Mr Chidambaram, argue this case now

Finance minister P Chidambaram has recently received flak for some of his comments during a press conference held to explain the government response to the CAG report on coal mine allocation.

During the press conference, Chidambaram argued that 'if coal is not mined, if coal remains buried in mother earth, where is the loss?' He contended that none of the private companies listed as beneficiaries in the CAG report have started mining operations. If no coal has been mined and sold, or used in a process that is remunerative to the licensees, there is no loss to the public exchequer. That was the core of the government's argument.

All mineral resources within India's geographical borders are the country's sovereign property. A license granted by the government to a company to explore and extract a resource, like coal, is only a right to mine the resource. The mining license does not grant any ownership right over the resource to the licensee, until it is mined or extracted and a royalty is paid to the government. 

In other words, until the licencee mines it, the resource remains sovereign property. This principle was one of the government's main arguments before the Supreme Court, in the case against Reliance Industries over natural gas pricing. Ownership of all natural resources vests with the sovereign and hence the government has the absolute right to fix prices for such resources as it pleases.

Reliance Industries is only a contractor with a license to extract natural gas and the company is bound to accept the price set by the government, it was stated before the apex court and the justices did not demur. From this perspective, Chidambaram's contention that there is no loss to the government in coal mine allocations as long as the coal remains on the ground appears to have some legal grounding.

Nevertheless, a recent article in Mint newspaper argued that Chidambaram is wrong, because company valuations of the licensees will be higher when the value of growth opportunities from the mine is added to their book values. To substantiate this point, the author cited the case of listed companies such as ONGC where the market value is significantly higher than the book value.

The market valuation obviously reflects the higher potential prices for resources such as oil and minerals that these companies can extract and sell in future. While the reasoning appears conceptually sound, it is only an academic exercise as the article missed the key point that the coal licences were given for captive use only and the licencees are not in a position to extract market prices for the coal.

Hence the coal mine licensees cannot be compared to ONGC and other companies that are allowed to sell the extracted resource, at a price above the mining costs.

The riposte from Arun Jaitley, a lawyer equally erudite and accomplished as Chidambaram, was more effective. He argued that, by granting mining licences, the government has ceded control over the mines to the licencees. So in effect, a mining license is as good as handing over a valuable resource to the licensee, whether or not the legal ownership of the resource is transferred. ''someone takes out money from Chidambaram's bank account, puts it in one's own account but doesn't encash it, will he (Chidambaram) assume he has not suffered a loss?'' Jaitley asked.

But here the question is whether the hypothetical thief is really in a position to withdraw the money from his account. What if the banking system is structured in such a way that whenever the thief tries to withdraw the money, most of the amount is automatically ploughed back into Chidambaram's account? At least in the case of coal mines allotted to power companies, that seems to be the case.

The power sector uses more than 80 per cent of India's coal output, and power producers form the bulk of the companies named in the CAG report.

Independent power producers like Reliance Energy and Tata Power named in the CAG report will have to sell most of their future output, if their plants eventually go on stream, to state electricity boards at prices fixed in the power purchase agreement (PPA).

This price is negotiated on the basis of estimated generation costs, plus a reasonable profit. While calculating estimated generation costs, the cost of coal will not be taken as the average market price but the actual cost of extraction from the captive mine. In the case of UMPP projects, the power generation companies have quoted low electricity prices on the assumption that the cost of coal will only be the mining cost from a captive mine and not the market prices.

If these independent power producers were asked to bid for the coal blocks and pay market prices for the coal, the electricity prices they quoted to the state electricity boards would also been raised correspondingly higher. The profit margins of the power producers would be more or less identical, whether they are given captive coal blocks without any bidding or are asked to bid at market price.

So the net result of granting captive coal blocks to power producers is that the state electricity boards would get electricity at a cheaper rate. There is no real or substantial benefit to any private power producer. No matter what the purchase price of electricity is, the state electricity boards will charge very low rates for household consumers and farmers, for political reasons.

If the purchase price is low, the electricity subsidy bill of state governments will also be low. On the other hand, if the coal blocks are auctioned and the average purchase price goes up, the subsidy will also go up correspondingly. The amount the government will possibly net from coal block auctions will end up paying for the subsidy bill. The only difference is that, in the latter case, the central government wouold collect the money and then transfer it to the state governments to be passed on to the state electricity boards to compenasate them for the higher cost of power bought from the power producers.

In the case of coal mines allotted to steel and cement producers, the coal blocks were available for all manufacturers, large and small, on the same terms and conditions.

No manufacturers have so far complained that they were denied a coal block or were asked to pay a hefty kickback for an allocation. As both these industries are relatively competitive, it is not unreasonable to presume that the cheaper coal costs did get transferred to the consumers in the form of lower product prices.

Yes, there have been allegations of price cartellisation in the cement industry. But that is not the result of captive coal block allocations. Steel and cement producers can be asked to pay market prices for coal and other inputs in future, provided there is no discrimination between public and private companies. Product prices will initially move higher but will stabilise eventually. The government will net some money, though some of the planned steel and cement projects may get cancelled or delayed. But, is the country ready for higher prices of primary goods such as steel and cement?

The prime minister's explanations in the parliament were weak and difficult to comprehend, and the opposition has prevented further debates. Instead of being always on the back foot, it is time for the government to make its case forcefully before the public. There is no one in government who is more qualified than P Chidambaram to argue this case. If he doesn't do it now, the economic environment will remain vitiated, and it will make his task of reviving the economy that much more difficult.