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Profit Sharing in Mining Industry: Changing regulations and needs, Shri Pukhraj Sethiya, Mining Expert, PricewaterhouseCoopers (PwC)

India is a mineral rich country with occurrence of about four fuels, 10 metallic, 46 non-metallic, three atomic, and 23 minor minerals spread across the length and width of the country. India has world's fourth largest coal reserves, the fifth largest iron ore reserves, and significant proportion of reserves of bauxite and several other minerals. Given the large infrastructure deficit the country faces, these resources play a direct role in our economic and social development.

Indian mining and mineral sector has recorded a strong growth of 8.29 percent during 2009-10 over the previous year. The growth recorded by the sector in this year is significant over the historical growth, which was modest at about 4 percent over the last five years. The contribution of mining industry in the India's total GDP has been significant at 2.5 percent with growing GDP at the rate of around 8.5 percent. The mining industry, today, values at $28.8 billion in production, of which coal and iron ore contribute more than 50 percent. The pace of growth is expected to accelerate keeping in view the fact that the country has sizeable potential for mineral wealth and demand from manufacturing sector continues to expand.

This expanding nature of economy will need significant growth in the mining industry to sustain the growth percentage. However, presently, the mining industry has been facing challenges in the development of new projects due to resistance from local people as well as several other reasons. This has resulted in a delay in the timely development of a number of the mining projects resulting in the shortage of key minerals, like coal. In this context, it becomes necessary to assess the constraints in the development phase and reasons behind the non-favourability towards mining projects from the locals as well as way forward to sustain the growth of the country, in general and mining industry, in particular.

Mining, Minerals Industry in India: Growth Story

The gross budgetary support for Indian mineral industry (coal and metallic minerals, including steel) has been increasing each year and has recorded an annual compounded growth rate of around 25 percent.

The mining industry has been registering continuous growth, which indicates the expanding nature of mining industry and Indian economy in general. The significant growth in the mining industry has been registered due to the growing consumption pattern resulting in the growth of various industries. Though this growth is still lagging behind the targeted expansion programmes for the industry.

Budget Trend FY 05 FY 06 FY 07 FY 08 FY 09 FY 10 FY 11
Proposed outlay (INR crore) 6244 4828 6412 10699 15403 19292 23806
Revised outlay (INR crore) 5631 4255 6374 10988 12933 18002 NA
Planned Outlay (%) 63% 87% 90% 94% 95% 95% 96%

Currently, the total coal production stands at about 550 million tonnes against a demand of more than 600 million tonnes. By the end of the twelfth five year plan, the coal production is projected to be more than 1 billion tonnes. Similarly, the iron ore production has been growing in the country.

Growing Mineral Industry facing local resistance

The production of coal and iron ore is concentrated in the eastern region of India, i.e., Jharkhand, Orissa, West Bengal and Chhattisgarh. These four states itself account for more than 78 percent of the total coal production of the country while more than 50 percent of total iron ore production comes from eastern zone of India. Even in the future this trend is expected to continue, considering large mineral resources occurring in these states. Orissa alone is expected to add to more than 250 million tonnes per annum of coal production in the next few years.

Considering the above, while the minerals industry is providing many parts of the country with considerable opportunities for economic development, specially the mineral rich eastern region, i.e., the four states of Jharkhand, West Bengal, Orissa and Chhattisgarh; they score low in per capital income and living standard. This indicates a disparity between the growing mining industry and the lower economic growth of host population. The benefits of growth have not accrued to the locals and pose serious socio economic challenges. Even though these states are not in an encouraging state of economy, there has been growing resistance to the development of mining industry and increase in mining activities in almost all parts of the country and these states in particular. A number of these concerns have been noted to be arising on account of the environmental concerns but in many of the cases, resistance is observed from the local community, who, in turn, is expected to get benefited from the jobs and opportunities which mining activities may create. Thus, it becomes important to analyse the root cause and understand the reasons of these resistance by the local communities.

In the initial stages of mining operations, the activities involved are land acquisition, land preparation, mine development, etc., which involves a gestation period ranging up to a few years (many a times, 4-5 years). It is this initial period in which the land acquisition is undertaken, resulting in the displacement and loss of livelihood to the land owners. Compensation paid, as per prevailing government policy or as agreed, may not fully compensate for the loss of sustainable livelihood. Generating an alternative sustainable livelihood takes time and is expected to shape up only once the mining activities comes in full swing, resulting in developmental activities and ancillary industries. It, thus, results in enhanced employment opportunities for both skilled and non-skilled workforce.

Need of regulatory changes

The discussion above clearly signifies the growing discomfort among the locals losing their livelihood to the industry and industry looking for development and economic growth. Though once the mining activities take final shape and is expected to generate direct and indirect employment and livelihood for the locals displaced, the time elapsed is significant enough to discourage locals from participating in the growth opportunity. Industry has been adopting various practices to compensate the land losers and displaced people. In many cases it is onetime lump-sum compensation while in some of the cases companies have adopted innovative compensation structure by offering ownership (equity participation) in the project. A onetime compensation package may bring immediate smile to the face of land losers but in the long run, the same also gives a sense of losing livelihood and exclusion from the growth. This result in resistive moves and agitation by locals against industry and may also result in law and order issues.

Thus, it becomes important for the government to strike a balance and provide a sense of security to the locals to ensure growth of industry and ensure a sustainable framework for inclusive growth for the project affected people. The objective can be achieved by regulatory provisions to make it compulsory for the industry to share its benefits with the local people. The benefit sharing may come out in many ways like providing employment in the mines, creating self employment opportunity, etc., but all these will need developing certain set of skills which all the locals may not have. Thus, either some of them will not be eligible or may not perform up to their expectation in case of forced employment. Thus, a mechanism providing them with their share of benefits and giving them freedom to choose their livelihood will make them empowered as well as a more sustainable dynamics can be created between industry and people.

To address this, recently government has introduced provisions of sharing the profits or ownership in the mines in the draft Mines and Minerals (Development and Regulations) Act.

Draft MMDR Act, 2010 provides for a number of provisions for the socio-economic development of local host populations in and around the mining area. Under the provisions of the draft Act, the State Governments are required to consult Gram Sabhas and District Councils prior to notification of areas for granting mineral concession in scheduled areas and District Panchayats, in case of non-scheduled areas. The draft Act also mandates State Governments to grant mineral concession to co-operative society of tribal on preferential basis in scheduled areas through a notification. These provisions are aimed at ensuring prior consent of the local tribes and ensure their participation in the development.

For ensuring sustainable income generation to the land losers, the draft bill guarantees assured annuity to the local population, either through a 26 percent share of profits (post tax paid) earned by the miner in case lease holder is a person or 26 percent of equity participation in case the lease holder is a company, resettlement and rehabilitation of the local population through employment and skill enhancement as outlined by the concerned state government. The current consultation version by the GoM is expected to have adopted the basis to 26 percent profit sharing with alternative of paying royalty in case of loss making entities. The current draft tenets resemble to the intent of Black Economic Empowerment (BEE) Act, 2003 of South Africa, which required holders of mining rights to achieve 26 percent ownership participation by historically disadvantaged South Africans in their mining operations by 30 April 2014, of which 15 percent needed to have been achieved by 30 April 2009 pursuant to the Mining Charter. This provision of draft MMDR Act, 2010 is aimed at increasing the inclusiveness of the host population in ensuring the success of the mining project.

These new provisions are aimed at ensuring local participation as well as smooth development of the mining projects. The provisions are expected to build a sense of ownership to the host population, which may also result in curbing illegal mining due to constant watch of local. However at the same time, the impacts of such policy provisions on the financial health, cash flows and downstream/market pricing of mine outputs (non-value added or value added products) would need to be analysed. It would also need to be borne in mind that in a globalised economy, mineral businesses often represent a strategic input to other core industries providing key inputs for infrastructure development, for e.g., power, steel & cement, to name a few.

Impact of profit sharing provisions

The proposal of sharing profits with the locals seems to be a good move for inclusion of locals in the growth story and ensure income to improve their economic condition and living conditions. However, the overall impact of the profit sharing also need to be understood before coming to a conclusion or devising detailed framework for implementation of the Act.

First and foremost visible impact is that profit sharing will provide a constant income source to the locals who lost their livelihood. This will also help in improving their living standard and economic condition, which means growing participation in economic activities and overall development of the mining area beyond the industrial limits.

Though the provision will be beneficial to the immediate population being impacted due to mining activities, but adverse impacts of the proposal also need to be understood for proper implementation of the plan. 26 percent of the profits is a large sum and are expected to have significantly adverse impact on the mining projects.

The major objective of profit sharing is to let the locals have their share in the benefits generated from the mining operations. At the same time, it is expected to reduce the resistance from locals to the mining projects. But this huge burden may make many of the mining projects unviable. Further compulsory sharing of large sum out of the profits will discourage miners form taking any social initiatives. Thus again adversely impacting the impression of mining activities among locals.

Also, this provision will reduce the profits to the mining company, thus impacting its bottom line. In such scenario, to maintain the profitability level, i.e., profits for the company, mining companies are bound to increase commodity prices, which, in turn, will be reflected in the increased prices of end products like power, steel, etc., which need to be borne by the consumers.

Further, the implementation of the provision itself seems to be difficult proposition. Though recent discussions of GoM suggest that only the profits generated due to mining activities will be shared and not from the downstream activities. However, on which basis will the government decide the profits generation from mining and beneficiation activities, as in many of the cases, washing and beneficiation activities are integrated with the mining operations? In India, captive mining forms a significant proportion of mining activities, which is expected to increase in future. In case of captive mining, profits from mining activities will depend upon the cost accounts of the mining operations and the transfer price (if any) of commodity to consumer unit. This provides opportunity to recognise lower profits from the mining operations.

The draft act also provides that the amount shared will be higher of the 26 percent of profits from mining operations or royalty. Thus, even if companies are not generating profits from the mining operations, they are bound to share amount equal to royalty, which, in turn, will only increase loss to equity owners. It needs clarity on whether any such minimum payment can be recognised as accumulated profit shared in advance and credit for the same can be taken in the years of higher profits. This will provide some relief to the miners.

Conclusion

Given the need of including local population in the growth and development happening as result of mining activities, the profit sharing proposition seems to be a step towards realising their dream but at the same time, 26 percent burden seems to be too high to discourage industries from taking CSR measures and invest in the development of local infrastructure and people. Another huge impact of 26 percent profit sharing can also be unavailability of many mining projects, thus reducing the pace of growth of mineral sector which is the backbone of the economy.

Thus, before the draft provisions are finalised and takes shape of Act, a balance need to be made between the rights of local population and growth of mineral industry as whole.

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The views and observations expressed in the above article represents the personal and independent views of the authors and should not be construed as representative of the views of the firm.