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India’s coal sector bears brunt of reform

INDIA COAL
Photographer | Collection | Getty Images

India's move to cancel allocations of coal reserves promises plenty of turmoil, ranging from potential power shortages to possible debt defaults among metal producers, but the move may be more business friendly than it first appears.

"One of the key concerns of Indian industry is that the decision by the Supreme Court to cancel almost all the leases under investigation creates investor uncertainty about investing in the Indian mining industry," Rajiv Biswas, chief economist for Asia-Pacific at IHS, said via email.

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"However there has been a great deal of public mistrust and lack of confidence in the mining lease allocation process for many years, which also undermines investor confidence," he said.

Confidence could be restored if the government takes the opportunity to create a better, transparent tender process for the leases.

To be sure, there's no shortage of analyst concern over the decision by India's Supreme Court to cancel most of the around 218 coal fields awarded to private companies from 1993-2010, ruling that the allocations were arbitrary and lacked transparency, with most of the blocks assigned without competitive bidding. The court also imposed a penalty of 295 rupees (around $4.80) per ton of any coal extracted since the blocks were allocated.

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"This is the worst possible outcome for the metal and power companies," said Anubhav Gupta, an analyst at Maybank-KimEng, in a note Thursday. "Production cost will surge," he said, estimating coal producers may face penalties of up to $3 billion. "The [metal and power] companies will have to buy coal from Coal India or import it and spend additional money on re-applying for their blocks."

Coal is a key industry for India, with Gupta noting the mines in question feed about 10 percent of the country's total power capacity and around 10 percent of its steel production.

"This de-allocation could further worsen the demand-supply gap in coal, given that coal block auctions would delay the ramp-up of these mines by 6-12 months at least," Credit Suisse said in a note Thursday.

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Even as IHS's Biswas is looking on the bright side of the decision, he's also concerned about the immediate economic impact.

"The Indian power industry is already operating on very thin stocks of thermal coal, with half of India's power stations having coal stocks for less than one week," Biswas said. "Given India's chronic power shortages, further disruption to coal output could create more severe problems for the power industry as well as the steel and cement industries, which are other major consumers of coal."

The coal shortage may ricochet.

"This temporary setback is also likely to increase overall short-to-medium-term reliance on coal imports, and there are concerns that the ports will not be able to cope with the surge in imports," Romita Das, an associate analyst for India and South Asia risk analysis at Control Risks, said via email.

The banking sector may also face a hit, Nomura noted.

"Some of the smaller steel/power companies are now facing significant debt servicing challenges after the cancellations as their profitability was largely driven by these block allocations," Nomura said in a note Wednesday, estimating around $10 billion of lending to these companies.

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But some expect longer-term positives may offset the short-term hit.

"While judicial activism has become a concern for investors, the court's decision also ends a period of prolonged uncertainty," Control Risks' Das said.

"The judgment will allow the government to put in place a clearer and more transparent policy framework to regulate the allocation of resources through competitive bidding. This will boost confidence in the longer term."

In addition, government coffers, perennially beset by budget deficits, are likely to feel a tad plumper.

"The lost government revenue through the previous process of granting leases [was] estimated by government auditors at around $33 billion," noted Biswas.

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1