CRISIL for competitive bidding of coal blocks

Research agency CRISIL has recommended linking the valuation of coal reserves to be put up for bidding to international prices. In its draft report on coal block auctioning, CRISIL has said giving subsidies for use of natural resources does not provide incentives for market participants to judiciously utilise the scare resource in the long run.

The coal ministry had outsourced the task of finalising a methodology for deciding the floor price to CRISIL after the recent spate of corruption charges against the government during block allocation in the past made officials wary of taking decisions related to the matter, according to sources.

"The most optimum method to value scarce natural resources is one that promotes their best and highest use. Hence, the right coal price to value the mine should be the equivalent international price of coal," the draft report notes. It quickly adds, however, that the final decision to use either the Coal India Ltd (CIL) price or the use of import parity or e-auction price rests with the government.

The draft report notes at least five factors will impact the value of a mine to be bid out. These include coal price considered (whether import parity or CIL), discount rate considered for net present value (NPV), operating cost assumptions (whether departmental or outsourcing), timelines for development and additional payment to project affected people according to the draft Mines and Minerals Development and Regulation (MMDR) Bill.

According to CRISIL, it is best for the government to put up blocks for bidding only when they are explored. Putting the unexplored acreages on the block may lead to "highly erroneous results", it has said.

Among the 54 blocks identified by the government for allocation, 32 are either unexplored or partially explored. This advice is similar to what the government has proposed in the draft of the MMDR Bill 2011. The bill has proposed allocating those mining leases (MLs) on first-come-first-serve basis where the value of mineralisation is not known.

For explored blocks, CRISIL has recommended carrying out detailed exploration, preparing a robust feasibility report, and then using the discounted cash flow (DCF) method to value mines.

The

DCF method, recommended by the finance ministry, relates the value of an asset to the present value of expected future cash flows of the asset. It is based on the principle that for any initial investment, an investor will assess future cash flows from that entity to provide a minimum return.

Even for valuing unexplored or regionally (partially) explored blocks, it has been recommended to first carry out detailed exploration and, after preparing a feasibility report, using the DCF method to value the mine.

But in case the government is keen to auction the blocks quickly without carrying out detailed exploration, CRISIL has suggested an alternative "comparables" approach. This approach includes carrying out bidding in two stages. In stage one, only the blocks with detailed exploration are auctioned. In stage two, the regionally explored blocks may be auctioned and their floor/reserve price could be set based on the comparable bids received in stage one.

The bids for the second stage may be invited on one of the four approaches identified and the bidder with the highest quote could be selected as winner.

The first approach is 'profit share' with cost recovery allowed to bidder as is done in new exploration and licensing policy bidding in oil and gas sector. Under this, the bidder is assured of recovering all costs before sharing profits with government.

The second approach is 'revenue share'-based bidding with no cost recovery allowed. Under this, the bidder quotes a rupee per tonne number which is multiplied with actual production to determine the price to be paid to the government.

The third approach is 'reserve linked bidding' under which bids can be invited on a reserve multiple to be quoted by the bidder. Finally, the fourth approach is 'lump-sum bidding' where the bidder quotes a lump-sum amount and has to take reserve, production and cost risks into consideration.

The 54 blocks to be bid out carry 18.2 billion tonne of reserves. This includes 16 blocks for government companies, 16 blocks for power sector companies selected through tariff-based bidding and 22 blocks for companies selected through the auction mode. The 54 blocks will be allocated for six end-uses - steel, cement, sponge iron, surface gasification, power and commercial mining by government companies.