1. Metal firms feel coal heat

Metal firms feel coal heat

New auctions would raise cost for user companies, but Coal India stands to gain

By: | Updated: June 10, 2015 1:11 AM

The coal ministry will hold the third round of coal mine auction in August for the non-regulated sector like steel, aluminum and cement. Ten mines with a peak production capacity of 13 million tonnes and reserves of 356mt, will be auctioned in this round under a new bid method. Of the 10 mines, five are from the earlier round, where interest was low.

The auction of non-power linkages this time is expected to push up the fuel cost for metal companies, though Coal India will get higher prices for its produce. Public sector firm Nalco will be biggest loser from the new rules, as it has been entirely dependent on linkage coal. By the ministry guidelines, existing linkages will either expire or be terminated by giving a one-year notice before July 1, 2016.

Significantly, the coal auction process has also been changed from the current practice of the standing linkage committee (SLC) using its discretion. The process is more aligned to spectrum auction in style. Coal India linkages will be allocated through a ‘supplier controlled ascending market clearing auction’ (SCAMCA), a modified version of Dutch auction. The price and quantities will be fixed for five years. There will be caps to ensure wider participation. The offered quantities will be bucketed for different sectors.

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The auction works like this: prices are increased till demand-supply equilibrium is established. The initial floor price is the relevant CIL price for a particular link quantity. If bids are for a higher quantity, floor price is increased in steps; auction stops when bid quantity equals quantity offered. Maximum bid quantity would be lesser of 65% of requirement or 15% of auctioned (see chart.)

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Top 50% of the pre-qualified bidders are allowed to participate in the e-auction process. In the earlier process, multiple bids by one entity were counted separately to determine the top 50%. In the next round, multiple bids by the same entity would be counted as one.

In the new method, an estimate by Motilal Oswal Securities Ltd (MOSL) says the cost of linkage coal for metal companies will increase by R600 per tonne, with the price moving closer to the e-auction price of coal. Aluminum companies will be the most impacted, with gross earnings (Ebitda) in aluminum likely to erode by $100/tonne, or 5% of the current all-in-aluminum price. Nalco’s Ebitda could see a 13% impact, in FY17, once its current linkages are terminated.

Similarly, Hindalco has 3.5 million tonne linkage expiring in 2018, but this will now be terminated by June 2016.

This will lead to a 2% erosion in its Ebitda in 2017. If it is able to secure coal mines in round-3 auction, the actual impact will depend on the bid price.

Once the existing linkages are terminated after a year, companies would have to participate in the auction, with effect from July 1, 2016. The fuel sales agreement (FSA) empowers the seller to terminate the agreement with prior written notice in the event of a material change in the coal distribution system on a government directive.

According to Citi Research, the new auction will mean pricing upside for CIL. The coal miner sold about 105 mt (of 489mt) of coal to the non-power sector in FY15; of which about 47 mt was in the e-auction market. Thus, coal sold via FSAs to the non-power sector was about 60 mt (12% of despatches), which would be put up for auction from July 2016. Prices for the various grades to the non-power sector range from $9-77/tonne. Citi Research sees pricing upside from FY17 for majority of this coal.

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