CIL’s New Coal Pricing Policy: Bleak Future or Bright Reform?

Posted in Finance Articles, Total Reads: 4747 , Published on 20 March 2012
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While New Year beginning ushered in hope and happiness for most of us, for coal user industry it came as a major surprise. As the year started, state owned Coal India Limited (CIL), India’s largest coal producer, has reformed its age old coal pricing policy and moved towards gross calorific value (GCV) based pricing for non coking coal. The policy, effective from the 1st of January 2012, came as a shock to user industries, especially Power utilities and Cement Manufacturers, as the new policy will result in steep rise in product cost.

CIL pricing policy

Earlier, CIL used to classify non coking coal based on their Useful heat value (UHV) in to seven grades i.e. from A to G. In this Indian nomenclature, developed in the 1970's, UHV defines energy (kilo calorie) in every kilogram of coal after discounting the moisture and ash content. In the new policy the coal grades are classified based on their Gross Calorific Value (GCV) with total number of grades increasing from 7 to 17.

Based on the new mechanism, coal grades are divided between 17 slabs of 300 kilocalorie bandwidth, starting from 2,200 kcal/kg and ending with 7,000 kcal/kg, and above 7,000 kcal/kg. However, in old price mechanism, the GCV Band was not uniform and varied significantly from 400 to 750 k.cal/ kg (Table-1).

Old & New Pricing Mechanism

Table 1: Old & New Pricing Mechanism

CIL, in its new pricing policy, seems to have aimed for:

  1. More focus on quality based pricing
  2. Incentive for producing certain grades of coal
  3. Achieving parity with global standards of pricing

Nevertheless, user industries seem to be dismayed by CIL’s move and following are a few reflections captured in recent time from various media,

  • Power department officials expressed dismay as power minister Manish Gupta said, "The hike should have happened after the coal regulatory authority was set up" (TNN, 2012)
  • Hike in coal price to raise cement price rise: CRISIL  (Mazumdar, 2012)
  • Captive power companies oppose CIL's new pricing system. (India, 2012)
  • Vinod Juneja, managing director at Binani Cement said, “So far we have not yet decided on price increase but definitely we will like to pass on the rise in input costs to consumers” (Mazumdar, 2012)
  • When asked about the impact on finances, N C Jha, chairman and managing director of CIL, said, “There will surely be a positive impact. As far as prices are concerned, the result would be different for different subsidiaries; some will get more and some will get less. We will look into the impact on revenue after three months." (Jacob, 2012).

Measuring Change

Understanding the intensity of above concerns, it has become imperative to measure percentage change in prices and its impact on bottom line. In the study, percentage changes in prices are arrived by the following set of assumptions and considerations.

  1. Each Grade in both pricing system has been compared on the basis of GCV Band.
  2. Highest price for each grade of coal has been considered in case of old mechanism.
  3. As new mechanism have 17 grades and many of them overlap in terms of calorific value while comparing with old mechanism, weighted average price has been taken in to calculation.(Table -2)
  4. This is a simplistic approach to understand effect of new pricing policy and more depth study is required to calculate effect for particular company.

New Coal Grades – Weighted Average Pricing

Table 2: New Coal Grades – Weighted Average Pricing

For example, Price for B grade coal according to new pricing mechanism is calculated by,

Wt. Average Price for B = 13%* Price of Gr. 3 + 74%*Price of Gr. 4 + 13%*Price of Gr. 5

Price Increase over Old Prices

Table 3: % Price Increase over Old Prices

Impact Assessment

Interestingly the prices of grades A, B, F and G have posted little increase. On the other hand, drastic increase is evident in the prices of C, D and E grades. Besides, this increase will certainly impact sectors using non cocking coal; however intensity of the impact will differ depending on the sectors. / not be the same across different sectors. For power generators, who are already tottering around poor tariff issues, coal linkage problems, and high prices of imported coal, the increased rates of E and F Grade coal will only add to their woes. Cement makers generally purchase 50-70% of their requirement through domestic coal linkages. This industry uses high grade coal such as C and D to fire kiln, run captive power plant etc. Unlike power, cement is deregulated market and hence 35-60% of increased cost will be passing on to customers.

The question arises here is what will be the financial impact of this new mechanism on user industries?  For example - Power Generators, which majorly uses E &F Grade coal, are already tottering around poor tariff issues, coal linkage problems, and high prices of imported coal. Amidst these concerns, CIL’s new pricing will have major impact on sector profitability. Cement Makers will face even worse condition. They generally purchase 50-70% of their requirement of high grade coal such as C and D through domestic coal linkages to fire kiln, run captive power plant etc.

Case – M/s ABC Limited

Company has planned to produce 100 Metric Tonne of cement. Company uses C Grade coal to fire their kiln and other purposes. Also, 25 MT of coal is required to produce 100 MT of cement. Market Price of standard 50 kg bag of cement is INR 265.

Particular

Value

Unit

Notes

Price of Cement

5.3

` per Kg

265/30

Planned Production

100000

Kg

100*1000

Coal Required

25000

Kg

25 tonnes coal per 100 tonnes of cement ( )

Cost of coal per kg of cement as per Old Pricing

0.61

` per kg

(Old C grade coal price x Qty) / Planned Production of cement ; (2420*25/100000)

Cost of coal per kg of cement as per New Pricing

0.94

` per kg

(New C grade coal price x Qty) / Planned Production of cement ; (3779*25/100000)

Difference

0.34

` per kg

0.94 - 0.61

Increase

17

` per 50 kg cement bag

0.34 * 50

ABC Limited will see around 6.4% of increase in cost when compared to price. Even in a very optimistic scenario, ABC limited will bear 5% increase in cost.

Conclusion

If these prices will continue without revision, industries like cement and power will face strong financial impact of at least 5-6%. Coal Ministry will review new pricing mechanism on January 20 and will come out with a solution in the next seven days so that the increase in rates is not more than required. If the outcome is not in favour of industry, one thing is sure and that is the ultimate bearer of cost increase will be the consumer.

This article has been authored by Biren Gandhi from School of Petroleum Management.

Image: tungphoto / FreeDigitalPhotos.net


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