Cancellation of coal block allocations: A murky tale

By Bhumika Tripathi, Khaitan Sud & Partners
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India is one of the largest energy consumers in the world. Coal is the most important and abundant fossil fuel in India and accounts for 55% of India’s energy consumption. The iron and steel, cement and power generation industries are major coal users in India.

Bhumika Tripathi
Bhumika Tripathi

Through 1976 and 1993 amendments to the Coal Mines (Nationalisation) Act, 1973, companies engaged in iron and steel production and power generation were permitted to carry out coal mining operations for captive use. Under the amendments, a Screening Committee composed of officials from the coal and railways ministries and relevant state governments was constituted to consider applications from private power companies interested in captive mining on a first come-first served basis. Accordingly, coal blocks were allocated to public and private sector enterprises from 1993 to 2010.

Allocations cancelled

A three-judge bench of the Supreme Court of India (headed by the then chief justice, RM Lodha) has held that these allocations were made in an “illegal, arbitrary, and non-transparent” manner and suffered from the “vice of arbitrariness”. After considering the “far-reaching consequences”, the court quashed the allocation of 214 out of 218 coal blocks made since 1993.

The projects that retained their coal blocks – two ultra-mega power projects and two other projects operated by Steel Authority of India Limited and National Thermal Power Corporation – were slapped with an additional levy of ₹295 (US$4.80) per tonne of coal extracted. The court also clarified that the Central Bureau of Investigation’s inquiry into alleged criminality in the allotment of 12 blocks will continue and will be taken to its “logical conclusion”.

The court tried to ensure a harmonious transition by allowing mining to continue until March 2015 (during which time the additional levy will apply), and by giving Coal India Limited six months to prepare for the takeover of the blocks.

Impact of the ruling

Banks and other financial institutions are set to take the first hit as they have significant exposure in companies which have been directly or indirectly impacted by the decision. The judgment will reduce the chances of recovery of loans given to the power companies and may lead to a rise in non-performing assets of banks and other financial institutions. Also, projects which are yet to commence operations are likely to be abandoned or suffer an inordinate delay having a negative impact on the repayment schedule and interest payments to be made to the financers.

The ₹295 levy will increase the financial burden on power generation companies especially in cases where any upside on account of pass through tariff is not available. The de-allocation will also result in a major spike in import costs on account of import of coal.

Given that fuel costs are typically prioritized over debt servicing, the lack of available proceeds/cash will impair the ability of such companies to service the existing debt, and the viability of such projects. Additionally, it is unlikely that the power generating companies will be able to maintain financial covenants such as debt service coverage ratio and fixed asset coverage as stipulated in the financing agreements due to the detrimental impact on the financial model of the projects implemented by such companies.

Possible consequences

In such a scenario, one of the measures that would be adopted by the financiers would be to instruct the project developers to infuse further equity into the project leading to a reduction in the debt component of the project cost. This may cause serious concerns for project developers as an investment of equity above 30% of the project cost will be treated as a normative loan on which the returns to the project developers would be comparatively lower. This in turn will hit the viability of power generation projects in India.

If increased costs (due to the additional levy or on account of coal imports) are structured as pass-through (as has already been done in some states) the burden of increased costs will fall on the final consumers, resulting in a steep escalation in electricity prices.

A recent notification by the Reserve Bank of India, which allows takeout of 25% of the outstanding loan by value (compared with 50% of the outstanding loan earlier), may offer some relief to the banks and financial institutions. However, the ensuing negative impact on the process of debt recovery, viability of projects and investor sentiment cannot be ignored.

Moving forward, it will be interesting to see the direction the central governments adopts to address the issue of allocation of coal blocks afresh. The government should bear in mind the existing investments made including the exposure of banks and financial institutions and the risk of it being classified as non-performing assets.

Khaitan Sud & Partners is a fast growing law firm providing specialist legal services to both domestic and international clients. Bhumika Tripathi is an associate at the firm.

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