Date | Sept 07, 2016:
The Comptroller and Auditor General (CAG) of India submitted a report to the Indian Parliament on e-auction of coal mines (Report No. 20 of 2016), which set a debate on yet another accusation of undervaluation of coal mines auctioned in the first two tranches of auction held in early 2015. There are, of course, other observations too, some of them quite pertinent with regard to the process and maintaining audit trails, but the undervaluations caught the imagination of many as the coal sector has barely emerged from the era of coal scam with unimaginable number of notional losses to the exchequer.
In my previous columns, I had written about the flaws in coal block auctions too, and hence, validation of my views was of my interest. I was disappointed, quite expected though, given that my views were largely investor- or project developer-centric while the CAG focused its attention on procedural compliance, albeit with greater attention to any gains that the government of India might have foregone. If one reads the content in the Annexure II that details the CAG’s observations on computation of intrinsic values of coal blocks, the key findings of these are in the main body of the report in paragraph 4.1, one can conclude that the CAG has done detailed work and has looked into assumptions that go into financial modelling for valuation purposes with a keen eye.
Responses of the ministry of coal or Coal Mine Planning and Design Institute Ltd (CMPDIL), while agreeing on the CAG’s observations in several cases and attempting to explain the differences in approach taken in several others, appear defensive. CMPDIL may have certainly had better explanations for parameters, which pertain to geotechnical features such as deriving average grades or production schedules, those who appreciate the challenges of application of broad-based guidelines in a field like geology and mining engineering would agree. Every mine is unique in its geological setting and within a mine as well, the quality and quantity parameters can vary significantly within a short distance. Even high borehole densities cannot, therefore, provide absolute degree of certainties to available quality and quantities of coal and hence, average grades are no more than just mathematical numbers.
CAG, simultaneously, seems to have overlooked the embedded error in usage of contract mining fee numbers as a proxy for operating costs as these would include return of investments, as in depreciation, and also return on investments (on equity and debt), which in net present value computations would also be captured separately in the process of discounting, thereby leading to double-counting and risk of undervaluation of coal blocks.
However, the objective of this column is not to address these concerns but the other significant ones that are alluded to by the ministry in its responses but not accepted by the CAG.
Typically, intrinsic values are theoretical values. Valuation also is an art more than a science. Similar also is the nature of mine design and planning, which have now got to be even more flexible to accommodate dynamics of strategic landscape. In such a scenario, market is the only true determinant of value at any given point of time. To ensure better realisation of value, however, one has to ensure information symmetry and competition.
To the credit of the ministry of coal, it has fared well on these two accounts. Only too well on the competition front, given the aggressive bids received for both regulated and non-regulated sector coal blocks, so much so that many of the successful bidders are believed to be suffering winners’ curse. There have been a few challenges on the information dissemination as well, such as the limited time provided for site visits and for due diligence on documents provided by the prior allottees, which have led to legal hurdles post-facto in some cases. The challenges of reserves and resources classification have been a perennial issue, not specific to coal block auctions, but when an investor is expected to put money on the table, this piece of information certainly assumes criticality when compared with the earlier regime when upfront financial commitment was negligible. But the quantum of information, including absence of some of the vital ones, appeared more or less symmetrical.
Given these, there could be two perspectives on valuation of the coal blocks in an e-auction process—the compliance perspective, which the CAG has taken and has arrived at conclusions; and the outcome perspective wherein the valuations are typically market driven, defined as fair market values, or simply, market values. The ministry appears correct in its economic assumption that as long as it managed to create enough competition and information symmetry, coal blocks could fetch competitive market values, the level of intrinsic value notwithstanding. The CAG is right to believe that setting a higher floor in several cases would have fetched the government slightly higher upfront fees. But there is no guarantee that market values could reflect higher floors.
The market valued the coal blocks based on the expectations of availability of coal, both in domestic and international markets, and their price trends, the risks in their supply chains and strategic and competitive advantages of ownership of a key raw material source. These assessments are dynamic and are not typically affected by the floor prices set by the government. Now the same assumptions have changed. Market prices today will, therefore, be substantially different, possibly much lower, than when the e-auctions were run in early 2015.
(Source: http://www.vccircle.com/)