Three months ago, the rating agency gave the highest rating for the IPO of the monopoly coal producer based on 'strong fundamentals'. Today, it says new thermal power projects will suffer due to a demand-supply gap that is widening. Did it ignore the risks?

Barely three months after the rating and research firm ICRA assigned the highest grade for Coal India's (CIL) initial public offering on the back of 'strong' fundamentals, it has started talking about a shortfall of coal production for new coal-based thermal projects.

ICRA, an associate of Moody's Investors Service of US, in its latest report, says, "The spurt in demand has led to a significant rise in import levels, given the failure of domestic coal production to keep pace with the increasing demand because of structural bottlenecks that prevent quick commissioning of mining projects." The domestic production of course predominantly comes from CIL.

The same rating agency, three months ago, gave the highest grade, '5/5', for the CIL IPO citing strong business fundamentals as well as financial strength. It had said that CIL is the largest coal producer in the world and owns vast reserves, a highly favourable demand-supply situation in the domestic coal industry, and that this monopoly in the coal industry is expected to result in strong growth prospects for the company.

CIL accounts for around 80% of India's coal production and provides around 70% fuel for the country's thermal power plants. The Coal India IPO, which was oversubscribed 15.3 times, raised Rs15,000 crore from the market.

The question is, what fundamentals were taken into account while assigning the grade-coal reserves, the monopoly of the company or its financial figures? It seems that credit agencies and industry experts do not bother to pay attention to risks in the nature of business of state-owned companies in which the government has tight control.

In its recent report, ICRA says, "The demand-supply gap in the domestic industry is likely to widen significantly over the medium to long term as many large-size, coal-based power projects are expected to commission over this period. Many of these projects were conceived on the premise that domestic coal would be available to them in the required volumes."

"While such projects have been able to secure letters of assurance (LoAs) from the Coal India group, such contracts actually guarantee coal availability of 50% of their annual requirements from domestic mines," the report says.

Since environment minister Jairam Ramesh slapped the Comprehensive Environmental Pollution Index (CEPI) on many of its coal blocks, CIL has lowered its production target for this financial year by 3.5% to 444.50 million tonnes, and for FY12 the company has reduced the production target by 8% to 447.50 million tonnes.

Lower supply of coal in the domestic market will force power companies to import coal. Coal prices are higher and volatile in the international markets and this would eat into power companies' margins. The report says that higher coal prices for new thermal projects will impact returns and undermine the debt service capabilities of the project promoters.

According to the report, domestic demand for coal witnessed a compounded annual growth rate (CAGR) of over 8% between FY2006 and FY2010, while production CAGR was under 7% during the same period, due to several issues like environment clearance, land acquisition and political unrest in coal-producing regions.

Source: Outcome Budget of 2010-11, Ministry of Coal and ICRA research

The graph (Coal demand-supply position) shows that though the state-owned company sits on largest reserves, or produces the highest amount of coal in the world, India has been largely dependant on imports.

ICRA estimates that the demand-supply gap will increase further as many thermal projects are being commissioned. It says that the installed capacity of coal-based thermal power plants increased from 71GW in FY2007 to 90GW at the end of November 2010. By the end of FY2012, ICRA expects the thermal power capacity would be 113GW.

Demand from other industries, including steel, aluminium and cement is likely to be very high in the next five to seven years, although a number of thermal power plants are likely to be based on imported coal.

ICRA expects coal production in the country to grow at the historical rate of around 7% per annum. This could see the demand- supply gap increase to more than three times over the next five to seven years from the current gap of 67 million tonnes, a clear indication that the power sector will largely depend on import of coal.

Interestingly, ICRA also says that the Ministry of Coal from its Mid-Term Appraisal report for the 11th Plan period has reported that to bridge the gap the country would require to import 83 million tonnes in FY12. CIL, in its red herring prospectus, had said that it would face a deficit of 110 million tonnes and 235 million tonnes in FY11 and FY12 respectively, if all thermal power plants with LoAs from CIL are commissioned on time.