Stay Away from Coal India, as it's look like risky investment pick

The sharp fall in the prices of Coal India – from a 52-week high of Rs 422 to around Rs 307 on Thursday – is a signal of major changes in the industry that could end the company’s free run so far.

According to a report in BusinessLine, the coal ministry under Sriprakash Jaiswal has not only proposed the auction of coal blocks in future, but that even Coal India would have to pay a minimum reserve price for the blocks allocated to it. If this policy is implemented, Coal India’s future profitability will be crunched.

Coal India
Coal India’s share value derives primarily from two facts: its monopoly in coal mining (barring the blocks given out to power or steel producers for captive use), and its ownership of the world’s largest coal reserves.

Coal India’s shareholders will live in interesting times. They should avoid fresh investments till the policy map is clear.Reuters

But the this cosy world of monopoly and government mollycoddling is under threat from three directions: minority shareholder activism, the recent Supreme Court directive that all scarce natural resources must be auctioned, and the Comptroller and Auditor General (CAG) report which critiqued the UPA government’s decision to award coal blocks to power companies without calculating the loss to the exchequer from such munificence.

These three pressure-points will push up coal prices even while biting into Coal India’s future.

In the first half of March, a hedge fund, The Children’s Investment Fund, sent a notice to Coal India Ltd’s (CIL’s) board warning that if it continues to follow the government’s dictates on pricing, it would sue. While nothing much has come of this threat so far, it has alerted the government that sooner or later it will be vulnerable to shareholder activism.

In the second half of March, a leaked draft report of CAG talked of a potential revenue loss to the exchequer in view of “undue benefits” of Rs 10.67 lakh crore given to private companies who were allocated coal blocks without an auction between 2004 and 2009.

Two additional factors seem to have spurred a change in the government’s thinking on coal and Coal India. One is the embarrassment caused to the UPA and the Prime Minister in the 2G scam, where the government acquiesced in A Raja’s decision to give spectrum in 2008 at throwaway 2001 prices. The other is the leaked CAG report on coal blocks, where too the PM has been embarrassed by the fact that he was directly in charge of the coal ministry when the blocks were awarded.

It is against this backdrop that Coal Minister Jaiswal has proposed a new “transparent mechanism” for auctioning coal blocks within the next three months. While Coal India’s existing coal blocks may escape the auction burden, the attempt to level the field for all players in coal will crimp its future room for manoeuvre.

But Jaiswal is clearly doing the right thing. It makes no sense to open up coal to the private sector and then retain a public sector near-monopoly with huge advantages.

Here’s a policy framework that may work better than merely auctioning coal blocks at high prices.

First, the government must commit itself to competition as a means to improving coal production efficiencies and keeping costs in check. This means Coal India’s monopoly must be formally ended by either amending the Coal Nationalisation Act of 1973, or by offering its mines for private co-ownership. (Each mine could be spun off into a company and 49 percent stakes given to private operators for captive use).

Second, coal pricing has to be freed – subject only to a review by a neutral coal regulator.

Third, bidding for coal mines should be delinked from power tariffs. Currently, companies bid for supplying power on the basis of tariffs, and the coal block itself comes almost for free. Given that coal can be used for power and many other things, the economic value of coal should be delinked from power policy imperatives. If power tariffs have to be kept low for any reason, they should be kept down through direct state subsidies. Not by gifting away coal blocks – with possibilities of pilferage and misuse.

Fourth, since coal projects are always going to be vulnerable to ecological issues (many coal reserves are in forest areas), clear laws must be formulated on absolutely no-go areas, and places where forests can be partially cut and then reforested after the mining is done.

But whatever happens, one thing is clear: Coal India’s shareholders will live in interesting times. They should avoid fresh investments till the policy map is clear.
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