Friday, September 14, 2012

Flawed propositions in Coalgate

I have had a chance to go through the CAG report on Coalgate. I believe that there are several flawed propositions in the ongoing controversy:

1. Coal blocks had to be allocated to the private sector because Coal India Limited (CIL) was inefficient.

Not true. CIL couldn't make progress with its exploration or mining because of environment and land acquisitions problems, lack of rail connectivity from mines, etc. For these very reasons, private operators have not been able to go ahead with the blocks allotted to them. CIL's track record over the years has been pretty good in relation to its internal targets.

2. Auction is the best route for selling natural resources.

The CAG has asked for competitive bidding in the case of coal. Private parties, however, would find it difficult to bid because of various uncertainties- you don't know about extractable reserves, coal quality, the cost of mining etc. That is why bidding for such resources involves royalty related to the resource extracted rather than a lump sump upfront payment. Perhaps, private players could have been asked to bid for a bundle of mines. But what if the projections are belied after allotment? The player may simply walk away from the mines instead of wasting more money.

Secondly, competitive bidding would tend to push  domestic prices of coal up to the international price. This would wreak havoc on the power industry and end-users of power. (For this reason, scrapping the coal mine nationalisation is undesirable in today's situation). In principle, one could set the coal price as the bid parameter and seek the lowest bid. Again, what if the allottee found that the coal price to which he has committed is uneconomical? Or, if the low price caused operators to compromise on safety or resort to stripping coal in the shortest time? It may be better, therefore, to seek the highest bid price for a mine and expect to tax profits in the hands of end-users.

3.  The government has lost Rs 185,000 crore in the allotment to private sector.

This estimate is based on several assumptions, notably the sale price and extraction cost of CIL (which latter may not apply to new players), and not discounting the stream of benefit. If you discount the flows, you arrive at a figure of Rs 58,000 crore, which too represents an upper limit.

4. The government should cancel all allotments made so far

This doesn't make sense if you accept that competitive bidding was not desirable and allocation was, therefore, inevitable. Allocations based on transparent criteria and where the allottees have made acceptable progress do not need to cancelled. Where allotments were clearly mala fide and allottees have been sitting on their allotments, cancellation is in order- and I imagine that is just what the government is doing.

More in ET column, Coalgate uproar is overdone


RealtyExpress said...

I agree that auction mechanism would be flawed and getting the correct and fair royalty calculation can be the most suitable way. Hence the question now is how much should be the royalty.

However before we step into the above we need to be clear on the motive of the Mine allocation.

Is it for captive supply
Is it because CIL is unable to meet the industry demand.

If the above is Yes, then the royalty mechanism should be such that the between the CIL/Open Market price and the cost of Mining should be the Royalty. Which mean that the mines owners should only get a fixed cost of mining and the balance should belong to the society/country.

The price of the end product of the industry is always determined by the free market forces. I do not agree that paying market price for the mined product would make the end product more expensive.

Does Tata Steel Sell their Steel Any Cheaper , they have all the Free Iron Ore Mines.

RealtyExpress said...

How ever if the purpose is other then stated above , No need to give mines

Anonymous said...

"competitive bidding would tend to push domestic prices of coal up to the international price. "

That is precisely why it should be done asap, like for petrol and diesel prices. Yes, price rise initially will be high, but that will bring more money into the sector, remove supply bottlenecks and eventually decrease prices because the resources are there, and not scarce. We need to build infra and what better way to do it than to go to higher market prices to make it economical for money to enter the sector? Price controls/nationalization don't work and lead to higher prices in the long run. Market prices best balance supply and demand in the long run. Its the experience of every country and there is a lot of data for this. That is what is taught in IIT, Stern and IIM. I'm not sure why you don't agree? Where is the data or analysis to back your argument in favor of nationalization?

Do you not agree with the very well-accepted notion that price controls don't work?

Private sector, markets are best to deal with uncertainty.

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T T Ram Mohan said...


Sorry, I couldn't respond earlier. Yes, there has to be a transition towards market prices (by which I suppose you mean international prices). But the trick is always managing the transition.

In the present environment, to let coal prices be set at international prices would spell disaster for industries and for banks exposed to them.In the case of petroleum products, this makes sense since the bulk of crude is imported. In the case of coal, we have huge domestic reserves, so cost plus may be a better approach for now. CIL makes a handsome return on equity as it is.

No matter what is taught at Stern or Chicago, no economy has complete laissez faire. If coal and power prices were to go up, farm prices would have to go up and this again would destabilise the economy. In the US and Europe, agriculture is still protected, despite what is taught at Stern. The labour market is incredibly rigid in Europe but they did well for themselves until now. China, the superstar of the global economy, is pretty much a controlled economy even today.


Anonymous said...

Dear Sir,

Its heartening to see that your recommendations are for the transition and not a long term solution.

But, couldn't we go for domestic market prices straight away? And, keep some export restrictions in place to dissociate from international prices?

Also, I don't understand why increase in farm prices would destabilize the economy. Farming would be more attractive and would actually stabilize the economy since food inflation has been the biggest source of worry for the common man. More than half of the country is engaged in farming and would benefit. The rest are not hurt as badly from food inflation.

I don't think merely going to market prices means an endorsement of laissez faire. The way I see it, there is no option but to have market prices, atleast domestically to start with.

China wouldn't be a superstar if it had not been able to take advantage of open manufacturing markets in the West. The advantage of Chinese control has only been the speed with which they have been able to take advantage. That says nothing about the robustness or whether their SOEs are a weakness in their economy at the present time.