Uncertain Future - Regulatory changes needed to attract foreign miners in India

(My views on regulatory and policy changes required to attract foreign miners to Indian mining - published in the Indian Infrastructure magazine July 2019 issue: https://indianinfrastructure.com/2019/08/01/uncertain-future-2/)

With the new government taking charge at the centre, and the efforts of NITI Aayog’s high-level committee on mining in consulting various industry stakeholders, hopes of growth and investment in the mining sector have revived. There is a degree of optimism in the industry that the much-needed reforms will now be pushed forward. Foreign mining companies that have been observing Indian markets may have reason to cheer, even though theirs is certainly cautious optimism.

Foreign mining companies’ experience

While foreign direct investments are permitted in the Indian mining sector, the participation of foreign miners has been limited at best. One of the largest global mining conglomerates, had a joint venture agreement with Odisha Mining Corporation Limited, but the project did not take off. It has also recently abandoned its diamond project in India, perhaps on account of commercial reasons and its global strategy. Several other mining firms that have had offices in India for a long time do not have any significant footprint in the market.

The National Mineral Policy, 2019, reiterates the need for foreign participation for improving technology penetration. It is therefore time to review regulatory and policy frameworks to assess the challenges facing global miners and then take course correction measures.

Auctions may have tilted the balance

Considering the evidence from the concluded auctions and the economics of mining by commercial and captive consumers, it may be safe to state that auctions have put commercial miners at a relative disadvantage. Foreign firms that are focused only on mining in other parts of the world may not have any interest in setting up downstream processes in India when their business model, capabilities and risk appetite do not match.

Auctioned blocks for both coal and other minerals have been won largely by captive consumers, some as an outcome of restricted eligibility for bidding and others on account of economics that favour them.

As indicated in the graph, captive consumers with a strategy of supply security are able to offer higher auction premiums for mineral blocks. It can be observed that the mine-head price (the revenue share of which is the bidding criterion for all the mineral auctions) sets the upper limit for commercial miners. At this price, commercial miners are expected to meet all their operating costs, pay royalties and taxes, and earn some profits to return to investors. A prudent commercial miner, therefore, can offer to pay only a portion of the profit margins to win an auction, which as a proportion of the mine-head price would be low.

Contrast this to captive consumers, whose benchmark may be the landed cost of mineral procurement at the plant or mill. If they procure from the same mine as the commercial miner, they would compare the cost of procurement with that from alternative sources, which in the case of Karnataka’s iron ore mines could be imports from Australia. Hence, if the bidding strategy of captive consumers for these mines is to target supply security, and as long as their landed costs of procurement from alternative sources are considered the ceiling, they can offer their entire mining profits and savings in transportation costs to the state government.

As a result, mining projects offered through the auction route have become a no-entry zone for foreign commercial miners.

Exploration is the gateway for private and foreign miners

The reason for foreign firms shying from exploration in India has been the lack of certainty of converting an exploration asset into a mining asset, as the provision for exploration licences requires that the discovered mineral deposit be put for auction for the mining licence, with not even a right of first refusal (RoFR) to the exploration licensee. Even if the RoFR was in place, rather than creating a degree of comfort, merely having the RoFR creates uncertainty. This, in particular, when revenue share-based auctions may result in costs that the exploration licensee may not consider economically viable. This uncertainty has been observed to have kept risk capital and explorers at bay. In the process, large private and foreign miners that may depend upon these explorers to build their project pipelines may have stayed away as well.

Large private and foreign miners are also not excited at the opportunity of bidding for mining licences. Auctions tend to favour captive consumers. With large revenue shares being offered for the assets, as observed in the bidding process conducted by a number of states so far, private and foreign miners may wonder about the financial feasibility of these assets if they were to operate them. The costs of large private and foreign companies, typically due to their focus on state-of-the-art technology and sustainability, are relatively higher than the small and contract mining companies in India, making the former uncompetitive in auctions on account of their best practices.

Of the two possible gateways for large private and foreign companies to participate in the Indian mining industry, it is likely easier to attract them in exploration projects by ensuring seamless transition of licences and transactions to monetise the mineral asset at any stage of development. It may suit their character better to look for discoveries and take the mineral from under the ground to market.

Scale of operation and freedom to market may be a hindrance

Indian mining operations are typically smaller in scale as compared to global mining projects. In coal mining, for example, the size of mining operations is typically lower than 5 million tonnes per annum even though some larger mining projects also exist. The median size of other mineral opencast mines also tends to be lower, both in terms of peak capacities and resource base. Indian underground mining operations have also had significant capacity constraints on account of geological disturbances and geotechnical challenges.

Moreover, there have been restrictions on end use. The Indian policy framework is heavily tilted towards captive consumption. With commercial miners this has been a challenge, which gets compounded by aspects such as export duties, which, in an economic sense, limits the market for the mineral products produced after making significant investments and taking risks.

Together, the smaller scale of operations (that may restrict economies of scale) and market restrictions create obstacles for foreign companies while considering investments in India.

Taxation and procedural hurdles

The Indian mining sector is taxed heavily in comparison to other mineral-rich global destinations for foreign miners. The sum total of applicable taxes and other contributions, sans auction premiums, make up almost half the revenue potential (40-50 per cent), depending upon the minerals and their market prices. Added to this is the revenue share-based auction for minerals, where aggressive bidding has been observed in the past. Even with reserve prices being taken into account, the total tax contribution is close to two-thirds of the revenue in the case of many minerals.

This may make investments in the Indian mining sector less attractive to foreign miners when global projects compete for their wallets.

Similar challenges have been observed from a procedural perspective for exploration and mining. Getting clearances and permits has been cumbersome, unpredictable and time-inefficient. Shareholders of global miners seem to have little tolerance for compromises and such compromises in Africa and South Asia and other emerging markets have had a significant impact on the management of these companies in the past. While Indian companies too have faced such challenges, these seem more daunting for foreign companies that have very little room for manoeuvring.

METS opportunity is significant

The Indian mining landscape has been undergoing rapid transformation in terms of market participants and operational profile, with greater mineral production coming from contract miners. This is due to the operational efficiency, productivity improvement, innovation and labour cost arbitrage that contract miners offer. Their greater participation is likely to continue. Thus transformation is about privately owned contract miners driving production in the industry even while ownership of mining projects is still constrained by the legislative framework. This has a far-reaching impact on the demand for mining equipment, technology and services (METS) by the Indian mining industry.

Consider the selection process of a contract miner or mine developer and operator (MDO) as they have come to be known in India, primarily due to the widened scope of work that often includes seeking permissions, acquiring land, financing infrastructure and mine development, and subsequently operating the mines ensuring quantum and quality of production. MDO selection is usually through a competitive tender with heavy emphasis on the lowest possible cost. It can thus be deduced that METS that can be deployed to enhance efficiency and improve economics of extraction will find favour. Innovation that helps a contract miner save any additional rupee per tonne of mineral produced will be able to find takers. However, those that have substantial investments upfront with a long fruition time to reap benefits may have to wait. Also, those technologies that focus on eliminating labour may not always find favour due to the low cost and easy availability of labour in India.

Conclusion

The mining industry awaits reformative policy initiatives that could enthuse foreign miners to consider India as a favourable destination. For this, loosening the exploration norms may be the most feasible way, with the provision for seamless conversion of exploration licences to mining leases with no restriction on monetising the assets at any time in the life cycle. Auctions for such exploration licences need to be dispensed with and the first come, first served method adopted. Foreign miners may find competing for mining leases through auctions tough given that these favour captive consumers. Apart from exploration and mining, significant opportunities exist for METS providers, which do not necessarily require any legislative or regulatory initiative.