What's behind Coal India's missing profits?

Stagnant prices in e-auction, coupled with rising costs, are eating into the world's largest coal miner's net realisations

Coal India, the world's largest coal miner, has upped output prices as many as three times in the current financial year so far - a record of sorts. This, coupled with 5 per cent higher production, should have expanded margins and boosted profits like never before. On the contrary, the company posted a 10 per cent dip in net profit at Rs 6,783 crore in the first half of the current fiscal (Apr-Sep 2013) - its first loss in several years. Net profit had jumped 12 per cent during the same period previous year (Apr-Sep 2012). So, what went wrong?

An analysis of the company's month-wise performance reveals how the electronic spot sales, which have acted as the company's safeguard against declining margins and stagnant efficiency levels for years, ditched the miner this year. Data shows that while Coal India is selling significantly higher volume of coal through e-auctions this year, its price has remained stagnant despite a jump in notified prices, pulling down the net realisations on the back of rising fuel and employee costs.

Around a tenth of Coal India's annual 452 million tonne (MT) output is sold through e-auction at market rates largely to non-core consumers. These prices have historically been 50-80 per cent higher than the notified price at which the rest of the produce is sold. Between April and November this year, e-auction volumes grew 32 per cent to 34.8 million tonne. However, the price remained stagnant at around Rs 2,220 per tonne. To add to the problem, Coal India's premium in e-auction over the notified price has dropped significantly both on a sequential and year-on-year basis (see table). In other words, consumers are buying more e-auction coal but paying less. This naturally impacts the company's bottom line.

The developments in the two months of May and June highlight the new trend. While Coal India raised notified prices on May 28, making coal dearer by an average 10 per cent, e-auction volumes jumped 28 per cent in June. On the other hand, the price remained largely unchanged (see table). In the quarter ended September, Coal India's e-auction sales volume jumped 25 per cent -in stark contrast to a meagre 4 per cent growth in overall sales. Yet, realisation dropped by Rs 19 to Rs 1,418 a tonne.

The company accepts the dampening impact of declining e-auction realisations on overall performance. "In the second quarter, despite the growth in sales, our average realisation came down to Rs 1,418 per tonne, as compared to Rs 1,437 per tonne last year, largely due to the reduction in e-auction realisation," Coal India Chairman and Managing Director S Narsing Rao says. He attributes the dip in realisation to demand slump in the manufacturing sectors of cement and sponge iron, the non-core sectors which consume a large chunk of e-auction volumes. "Because of the dip in demand, buyers are not bidding aggressively, impacting realisations," he says. However, the overall volumes are still higher as core sector consumers in the power and steel sectors have started lifting more coal because of the domestic demand-supply mismatch that widened to 135 MT last fiscal.

Rising costs
The net realisations came under pressure also because of higher fuel bill and rising contractual expenses. Coal India's average cost of production per tonne rose from Rs 1,037 in 2011-12 to Rs 1,049 in 2012-13. In the quarter ended September this year, the company spent Rs 13,112 crore to mine coal against Rs 12,098 crore in the same period last year.

The stagnant e-auction prices may be threatening Coal India's profitability but it has corrected a major anomaly in the utility of the electronic trading platform. While e-auction was introduced by the government in 2005 to meet the short-term requirement of non-core sector consumers (cement and sponge iron companies), it gradually developed into a cushion for Coal India against near-stagnant efficiency. This trend has now been reversed.

What is worrisome for the company is that the dip in demand from the sponge iron sector is likely to continue. This means Coal India will have to grapple with lower spot realisations over the coming months. "The sponge iron manufacturers are not buying coal because their plants are running at below capacity. This is because, thanks to the illegal mining scam, there is no availability of iron ore. All the iron ore mines are either shut or restricted," Purushottam Kandoi, president of Odisha Steel Federation, which represents the sponge iron manufacturing companies in the eastern state, says. Odisha is one of the three sponge iron hubs in India, apart from Chhattisgarh and Bellary in Karnataka. The state has 104 dedicated sponge iron plants in addition to 30-odd integrated units that process sponge iron into steel. All of them are working at 10-20 per cent capacity. In Chhattisgarh too, a majority of sponge iron manufacturers have already closed shop. No wonder Coal India's spot sales are losing profitability.

Weak prices
Apart from the dip in demand, another reason for the hit to e-auction realisations is subdued global prices, particularly of high-grade metallurgical and thermal coal. "The price premium in the spot market is determined by global rates. The consumers, therefore, take the international prices as benchmark in the spot e-auction market. As the global rates are currently subdued, the bid price has been low as compared to last year's prices. The prices fetched by high-grade coal account for a significant portion of the profits," says Dipesh Dipu, energy specialist and associate professor-energy at the Administrative Staff College of India.

Benchmark prices of free-on-board Australian metallurgical or coking coal have come down from an all-time high of around $250-300 per tonne in January 2012 to $180 per tonne currently. Thermal or non-coking coal prices, too, have tumbled from $130 per tonne to $75 per tonne during the period. The historic price crash is a result of an ongoing industrial slowdown in China coupled with an oversupply in the Asian market due to increased shipment of high- grade US coal as new shale gas discoveries have displaced coal usage in that nation.

Dipu says these causes of the decline may not subsidise soon because global prices are expected to remain depressed over the next year. That factor, coupled with the demand slump from sponge iron sector, would continue to pull e-auction rates and hurt Coal India's profitability. However, he says the miner should look at the erosion of e-auction cushion as an opportunity to start focusing on internal efficiency. "Coal India must focus on improving efficiency levels if it wants to remain profitable now. It can begin with ensuring better availability of heavy earth moving machinery and streamlining human resources," he says.

Coal India's employee expenses rose 5 per cent to Rs 13,786 crore in the half-year ended September. Fuel bill increased 3 per cent to Rs 1,102 crore in the same period. Overall expenses rose 7.3 per cent to Rs 26,102 crore. The growth in expenses came along with a minuscule 2.6 per cent growth in earnings. Coal India's production grew 3.9 per cent to 452 MT last financial year. The company is likely to see its production growing at 5 per cent, a four-year high, in the current financial year. The expected annual production of 475 MT would still be short of the target by 7 MT.