India's Coal Bubble
A few short years ago the assumption that coal demand was essentially endless in China and India was seen as irrefutable. Now this 'coal consensus' is breaking as analysts from Citi Bank to Bernstein predict a rapidly approaching peak in Chinese coal demand. But while the end of the Chinese coal bubble has generated headlines the situation in India has flown entirely under the radar. Now the Indian coal bubble may have popped and no one seems to realize they’re standing in the rubble.
To understand the depth and extent of the Indian coal bubble you have to first understand the country's unique problem: Despite sitting on the world's 5th largest supply of coal, it can't secure affordable coal supplies. That's because the country can't mine coal fast enough, and has failed to expand transportation infrastructure (largely railways) to move coal where it needs to be (the power plants). The resulting supply crunch is so acute that power plants operators and Coal India have fought for years over 'Fuel Supply Agreements' while scores of coal plant developers have moved to India's coastline to bypass domestic supply problems in favor of expensive imports. In sum, this supply crunch is structural, and it's not going away anytime soon.
But it's not that India’s coal supplies have stagnated for lack of effort. Even now Coal India and the Ministry of Forest and Environment have green-lighted mine expansions across the country. The problem is expanding mining operations is easier said than done. You see if you layered maps of mineral resources, tribal populations, and endangered wildlife on top of each other you’d see a scary picture. That's because what's left of India's cheapest coal reserves lies in the exact same places as the country's remaining forests which also happen to be home to the country's remaining tiger populations and large numbers of tribal populations. It's this combustible mix that has fueled 'naxal' insurgencies in many parts of the country's coal belt.
What that means is that India's drive to expand coal supplies (as well as build new power plants) runs face first into fierce local resistance. These local communities have held back the goliath of coal expansion with little more than a slingshot and a rock. That heroism, aided by the beauracratic inefficiency of Coal India and a decrepit transportation infrastructure, has caused stagnating production, and heightened project delay (all of which investors in Coal India would do well to take note of).
Of course tight supplies alone would not merit the title economic 'bubble.' That was formed by a deregulated energy sector given the green light to build a whopping 455 coal plants under the assumption that a coal expansion was inevitable. You see developers rushed headlong into new projects without properly assessing the underlying risks around fuel supplies, and worse, were underwritten by billions in investment from Indian banks. The result is a massive asset bubble whose financial rot could now affect the entire economy.
Unfortunately this is exactly the situation the Reserve Bank of India warned of in 2012 saying 'over-exposure to the coal sector posed systemic default risk' to the Indian economy. It was this warning that should have put the sector in deep freeze. Instead analysts around the world have predicted galloping coal growth, ironically much like they did in China until only a few months ago. But while the RBI warning failed to slow investment, or the narrative that a coal expansion was inevitable, two outside shocks began the inevitable process of deflating this bubble.
First came the coal-gate scandal, which exposed $33 billion in coal leases that were simply given away to powerful companies and rich individuals developing power plants. With Anna Hazare awakening a middle class furious over rampant corruption the coal sector became tarred with the brush of corruption. The result is that dozens of mining expansions around the country have been quietly held in limbo as beauracrats seek to avoid any political exposure to the ongoing scandal. The already tight supply of coal squeezed even further.
Next came capital flight and the current account deficit (CAD) crisis. This was perhaps the knockout blow because it made financing coal projects more difficult while putting a macroeconomic strain on even big companies who might have been able to weather the storm. Particularly hard hit were projects reliant on already expensive imported coal because they have to pay for their fuel with foreign currency at a time when the rupees value continues to plummet. The most emblematic of these, Tata Mundra, has become in the words of Anil Sardana managing director of Tata Power an 'albatross around the neck.'
All of which brings us to our saga’s climax: the news that a whopping 30 'distressed' coal projects are up for sale in India – and no one wants to buy them. This is the moment when the true nature of the coal expansion has been exposed for what it always was: an illusion. The problem is the fallout is only just beginning as State discoms who are supposed to buy the power, have said they simply can't afford it. That means these 30 projects may become stranded assets while new projects will find it nearly impossible to secure financing given that their customers are bankrupt.
But in every crisis is an opportunity and a phoenix may yet rise from the ashes. Already there are high profile calls from Akhil Gupta and Blackstone to diversify India's energy mix starting with solar. After all India still needs energy and it will have to come from somewhere. But the only way deliver is to heed the hard learned lesson from this bubble: coal won't deliver, it's time to diversify.
-- Justin Guay, Sierra Club International