government of India between 1993 and 2010 as illegal and unconstitutional, the Supreme Court (SC) has ruled:
Entire allocation of coal blocks as per recommendations of the screening committee from July 1993 in 36 meetings is illegal and done in an arbitrary, and non-transparent manner.
Besides the central government or a central government company, only an undertaking satisfying the eligibility criteria under Section 3(3) of the Coal Mines Nationalisation Act [viz., which has a unit engaged in the production of iron & steel/generation of power/washing of coal obtained from mines/production of cement], is entitled to coal block allocation.
Allocation of coal blocks via the government dispensation route is impermissible under law. No state government of state-owned PSU (JV or otherwise) is eligible for mining coal for commercial use.
What should be the consequencesthe issue remains to be tackled and the matter requires further hearing (scheduled on September 1). A small panel of retired SC judges may be appointed to give its report on this matter in the shortest possible time.
The allocation of coal blocks in respect of ultra mega power projects (UMPPs) has not been challenged, as competitive bidding for lowest tariff would enable the benefit of the coal block to be passed on to the public. However, it is directed that the coal blocks allocated for UMPP would only be used for UMPP and no diversion of coal for commercial exploitation would be permitted.
The bigger picture
In our view, as the SC order stops short of directing a blanket de-allocation of the 218 coal blocks allocated by screening committees/government dispensation, and deems that a further hearing is required on this matter, the penal action (i.e. consequences) may not be uniform and possibly take into account a few case-specific factors, including status of coal production. Nevertheless, a potential dent to RoE (return on equity) and likelihood of making only cost-plus returns on captive coal usage appear fairly imminent.
The governments reaction to the SC verdict bringing the coal block allocation issue a step closer to finality vs. uncertainty possibly indicates that it may suggest a set of consequences for SC consideration in the hearing on September 1, in our view.
As the 218 coal blocks allocated are now illegal, the existing policy of providing tapering coal linkages by Coal India (CIL) together with the governments work-in-progress policy on surplus coal usage and making coal available to all ready-for-use power projects comes under a cloud.
Sector-wise break-up: 103 to the private sector, 19 to central government PSUs, 80 to state PSUs, 12 to UMPPs and four to JVs.
End-use-based break-up: 96 for power, 71 for sponge iron/steel, seven for cement, 40 for commercial mining and four for other purposes. Of these, 20 coal blocks have been de-allocated and notice of de-allocation was issued to another 31 coal blocks in February 2014.
The ministry of coal expects 42 captive coal blocks to produce 53mt of coal in FY15 (vs 40mt produced by 28 coal blocks in FY14). Of these 42 captive coal blocks (vested in 33 companies), 22 coal blocks are vested with the private sector and 18 coal blocks are vested with state government/ state PSUs.
Who is relatively better off and who isnt
The SC verdict expectedly puts an overhang on the entire power utilities space. Based on our reading of the verdict and pending the courts direction on treatment of these illegal allocations, within our coverage universe, we believe Coal India, NTPC and Power Grid are placed relatively better off whereas JSW Energy and Reliance Power face a significant risk to earnings/valuations.
Coal India (Buy): No direct impact, but if captive coal blocks in production are asked to shut shop and the government puts more pressure on augmenting supply to power projects by curtailing e-auction sales to minimum possible levels without a price hike commensurate to retaining the same level of profitability, the outcome could be adverse. On the positive side, need to pull out all stops to augment production by CIL would become even more imperative; asking CIL to develop some of the de-allocated coal blocks may also be considered.
NTPC (Buy): Although the SC has ruled allocation of coal blocks via government dispensation (the mode through which it has secured its five under-development coal blocks) to be illegal, the judgement also confirms that a central government company is entitled to (eligible for) allocation of coal blocks under the law. While there is a bit of ambiguity, prima facie, we think allocation of coal blocks to NTPC, being a central government PSU in the business (end-use) of power generation, would be above board. If not, a significant portion of the under-construction capacity would very likely be rendered stranded due to
lack of coal.
JSW Energy (Buy): While JSWEs investment in captive coal blocks and linked generation projects is immaterial, the SC verdict puts a question mark on its 1080MW Barmer facilitya regulated return project which sources lignite from captive mines owned by a 51:49 JV between RWPL (Raj West Power Ltd--JSWEs 100% subsidiary, unlisted) and RSMML (Rajasthan State Mines & Minerals Ltda government of Rajasthan enterprise) and likely to provide 50% share of JSWEs consolidated profits in FY15. The FCFE (free cash flow to equity) value of RWPL included in our 12-month TP (target price) of R54 for JSWE (which is under review) is R24/share.
Reliance Power (Neutral): With the SC ruling out commercial exploitation of surplus coal for UMPP-linked coal blocks, the risk to full monetisation of its captive coal reserves has come to the fore. Although contribution to earnings from this surplus captive coal is zero currently, R39 of our 12-month TP of R67 (which is under review) is attributed to the project pipeline (Chitrangi, Sasan-II) proposed to be fired by the same.
Adani Power (Reduce): Although Adani Power (APL) is not directly affected by the SC verdict, we note that it receives coal via tapering linkage from CIL for its Tiroda-I facility. As previously mentioned, the policy of tapering linkage (wherein coal is supplied by CIL until the captive coal block commences production or an alternative coal block is allocated), may itself be questioned now.
Power Grid (Buy): Indirect negative impact as concerns over the pace of transmission capacity addition (in turn, earnings growth) could rise given that the viability of several captive-coal fired projects (private and state-owned) would be questioned.