owner pays for all of these as the coal is mined and delivered to the owner. This model reduces the capital expenditure required by the owner for the coal mine development to nearly negligible.

Other business model is that of equipment leasing, which reduces the initial capital cost substituting the same by a more manageable lease rentals. The finance and operating types of leases help the mining project to have substantially lower cash outflows at the beginning of the project and help match the revenues with the costs when the mine starts the production of coal.

Capital Cost Management

Costs form a part of the decision-making process and cannot be used as a stand-alone decision-making tool. For this reason, there are several frameworks that can be used as a decision-making tool for surface and underground mining projects. These frameworks incorporate thinking obtained from viewing costs as a holistic entity. Strategic Cost Management (SCM) provides the thinking behind viewing costs as a strategic issue. Life Cycle Costing (LCC) suggests making use of the Net Present Value (NPV) approach to account for the use of the capital equipment. The LCC approach incorporates a tool into the framework that ensures that the cost of technology (capital) is accounted for over its lifetime.

Costing is the processing of expenditures to calculate their cost to each project. A typical and an ideal cost management profile is given below:

As costs increase, performance gets impaired. When cost reduction is periodically initiated, it often results in a temporary cull of capabilities, directly impacting on future ability to deliver performance. Where cost reductions are achieved, performance often recovers temporarily, only for focus on proactive cost management to be lost, and for costs to begin to increase again. Without specific cost management action, this cycle can continue indefinitely.

It must be observed that the ability to influence project success and enhance value is greatest at the start of project evaluation and rapidly declines as a project advances towards implementation. In the same instance, the cost of change dramatically increases throughout each project evaluation stage. This suggests that the quality of the decision making in the early stages of project evaluation, primarily focused at capital costs, is critical to an optimal project outcome.

Cost Escalations and Indices

In coal mining projects, capital costs are dynamic and are inflated when the projects get delayed. Cost indexes provide a means of adjusting out-dated capital and operating cost information for the effects of inflation due to such delays. They are based on statistical averages of costs for specific items and time periods. There are the composite indexes for capital and operating costs for each of surface and underground coal mining and coal processing (preparation) operations, which are calculated taking into account several projects done in the past as well as taking economic indices into account. Indexes for specific cost centres, e.g., labour, equipment, transportation, fuel, explosives, tires, electric power, natural gas, and industrial chemicals are available, which are being used by the industry and the regulators to allow prudent escalations in the capital and the operating costs.

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Views expressed here are personal. The author can be reached at ddipu@deloitte.com