## Monday, October 27, 2014

### Rethinking the policy framework in coal

by Suyash Rai and Ajay Shah.

### India needs more coal

Coal is the dirtiest of all modern fuels, whether measured by habitat destruction in mining areas, or CO2, SPM and SOx emissions, or radioactivity. However, there is no alternative to coal in India's energy strategy, as coal makes up half of India's energy consumption today, and as India is blessed with strong natural resources.

Despite the strategic importance of coal in India's energy strategy, domestic production growth has been slow, with an average compound growth of 3.65% per year between 1990-91 and 2013-14 (from 247.56 million tonnes to 565 million tonnes). Over that same period, coal imports went up from 5.56 million tonnes in 1990-91 to 171 million tonnes in 2013-14, a compound growth rate of 16.06%. Coal imports have become nearly 1% of GDP. India has become the world's third largest coal importer -- despite having the world's fifth largest reserves (with about 67 billion tonnes of proven reserves). It is reasonable for a country with abundance of a fuel to import that fuel for strategic reasons, but India is forced to import due to inefficiencies of the domestic coal sector.

These inefficiencies do not have to be. Reforms can rapidly increase productivity. As an example, Australia got a gain in the raw coal output per man-shift for open-cast mines from 20 tonnes in 1966 to 54 tonnes in 1974 -- almost a tripling in 8 years. In underground mines also, technological change can give massive improvements in productivity. The puzzle is that of improving the efficiency and environmental soundness of extraction, and improving the infrastructure of transportation. This requires a fundamental rethink of the policy framework that has been adopted.

As with most problems in India, the poor outcomes are coming from deeper problems of institutions. While we periodically try quick fixes, there is no running away from solving those deeper problems.

On this much, it is fair to say that there is a broad consensus. Everybody agrees on this much. What is not widely understood is the way forward.

### The elephant in the coal mine: Coal India

Coal India is the public sector monopoly that produces, processes and sells coal. It produces 80% of the country's coal. It does so with much lower productivity (measured in terms of output/man-shift or OMS) than that in many developed countries. For example, in 2012-13, Coal India's OMS for open-cast mines was 11.48 tonnes, while the same for Australia was 75.04 tonnes back in 2005. The situation with OMS for underground mines is much worse: Coal India was at 0.77 tonnes in 2012-13, while Australia was 50 times bigger. Coal India has improved its productivity, but the rate of change is not adequate for solving India's problem. Drastic improvements in technology and management are required, but Coal India has been persistently unable to muster the requisite change capacity.

There could be many reasons for this. Some of them are generic to the public sector, some of them are generic to monopolies, and some may be specific to Coal India. Public sector enterprises face constraints of procurement, and human resource management, which private sector enterprises do not face. A monopoly does not face the competitive pressure that punishes inefficiency. This is particularly the case for public sector monopolies where the consequences are borne by tax payers. Not all public sector companies suffer from a productivity gap on the scale of Coal India -- as an example, NTPC fares pretty well on efficiency despite being a public sector company.

The relationship with labour in Coal India appears to be lopsided, even by the standards of public sector firms. Junior staff at Coal India are paid rather well when compared with other employment with the similar skill and hardship. This may be attributed to powerful trade unions. The strength of trade unions may explain the low productivity at Coal India.

We could discuss the problems of Coal India and how to solve these. However, it is important to not hold India hostage while waiting for those problems to be solved. As an example, India was held hostage by DOT/BSNL/MTNL in telecom, but the 1999 telecom reforms broke past that barrier. While DOT/BSNL/MTNL are an important part of Indian telecom, India's progress is no longer hostage to them. Similarly, there are fervent discussions about the problems of Air India, however policy thinking about civil aviation in India is focused on the interests of India and is not held hostage by the interests of Air India. In the field of coal, the objectives are clear: We need to increase output of coal by bringing in modern management so as to achieve high productivity and high standards of environment protection.

### The previous legal framework

The Coal Mines (Nationalisation) Act, 1973 curtails private participation in coal mining. It limits allocation of coal mines to firms that will use the coal only for producing power, iron, steel, coal washing or any such government-specified use. Trading by private firms is forbidden: They were not allowed to sell the coal that they extract to other firms even for specified purposes. Since 1993, governments have allocated 218 coal blocks to public and private enterprises for specified purposes, under the provisions of this Act. More than two-third of these were allocated between 2005 and 2010, under the UPA government.

Allocations were done through a screening committee process, without competitive bidding. In 2010, an amendment to the Mines and Minerals (Development and Regulation) Act (MMDR Act), 1957 provided for auctions of coal blocks. But the Comptroller and Auditor General, in a 2012 report, asserted that the government had the power to conduct auctions even before this amendment. The report also asserted that the failure to conduct auctions led to a large revenue loss for the government and corresponding windfall gains for the allocatees. The government contested these claims. The matter went to the Supreme Court through writ petitions. In September 2014, the Supreme Court cancelled 214 of the 218 coal block allocations made since 1993, and imposed fines on the operational mines among them. The grounds for cancellation are primarily the failure to follow principles of due process.

For the 42 operational mines, the Supreme Court order takes effect in six months. These blocks were expected to produce 10% of India's coal production this year. Some of these users will resort to imports. Some of them will not be able to solve the logistics problems associated with imports, and hence the downstream economic activity (e.g. an electricity generation plant) will close down.

### The recent reforms by the NDA government

On October 21, the government issued an Ordinance, which amends the Coal Mines (Nationalisation) Act, 1973 and the MMDR Act, 1957 to, give effect to certain coal sector reforms. It will run auctions to allocate coal mines. For some of the mines (74 mines), only actual users of coal in the cement, steel and power sectors will be allowed to bid, while for others (204 mines), the auction pool may include those who will produce and sell coal. While auctions had to be held after the CAG's and Supreme Court's interventions, opening of the sector to private firms for production and sale is a new step. This opens the window for giving mine leases to firms that are not in the business of producing power, steel, etc, but specialise in extracting and selling coal. It is important to note that the Ordinance also allows the government to continue with direct allocation of coal mines to public sector enterprises.

This Ordinance is a step forward in institutional reform. But it is an incomplete step. Looking forward, there are five areas of concern:

• The elephant in the coal mine needs reform. Allocating coal mines to private sector for extraction and sale will reduce dependence on Coal India, but this does not solve the problem of low productivity at Coal India.
• The role of the State in the field of coal. The Ordinance is focused on addressing the gap that has been created by the Supreme Court order. However, what is required is a more encompassing treatment of the tasks of the State in contracting, regulating, and supervising private players. Such a law needs to be written and this will correspondingly require creating State capacity for enforcing it. For an analogy, setting up financial economic policy is not a mere matter of auctioning some licenses to run a bank here or an insurance company there; it requires the full blown sophistication of the Indian Financial Code.
• Why have captive mines at all? There is no case for limiting trading in coal, between private players, by forcing captive mining. India will gain when some specialise in mining, and sell to others who specialise in downstream applications of coal.
• Why a dual system? Why is it necessary to directly allocate mines to government enterprises, and create a dual system in which some mines for auctioned and others are just allocated?
• Who knows how to run a coal mine in India? Private sector participation in extraction and sale is a step forward, but after decades of public sector domination, do any domestic firms posses expertise on achieving high productivity and avoiding environmental degradation in the process?

### We cannot ignore reforms of Coal India in reforming coal

Following the Ordinance, the government will give more mines to private sector for extraction and sale. But Coal India has preferential treatment with easy allocation of mines. This is not fair. Coal India must participate in open auctions on an equal footing with other bidders.

Even after this is done, private firms will find it difficult to compete with a huge government-backed firm with deep pockets. As an example, private airlines complain that the presence of a government-owned airline, which is able to bear huge losses, has had a negative impact on them.

It would make sense to break Coal India into several independent entities that actively compete with each other and with private firms, for the business of coal extraction and sale. This could set the stage for gradual privatisation of the baby Coal Indias.

As with the opening of civil aviation or telecom, the reforms will be opposed by trade union members of Coal India. Coal India should exist to maximise the interests of the people of India (about 1.3 billion) and not the interests of the 350,000 employees.

### Building State capacity for the role of the State in coal

Government must build capacity to do efficient regulation, contracting and contract monitoring of private participation in the coal sector. Given the complex contracting problems and environmental consequences, government-private sector interface in coal sector must be backed by a sophisticated government that is capable of understanding difficult trade-offs and make the right choices. Government should draft a comprehensive coal sector law that encompasses various aspects of the government's role in the sector.

In addition to the problem of running auctions and writing contracts, the law needs to envision market failures, give the executive the minimum required powers to address them, and setup accountability mechanisms. Ultimately, the law should setup feedback loops through which the executive and the industry move forward towards world class capabilities.

In parallel, government should build human resources and other organisational capabilities to enforce the law in this sector.

### A competitive market for production and sale of coal is required

Since mines will be auctioned, the immediate question is: who will be eligible to bid? For auctions of the coal blocks affected by the Supreme Court verdict, the government is allowing only the current users of coal for specified purposes. Perhaps, that is required as an expedient measure for the 20% of cancelled blocks that were already being used. But for the remaining and subsequent allocations, it is important to hold open auctions. The expertise of coal extraction and sale is different from the expertise of producing power, cement, steel, etc. The government should decouple the two, and unbundle the two markets of extraction and trading/sale.

It is particularly important to not directly allocate mines to government enterprises. If such enterprises fail to win the auctions, they can go ahead and purchase coal from successful bidders. NTPC is good at producing power, but it need not own coal mines for that. It could very well purchase it from firms specialising in production and sale of coal. This is not to say that there should be zero direct allocations. In some contexts, especially where a downstream plant has been set up with an assumption of access to nearby mine, it might be uneconomical to auction the mines. But the principle should be that direct allocations should be done in the rarest of cases, and the government should do a formal cost-benefit analysis before direct allocation decisions.

### We need foreign players

As is evident from their superior productivity, firms in some other countries have substantially better expertise in coal extraction. If we continue to limit participation of foreign firms, we will also constrain investment and innovation. The government should open the auction to foreign firms, and enable introduction of productivity-enhancing technologies and management systems. If, for strategic reasons, the government wants to restrict the purposes of coal use, and/or place constraints on coal exports, it can do so. The key point to focus upon is to bring in the best expertise in the problem of extracting, value enhancing, transporting and selling coal.

### Conclusion

The recent Ordinance is a step forward, but it is a tiny attack on the larger problem of coal sector reforms. We must reform Coal India; We must build State capacity on contracting, regulation and supervision of private players; We must setup separate and competitive markets for extraction and trading of coal; We must bring foreign players who have the requisite skills.

Please note: LaTeX mathematics works. This means that if you want to say $10 you have to say \$10.