The states obviously have reason to cheer. With the bid premiums going up to 150% of the iron ore prices notified for Odisha by the Indian Bureau of Mines (IBM), they are looking at huge revenues – estimated to be in thousands of crores.
However, the bidding aggression is a cause for concern, given that the premium is over and above the cost a winning bidder will incur on mining.
It thus becomes imperative to tackle key issues promptly – taking a leaf out of the coal mine auctions – in order to ensure that such premiums are actually realised by the states and that mineral production remains unhampered.
To offer a quick recap, only 48 of the 329 leases that are set to expire on March 31, 2020, are operational. These are mostly iron ore and manganese mines, which account for around 30% of India’s iron ore production. Of these, as of March, Karnataka has auctioned four mines, while Odisha has auctioned 20.
Curiously, both captive and commercial miners have been aggressive in the auctions.
Captive players are obviously factoring long-term raw material security and potential savings on logistics cost in case of a linked mine compared with merchant sources. The successful bidder has the option to go for long-term investments in logistics, such as a slurry pipeline for its own mine, rather than have to transport ore from different merchant mines, through maybe different modes of transportation. This enhances their savings on a landed cost basis. It also protects them from being forced to import ore in the event of a disruption in supply.
But this doesn’t apply to merchant miners, who mine and sell ore at the mine head, from where the logistics responsibility is that of the purchaser. The high premiums look unsustainable even if these players were to increase prices. That’s because, given the ad-valorem nature of auction premium, the higher prices will lead to increased auction payouts by them.
As things stand, much of the states’ actual auction gains will depend on how the IBM prices iron ore and how these prices pan out from here.
Currently, the IBM specifies the average sale price of any mineral grade/ concentrate in a month as the weighted average of the ex-mine prices of non-captive mines based on volumes dispatched. Transactions between related parties are not considered and factored only on arms-length basis. For domestic sale, the ex-mine prices are computed by reducing the logistics cost from the sale value, and for exports, by reducing the logistics cost from the free on board prices. Also, the IBM does not reduce the sale value for royalty, district mineral fund (DMF) and National Mineral Exploration Trust (NMET) levies.
Given this, it becomes imperative to ensure the IBM prices have the required depth and are representative of actual market transactions. A few issues arise here:
First, once the auctions conclude, captive mines are estimated to contribute ~35% of the total production in Odisha. And even out of the non-captive mines, a significant chunk lies with the steelmakers who have acquired these mines in auctions. Given this, there will be very limited merchant capacity truly available and the market will lack depth due to limited transactions happening on pure merchant basis. This can render the IBM prices susceptible to major fluctuations, thereby hampering auction realisations of the states.
Second, the IBM prices are based on the sale value of minerals, which includes royalty, DMF and NMET. The prices so published are, in turn, used for calculation of royalty and the other levies in the next month. This creates a circular relationship. It remains to be seen to what extent the winning bidders will be able to absorb the auction premiums as part of their cost structures. However, if they were to pass through the entire auction premium, which is averaging around 120%, as part of their sale value, there will be a significant increase in the IBM prices from the current levels, and accordingly the auction payouts. This will hamper viability of these mines in the long run.
Third, the IBM pricing is defined for lumps and fines, which are further banded based on the iron (Fe) content. The existing difference in average iron ore prices between grades is very high – at ₹800 between 62-65% Fe fines and 60-62% Fe fines. Given this, the miner can potentially save around ₹950 per tonne on auction premiums by mining and dispatching only lower grades. Thus, correct declaration of grade is of utmost importance.
Yet another issue is that, similar to the Coal Mines Special Provision (CMSP) Act, 2015, the Ministry of Mines is contemplating transfer of existing statutory approvals to the new lessees for a period of two years during which they must procure fresh clearances.
However, given the experience in coal, the possibility of similar issues occurring in iron ore cannot be ruled out – especially the transfer of existing mine infrastructure or unsold stock lying within the lease area, or unattended closure obligations.
Steps that can help
First, the IBM needs to revisit the pricing methodology for iron ore and clearly define how the average sale prices shall be published post auctions. It must also look at and remove the existing circularity in inclusion of royalties and taxes in the prices.
A simple way could be to consider the ex-mine prices without the royalties, auction premium and other levies. Given that a significant portion of the ore production is going to captive miners, the IBM can look at alternative pricing methodologies to reflect the true value of mineral. And in the event of a few arms-length transactions, IBM can take into account international indices while fixing the average sale price.
Second, the mineral administration in the states needs to be augmented with proper procedures to reflect correct declaration of grades dispatched by the miner. Also, the local administration/ regional heads of the state departments of mines and geology should be fully trained on implementing those procedures.
Third, proper intervention by central and state governments is necessary to ensure takeover of mines so that it does not go the coal way, where a number of blocks are lying un-operationalised despite auctioned nearly five years ago.
States must also facilitate and expedite the removal of mine infrastructure or their transfer to the new allottee, and disposal of unsold stocks from the lease area to ensure that mines come on stream in the shortest possible time.
The author is Director – Energy, CRISIL Infrastructure Advisory. Views expressed are his personal