Natural resources: Fog is yet to clear

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Updated: Mar 29, 2015 1:27 AM

Auctions are the flavour of the season.

Auctions are the flavour of the season.

We were told that auction was the only correct way to transfer the right to use a natural resource. Thankfully, the Supreme Court retracted from that obviously wrong position and approved of any fair, transparent and non-discriminatory method of allocating natural resources.

The numbers have cast a spell.

R1,09,000 crore from the auction of spectrum. R2,05,000 crore from the auction of coal mines and growing with every mine put on the block. In the case of spectrum, it is revenue, at no cost, for the central government from an inexhaustible resource. In the case of coal, state governments have been told to expect a windfall over a period of 30 years.

The question that has been asked—and not yet answered by the government—is who will provide these humungous sums of money to the central and state governments. The impression that has been given is that the winners at the auctions will cough up the money. Absolutely untrue.

Pay through price increase

Where will the money come from?

The first stop will be the banks. The winners will go to the banks, flaunt the allocation orders and ask for loans. The banks will ask them how they propose to repay the loans. The winners will provide a statement of expected revenues. The key factor in the statement will be the ‘price’ of the final product: electricity, iron and steel, cement, aluminium, etc.

In the regulated sector, such as electricity, the cost of coal is a pass through. The winners will go to the regulator and demand a revised tariff that reflects the increased cost of coal. In some cases, thanks to the reverse bidding method, the winners have bid a negative amount per tonne of coal. In such cases, the pass through will be zero—that is the cost price of coal, it will be assumed to be zero! Inevitably, other variable costs will be inflated or the cost of coal will be loaded on the capacity charges and recovered from the distribution company (discom). In turn, the discom will apply to the regulator for an increase in tariff of the electricity that will be sold to the consumers.

In the non-regulated sectors (iron and steel, cement, aluminium, etc), the cost of coal will be reflected in the ‘price’ of the final product that will be paid by the consumers.

In the case of spectrum, the cost of acquiring spectrum will be amortised over a period equal to or less than the licence period and the amount of depreciation written in the books of account will be recovered through a revision in the tariff. The revised tariff will be the ‘price’ at which calls from your mobile will be charged.

Reform yes, but not enough

The government has claimed that auctioning the resources is a reform. I agree. It is a reform that has put in place a method superior to the first-come-first-serve method adopted in the case of spectrum since 2001 by successive governments. In the case of coal mines, it is a reform that is superior to the method of discretionary allotment followed since 1957 by successive governments. But it is a reform of methodology that does not go far enough.

Some interesting alternatives have been put forward and they deserve to be examined. Mr TK Arun has suggested that spectrum could be used as a common pool by telecom service providers on pay-per-use basis. Others have argued that once the government decided to end its monopoly on coal mining, it should have also ended captive mining and allowed the entry of professional mining companies. Alternatively, the government could procure mining services from professional mining companies, mine the coal and run a market for the coal.

Outright auction of a natural resource like spectrum or coal is easy and it is also an easy way to raise resources for governments. However, it has negative consequences for the consumer as well as the economy. There are anecdotal stories of irrational bidding by companies, especially prior allottees, to retain old or win new coal mines (cases of negative bids). In the case of spectrum, there have been irrational bids by service providers to retain key territories and to protect capital investments already made. Irrational bids will lead to inevitable outcomes: price (or tariff) increase, failing which defaults; lower capital expenditure and slower roll outs.

In the ultimate analysis, auction is nothing but a transfer of resources from the users of goods and services (consumers) to the owners of the resources (governments). The bills for R1,09,000 crore and R2,05,000 crore will be paid by the consumers. So brace yourself for price increases in many goods and services.

Milan Kundera wrote: “Man proceeds in the fog. In the fog, he is free, but it is the freedom of a person in a fog: he sees 50 yards ahead, and can observe what is happening close by and react. But when he looks back to judge people of the past, he sees no fog on their path. Looking back, he sees the path, he sees the people proceeding, he sees their mistakes, but not the fog.”

In the allocation of natural resources, the fog is yet to clear.

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