Last week, by a Presidential directive, the Govt of India advised (or arm-twisted, depending on the way one views it) Coal India Ltd [CIL], a GoI-owned listed company to enter into long-term Fuel Supply Agreements with Power Producers - to supply at least 80 percent of the requirements of these power producers - who have been troubled by the prospect of having to cope with sudden price spikes and even non-availability of coal. The decision has been in the line of fire from a number of quarters, starting with the CIL's own Independent Directors and other investors, prominent among them The Children's Investment Fund, Coal India’s largest foreign share holder, which recently initiated legal action against the government to protect its investment in Coal India.
The decision has been sought to be justified ostensibly with the public interest angle brought in, saying guaranteed coal supplies to power producers is vital to ensure the latter's viability given the unexpected spike in coal prices in international markets. Coal prices are currently ruling above the levels they had projected while bidding for the Mega projects. The FSAs effectively will ensure that the power producers are insulated from price changes of coal, but CIL will have to supply coal to them at the agreed price (at a deep discount to market price), either from its own production or by buying from the market. The latter scenario now appears highly probable, as CIL has not been able to add to its capacities due, again, to governmental restrictions on mining. Thus, we now have a situation where a company has been forced - through a government diktat - to supply its produce at below-market prices to a group of predominantly private sector players (NTPC is a beneficiary too), who had engaged in competitive under-pricing at the auction stage. The price risk has thus been willy-nilly transferred to CIL, whereas ideally this price risk ought to have been factored in by the power producers while bidding, either through hedging or through appropriate pass-through clauses in the Power Purchase Agreements they signed with the Power Distribution utilities. The audacity with which a few players threatened to stall work at their sites lest assurance on fuel supply came through was to be seen to be believed!
Only time will tell the impact of these FSAs on CIL's bottomline, if it is not able to augment its capacities soon.