October 2014

CRISIL Insight

Long-term measures needed to address

burgeoning coal imports

Long-term measures needed to address burgeoning coal imports

Governments announcement on auction of coal blocks could provide some respite

1

CRISIL Insight

2

Long-term measures needed to address burgeoning coal imports

Governments announcement on auction of coal blocks could provide some respite

Industries dependent on coal have been grappling with supply issues in terms of both quality and quantity of coal

for a while now, as regulatory, infrastructure and production-related bottlenecks have led to domestic output

continuously lagging demand. Players in these industries will be forced to step up imports to bridge the

burgeoning deficit in availability of the fuel in the wake of increased capacities, bringing their profitability under

pressure.

Power, steel, and cement companies will continue to account for almost 90% of coal imports. CRISIL Ratings

believes the impact of higher imports will be felt more on the profitability of new coal-based power generation

capacities having no or only partial fuel price pass-through. For steel players, whose profitability has already

been affected by weak demand in the recent past, the key factor would be the ability to pass on rising costs to

customers given our expectation of a marginal increase in coal prices from current levels. CRISIL Ratings

believes an increase in domestic non-coking coal price will not have a significant impact on the operating

margins of cement companies, as most players are undertaking initiatives to improve cost efficiencies.

Although the six-month timeframe given to the 42 operating coal mines to wind up operations in the recent 1

Supreme Court ruling ensures that there is not much loss of production this fiscal, the uncertainty surrounding

their reallocation and the timelines thereof could have potentially added another 25 million tonne (MT) to Indias

coal deficit in 2015-16 (refers to financial year, April 1 to March 31).

However, CRISIL Ratings believes that the ordinance promulgated on October 21, 2014 for resolving the supply

issues resulting from the cancellation of mines, is a step in the right direction and provides a fillip to industry

players who lost their coal blocks because of the SC verdict. The ordinance aims at:

Re-allocation of the cancelled blocks

Allocation of coal blocks to state owned entities through a need based approach without auction

Creation of a pool of coal blocks which will be e-auctioned to private companies in the power, steel and

cement sectors through a transparent bidding process

To flag off the process, the 42 cancelled operating mines and an additional 32 mines in various stages of

development are expected to be put up for auction in the first phase. This, in CRISIL Ratings' view should enable

players to regain the producing coal mines that got cancelled. A time-frame of three to four months has been

indicated for wrapping up the process. CRISIL Ratings believes that if the process is completed within the

indicated time, the loss of production resulting from the transition in ownership can be restricted to about one to

two months at ~5 MT in 2015-16.

Coal imports this fiscal will nonetheless touch 220 MT (~27% of domestic demand) from 160 MT in 2013-14. The

need of the hour is speedy reforms and decisions by the Government of India to address challenges related to

infrastructure and policy. The government is certainly headed in the right direction with the ordinance, which

along with the reallocation of the cancelled mines also includes an enabling provision for the introduction of

commercial mining in future, which can be the long-term solution to burgeoning coal imports.

1

The Supreme Court (SC), in its verdict on September 24, 2014, cancelled 204 of the 218 coal blocks allotted to the private sector and state government

undertakings between 1993 and 2010 after having termed the process followed for allocation of these coal blocks as legally flawed in a ruling on August 25,

2014.

Domestic coal supply continues to lag demand; will push up reliance on

imported coal

At 123 billion tonne, India accounts for 14% of global proven reserves but only 8% - or 605 million tonne (MT) of

production. Collective domestic output from Coal India Ltd (Coal India, CRISIL AAA/Stable/CRISIL A1+), The

Singareni Collieries Ltd (CRISIL CCR AA) and captive coal blocks has consistently fallen short of the production

target set by the Government (refer chart 1), leading to a fifth of Indias annual consumption (123 MT non-coking

and 33 MT coking coal refer charts 2 and 3) being met through imports. Domestic coking coal supplies have

stagnated at around 17 MT for years.

Chart 1: Domestic Production v/s MoC Target

Source: Ministry of Coal (MoC), CRISIL Estimates, MoC Target Source: Ministry of Coal, CRISIL Estimates

Chart 2: Non-coking coal consumption

0

100

200

300

400

500

600

700

Actual Target Actual Target Actual Target Actual Target Actual Target Est. Target

2010 2011 2012 2013 2014 2015E

CIL SCCL Others

458 488 483 488507 518

572 594661

3849 49 71

110 122

178208

192

0

100

200

300

400

500

600

700

800

900

2009 2010 2011 2012 2013 2014 2015

(P)

2016

(P)

2017

(P)

Million T

onne

Million T

onne

CAGR 2.3%

39 MT

shortfall

Domestic Supply Non-coking Imports Non-coking

CAGR

10%

Through 2017, CRISIL Ratings estimates demand for non-coking and coking coal to grow at a CAGR of 10% and

8%, respectively (refer charts 2 and 3), driven by requirements in the power, steel and cement sectors. This will

result in a consistent gap in domestic supply of coal against the demand over the next three years (refer chart 4)

3

Chart 3: Coking Coal Consumption

Source: Ministry of Coal, CRISIL Estimates Source: CRISIL Estimates

Chart 4: Domestic production v/s Requirement

17 17 16 16 16 17 17 17 17

24 2519

3236 33

4249 46

0

10

20

30

40

50

60

70

2009 2010 2011 2012 2013 2014 2015

(P)

2016

(P)

2017

(P)

Domestic Supply Coking Imports Coking

CAGR 10

%

Million T

onne

0

100

200

300

400

500

600

700

800

900

1000

Domestic

supply

Coal

requirement

Domestic

supply

Coal

requirement

Domestic

supply

Coal

requirement

2014-15E 2015-16E 2016-17E

Power sector @68% PLF Steel sector

Cement sectorOthers

Gap i

n sup

ply

Gap i

n sup

ply

Gap i

n sup

ply

Million T

onne

CRISIL Insight

4

Domestic coal prices set to increase in contrast to the trend in

international prices; still spurt in imports likely to impact profitability

given the significant price differential

Domestic prices of coking coal and higher grades of non-coking coal have been gradually catching up with

international prices. We expect domestic prices to increase around 10% as Coal India looks to cover increased

costs and reduced e-auction sales.

Chart 5: Non-coking Coal Prices

Source: Industry Reports and CRISIL Estimates

Chart 6: Coking Coal Prices

In comparison, international coking coal prices are expected to increase only marginally this fiscal from current

levels of about $110 per tonne (refer chart 6), while international non-coking coal prices are expected to remain

at current levels (refer chart 5). Increase in coal supply from new capacity additions in Australia, South Africa and

Colombia is expected to lead to oversupply amid weak global demand. Impact on demand due to possible

import curbs on low-quality coal in China is expected to be partially offset by an increase in imports by India.

Domestic supply will lag demand and although international prices are expected to be on a more benign course

in 2014-15, a significant spurt in imports coupled with the notable price differential between domestic and

international non-coking coal prices (four times costlier than domestic coal), will hurt the players. Coking coal,

which is majorly imported, could see prices picking up marginally through the fiscal from the current levels,

stabilising at around $120 per tonne, with a moderate uptick in steel demand in the final quarter.

0

20

40

60

80

100

120

140

2009 2010 2011 2012 2013 2014 2015 (P)

Australia 6300 kcal/kg Indonesia 4200 kcal/kg

India GCV 6100-6400 kcal/kg (core sectors)

India GCV 4300-4600 kcal/kg

0

50

100

150

200

250

300

350

2009 2010 2011 2012 2013 2014 2015 (P)

Australia coking coal Domestic coking coal

US

D p

er

tonne

US

D p

er

tonne

Power industry to bleed the most; profitability of steel companies also at

risk; cement companies profitability somewhat cemented

New power capacities are likely to rely heavily on imported coal

The power sector, which accounts for more than half of Indias coal imports, will be affected the most by the

trifecta of woes lesser supply, higher prices and increase in imports. For existing units, the decline in plant load

factors (PLFs) in recent years has largely been due to coal shortage. Power plants operated at an average PLF

of 68% for the 12 months ended July 31, 2014. For the plants to run at their normative PLF (85%), we believe

coal imports will need to grow exponentially (See table 1). However, this, to an extent, is dependent on power

producers ability to pass on higher cost of imports in tariff.

Table 1: Expected domestic coal supply and imports required for expected generation capacities

2014-15 (P)

2015-16 (P)

2016-17 (P)

Expected Coal-

based generation

capacity

Domestic

coal supply

Coal

requirement at

68% PLF

Imports at

68% PLF

Coal

requirement

of 85% PLF

Imports at

85% PLF

159 GW

170 GW

180 GW

430 MT

450 MT

495 MT

574 MT

611 MT

648 MT

144 MT

161 MT*

153 MT

717 MT

763 MT

810 MT

287 MT

313 MT*

315 MT

*Domestic coal supply for power sector in 2015-16 could dip by about 5 MT due to loss of production from the cancelled mines

Since April 2010, about 56 GW of coal-based capacities have come on stream (until June 30, 2014), out of which

CRISIL Ratings estimates 27 GW to be at risk, underpinned by domestic fuel shortage, no or partial pass-

through of higher fuel cost and weak counterparties. Under the new fuel supply agreements being inked by

power producers with Coal India, the domestic coal supply is restricted to 65% and 67% during 2014-15 and

2015-16, respectively, with the balance requirement to be met through imports. In such a scenario, the weighted

average cost of fuel per unit of electricity generated may double for plants located away from the coastline (See

table 2). Hence, profitability of the newer coal-based generation capacities having no or partial fuel price pass-

through will be impacted considering these are likely to rely heavily on imported coal, which is around four times

costlier than domestic coal.

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CRISIL Insight

6

Power projects located in eastern states closer to mines and ports are on a much better wicket. But those

located away could see profitability falling by approximately 40% at an import run rate of 35%.

The focus therefore devolves, at least in part, on fuel supply logistics. A major part of the capacities currently

under implementation are located away from the ports. Over the next five years until 2018-19, CRISIL estimates

about 51 GW of coal based capacities to be added. For power generation targets to be met, rail infrastructure will

need to be strengthened. Ability of ports to handle large vessels will play a decisive role, too.

Power plant capacity

Project cost

Distance from domestic coal source

Distance from nearest port

GCV of coal

Plant PLF

Inland transportation cost per tonne

USD INR exchange rate

Case-1 bid tariff

1320 MW

Rs.7920 cr.

215 km

1000 km

4500 kcal/kg

85%

Re.1/km

61

Rs.4.00/kwh

Base cost of Domestic (G10) coal

Inland transportation cost

Landed cost after royalty etc.

FOB cost of Indoensian coal

Freight cost

CIF cost in INR

Inalnd transportation cost

Landed cost after duties, port handling charges etc.

Rs.860/tonne

Rs.215/tonne

Rs.1345/tonne

USD 45/tonne

USD 11/tonne

Rs.3415/tonne

Rs.1000/tonne

Rs.5000/tonne

Basic Assumptions

Table 2: Variable cost of generation at different levels of imports

Domestic Coal

Imported Coal

Variable Cost of Generation

Fixed Cost of Generation

Total Cost of Generation

Power Tariff with Competitive Bid (fuel

price not pass through)

Profit Margin

Base Case

100%

0%

Rs.0.81/kwh

Rs.1.39/kwh

Rs.2.21/kwh

Rs.4.00/kwh

Rs.1.79/kwh

Scenario analysis

65%

35%

Rs.1.59/kwh

Rs.1.39/kwh

Rs.2.98/kwh

Rs.4.00/kwh

Rs.1.02/kwh

43%

GCV: Gross Calorific Value

FOB: Free on Board

CIF: Cost, Insurance & Freight

Pick-up in demand and ability to pass on raw material price increase - two

determinants of steel players ability to sustain profitability

2

CRISIL Ratings believes that primary steel makers are likely to sustain their EBITDA margin in 2014-15 close to

18.4%, with imports in the range of 70% to 74%, driven by coking coal prices stabilising around $120 per tonne.

Coking coal price, on its own, is not likely to dent the EBITDA margin of steel players significantly going by

current level of prices. CRISIL Ratings assumption of a $20 increase in coking coal prices through 2016-17,

could contract EBITDA margin by about 40-160 bps. The impact could be mitigated by the extent to which

companies are able to control other cost hikes coupled with their ability to pass on increasing costs to the end

users, especially in a subdued market. Understandably, if the coking coal price surpasses our expectation in

2015-16 and 2016-17 with companies not being able to pass on a fair share of the increased costs to end users,

higher imports could eat a sizeable share of the steel companies profits.

EBITDA margin vary depending on the mix of domestic and imported coking coal used. If a company that imports

around two-thirds of its requirement increases it to the entire requirement, its EBITDA margin could drop by

about 200 basis points (bps) even at the current low price of coking coal.

As a nation, India imports about two-thirds of the coking coal requirement. We see the steel industrys coking

coal requirements growing at a compounded annual growth rate of 8% through 2017, given capacity additions

and stagnant domestic supply, leading to an increase in import volumes to above 40 MT from roughly 33 MT in

2013-14 (see table 3).

Table 3: Expected domestic coking coal supply and imports required for increasing steel production

2014-15 (P)

2015-16* (P)

2016-17* (P)

Steel

Production

Coking Coal

Requirement

Domestic

coal supplyImports Impact on profitability

77 MT

86 MT

90 MT

59 MT

66 MT

63 MT**

17 MT

17 MT

17 MT

42 MT

49 MT

46 MT**

*Coking coal price assumed to increase to $130 per tonne in 2015-16 and $140 per tonne in 2016-17 from an estimated $120 per tonne at March 31, 2015;

realisation per tonne is assumed to be constant

**Marginal decline in coking coal requirement based on the assumption of availability of higher quality iron ore

40-160 bps with a

$20 hike in coal

price through 2017

Cement manufacturers are unlikely to see their operating margins dented much

For cement companies, coal cost averages between 14% and 20% of the cost of production. So a 10% increase,

ceteris paribus, will shrink EBITDA margin by barely 100-200 bps across companies. We believe the cement

sector will account for about 11-12 MT per annum of the overall coal imports (see table 4).

7

Base

average

EBITDA

margin in 3

2013-14

18.4%

2&3

Players looked at: Major players accounting for over 60% of Indias primary steel installed capacity

CRISIL Insight

8

Table 4: Expected domestic coal supply and imports required for increasing cement production

2014-15 (P)

2015-16 (P)

2016-17 (P)

Cement

Production

Coal

Requirement

Domestic

coal supplyImports

Impact on

profitability

251 MT

262 MT

277 MT

30 MT

31 MT

33 MT

20 MT

20 MT

21 MT

10 MT

11 MT

12 MT

Source: Industry Reports, CRISIL Estimates

100-200 bps

with a 10% hike

in coal price

Quick decisions by the Government the key to combat rising imports

For now, the way forward to ensure raw material security seems to be through higher reliance on imports.

CRISIL Ratings expects Indias coal imports could comfortably cross 200 MT annually. With imports expected to

mount every year, it is imperative that measures to augment domestic output are taken. In addition, the focus

has to be on addressing challenges related to logistics and infrastructure, to cope with the anticipated rise in

imports. Major ports account for about two-thirds of the total coal imports are all of them equipped to handle

such a rise in quantity of imports? Although some of the ports are adding coal berths to augment capacity, lack of

adequate rail connectivity from ports to end users located away from the coastal belt is likely to constrain the

operating efficiency of the ports. Moreover, augmenting capacities and providing rail connectivity will require

environmental clearances and land acquisitions, which will require speedy action by the government like the

one taken on October 21, 2014!

4

Additionally, penalties approximating Rs.100 billion could have a telling

effect on the cash flows of entities operating these mines

Although fuel un-availability is not likely to impact the state-owned utilities (which account for a majority of the

producing coal blocks cancelled) as they will benefit from the ordinance, we do believe that the one-time penalty

will dent their profitability this fiscal. The penalty amount for power sector translates to roughly Rs. 61 billion

(accounting for an estimated 60% of the total penalty payments), a majority of which is attributable to state-

owned power utilities. Cash flows of some of these state power utilities are already stretched, given that these

utilities are making losses and have combined debt of over Rs. 400 billion. Imposition of penalties will further

stretch their cash flows and they will find it difficult to fund the penalties.

Similarly, players in the iron and steel industry account for about 30% of the total penalty payments. Although, on

an aggregate basis, they are in a better position to cope with the penalty payments compared with state-owned

power utilities, we do see a near-term risk to the cash flows of these companies as well.

Table 5: Penalty split amongst the key sectors

Source: Ministry of Coal, CRISIL Estimates

Power sector (PS)

Iron and steel industry (ISI)

PS+ISI

Estimated total

In Rs. billion Estimated penaltyPercentage of total

penalty (%)

61

30

91

~100

61

30

91

4

With penalty levied at Rs.295 per tonne of coal produced, the gross amount to be paid as penalty approximates Rs.100 billion on the cumulative coal production

from the operating mines over the years.

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Last updated: August 2014

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