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Coal-Era: Drivers and Approaches to the
Valuation of Coal Properties
Coal remains one of the most widely used sources of energy in
Who Needs Coal?
the world, particularly for electricity generation. While
Global demand for commercial coal has risen from 2,343
million tonnes oil equivalent (“Mtoe”) in 2000 to 3,827 Mtoe
3
in 2013, at an average growth rate of 3.9% per annum.
According to the International Energy Association (“IEA”)
(2012) and BP (2013), coal meets 29.9% of global primary
energy needs, generates 41% of the world's electricity and
4
fuels production of 70% of the world’s steel.
developed countries continue to diversify their sources of
energy, many emerging economies remain dependent on coal
and other fossil fuels as their primary source of energy.
Coal in the Spotlight
On 25 August 2014, the Supreme Court of India concluded
that the process followed by the Government of India (“GoI”)
and/or its various agencies for allocating coal block licences in
India since 1993 was “arbitrary and illegal.”1 Subsequent to its
decision, the Supreme Court cancelled 214 licences of the
total 218 licences awarded over the relevant period, including
those of coal mines which were already producing coal. It also
ordered the companies that owned the operational blocks to
compensate the government for losses incurred at the amount
of INR295 per tonne of the total coal extracted over the
aforementioned period. (On the basis that such companies
were able to extract higher economic profits by owning coal
properties at the expense of the exchequer.) The Comptroller
and Auditor General of India (“CAG”), in its final report tabled
in August 2012, claimed that the inefficient allocation process
followed by GoI for the coal blocks has cost the exchequer c.
INR1.86 lakh crore (or c. US$30.2 billion).2
This recent mass cancellation of coal licences in India by the
Apex court has not got unnoticed. There has been some
commentary on this subject in various global publications and
media but the judgment has also commanded significant
discussions within India. Whether investors (local or foreign)
react by resorting to legal action, increasing their perceptions
of risk or reducing their India investments is yet to be seen. We
understand that many domestic players have already
reiterated their interest in the forthcoming auctions that would
seek to reallocate some of the cancelled blocks.
The judgment and imminent re-auction of particular recently
cancelled blocks have revived interest in coal and its
importance as a commodity. In this article we briefly assess
the importance of coal globally and in India, highlight the
principal value drivers of coal properties and introduce the
various approaches that may be adopted to value such
properties.
Total world coal production reached a record level of 7,896
million tonnes in 2013. Coal reserves, as of December 2013,
were estimated to be 892 billion tonnes which equate to c.
113 years of coal output at current production levels. The top
10 coal producing countries (namely, China, the United States
(“U.S.”), Australia, Indonesia, India, Russia, South Africa,
Kazakhstan, Poland and Columbia) account for c. 90% of
global coal production.
The figure below summarises regional consumption trends for
coal since 1988. It is clearly evident that Asia Pacific (“APAC”)
accounts for a majority of global coal consumption and all of
the increase in consumption in the last 25 years. These trends
are expected to continue.
Regional Consumption of Coal (in Mtoe)
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
1988
1993
1998
2003
2008
2013
North America
South & Central America
Europe & Eurasia
Middle East
Africa
Asia Pacific
Source: BP Statistical Review of World Energy, 2014, p.34
Source: BP Statistical Review of World Energy, 2014, p.34.
1 Supreme Court Judgment on Coal Blocks, 25 August 2014, p.4 and p.162.
2 Using an exchange rate of USD: INR = 0.016 as at 10 February 2015 (Source:
www.xe.com).
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3 BP Statistical Review of World Energy, June 2014, Historical Data Workbook.
4 Coal Facts 2013, World Coal Association, p.1.
Coal-Era: Drivers and Approaches to the Valuation of Coal Properties
Driving the APAC region’s growth in consumption is China, the
world’s largest producer and consumer of coal, accounting for
47.4% of production and 50.3% of consumption in 2013.
Meanwhile India, at 13% of global consumption currently, is
expected to overtake the U.S. to occupy second place by
5
2024.
Forecasted Global Demand for Coal till 2035
(in billion toe; reproduced)
Coal in India
In India, coal is a primary input for the power sector and in
industries such as iron, steel and cement. Although India has
the fifth largest coal reserves in the world (proven reserves of
60.6 billion tonnes and total estimated reserves of c. 286
7
billion tonnes) and is the fifth largest producer of coal, it has
been unable to meet its growing demand through domestic
production. In recent years, production has lagged
consumption — since 2007 (to 2013) coal production has
grown by c. 4% per year whereas consumption over the same
period has grown by more than 7% annually. As a result,
between 2005-06 and 2012-13, India’s coal imports more
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than tripled from 41.2 million tonnes to 140.6 million tonnes.
India imports thermal coal mainly from Indonesia and South
Africa and coking coal for steel production from Australia.
Indonesia is the largest source of coal imports to India,
9
accounting for 55% of total coal imports in 2012.
Domestic shortages may have been exacerbated by inefficient
delivery models. In addition, domestic coal production
generally has high ash content, rendering it unsuitable for
10
coking and use in the steel industry. With the demand for
metallurgical coal expected to remain buoyant, Indian coal
imports may continue to rise.
Source: BP Energy Outlook 2035, January 2014, p.68
After 2030, forecasts see China’s consumption of coal slowing
down as the economy shifts towards a greater focus on
services and domestic consumption. In contrast, India’s
forecasted demand remains robust as industrialisation
continues in the country, resulting in speculations that after
2025 India will replace China as the leading source of coal
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demand growth.
According to the Planning Commission, India’s demand for
coal is expected to reach 980.5 million tonnes of coal by
FY2017 with the power sector constituting roughly 70% of the
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total demand. However, indigenous coal availability is
projected optimistically by some accounts at 795 million
tonnes. Even assuming steady growth in domestic production,
therefore, the shortfall in demand is expected to continue. The
recent cancellations of coal licences may thus have a further
adverse impact on the availability of domestic coal, at a
minimum in the short-term, which will likely result in higher
import bills.
China, EU and India Coal Imports (in million tonnes)
400
China
350
300
250
EU-27
200
150
India
100
50
0
2008
2009
2010
2011
2012
2013
Source: U.S. Energy Information Administration, http://www.eia.gov/
7
BP Statistical review of world energy, 2014, p.30 and p.32.
Annual Report 2013-14, Ministry of Coal, GoI, p.67.
9
Effective 1 October 2014, Indonesia introduced a new export regulation
policy requiring traders to obtain appropriate licensing. This may affect
imports of coal from Indonesia in the future.
10
“Outlook for metallurgical coal is steady”, Mike Elliott (EY Minings & Metals),
World Coal Association, 24 January 2014.
11
Energy Statistics 2013, Central Statistics Office, p.1, and Coal India Annual
Report FY20 2014, p.7.
8
5
6
BP Statistical Review of World Energy, June 2014, p.32 and p.33.
BP Energy Outlook 2035, January 2014, p.69.
CRITICAL THINKING AT THE CRITICAL TIME™
Coal-Era: Drivers and Approaches to the Valuation of Coal Properties
Types of Coal (Reproduced)
Carbon/energy content of coal
High
Carbon / energy content of coal
High
% of world reserves
High
Moisture content of coal
Moisture content of coal
Low rank coals
47%
Lignite
17%
Hard coal
53%
Sub - Bituminous
30%
Uses
Power generation
Cement manufacture
Industrial use
Anthracite
1%
Bituminous
52%
Thermal
Steam coal
Largely Power
generation
High
Power generation
Cement manufacture
Industrial use
Metallurgical
Coking coal
Manufacture of iron and Domestic / industrial
including smokeless
steel
fuel
Source: World Coal Association
S
Coal Price and Drivers of Value
Coal is generally categorised according to its physical and
chemical properties, such as hardness, moisture level and
energy content, and its primary uses can be classified between
thermal coal and coking coal, which are used for power
generation and iron and steel production, respectively.
Thermal coal prices depend on the calorific value (“CV”) of the
coal product as well the level of impurities such as of sulphur,
ash and moisture. All else equal, the, higher the CV and lower
the impurities, the higher the expected price per tonne.
their market is global. Therefore, the revenues of commodity
companies may be heavily impacted by commodity price
trends and volatility.
In some circumstances, especially for more mature commodity
companies or mines, when outputs stabilise, changes in
commodities price and the commodity price cycles may explain
most of the variances in commodity companies’ revenues.
The other key value drivers of a mining property may include:
• The extent and quality of the reserves;
Coal is therefore not a homogeneous product and there are
several different coal markets that are segmented by end-use
(steam, metallurgical), quality (CV, ash and sulphur content,
etc), geographical location, regulations, coal supply contracts
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etc., each with different pricing structures. As may be seen in
the chart on the following page, for instance, coking coal
prices generally exceed those of steam coal and Asian prices
are higher than those in North America or Western Europe.
• sales arrangements;
A key underlying characteristic inherent in commodity
companies is their dependence on the price of the commodity
for their cash flows and value. Global commodity companies
are usually price takers regardless of their size especially when
Coal properties may differ in more than one respect and such
differences can be critical in inferring value and distinguishing
value between properties.
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Other factors such as freight costs (which in fact constitute a significant
portion of the total cost of delivered coal) can have a significant impact on the
final price.
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• operating, capital and extraction costs;
• applicable royalties, taxes, and duties; and
• project, market and country risks which may be reflected in
the expected cash flows arising from the mine or in the
discount rate applied to convert future cash flows to a
present value.
Coal-Era: Drivers and Approaches to the Valuation of Coal Properties
Coal Price Indices (US$ per tonne)
250
200
150
100
50
0
1987
1989
1991
1993
1995
1997
1999
2001
Northwest Europe marker price
Japan coking coal import cif price
Asian Marker price
2003
2005
2007
2009
2011
2013
U.S. Central Appalachian coal spot price index
Japan steam coal import cif price
Source: BP Statistical Review of World Energy, 2014, p.30.
Valuing Coal Properties
Mining projects are complex undertakings and often require
much effort and time to bring into production. They are
generally characterised by substantial investments in
exploration activities, mining equipment and infrastructure
before commencing commercial operations. Further, as
explained above the projects may be prone to the volatile
commodity price cycles and the regional or global imbalance or
balance of supply and demand fundamentals. In this context,
the economic value of the mine is a key issue whether in the
context of licensing, mergers and acquisitions or in disputes.
The recent developments in the Indian coal sector have
highlighted the perennial interest in coal properties. The
Supreme Court of India has cancelled a majority of the coal
licences awarded to private players since 1993. It has further
penalised certain companies for the extraction of coal over the
relevant period and ordered a fresh auction of the various
cancelled coal blocks to ensure transparency and fairness in
allotment. Economic value of the said coal properties would be
particularly relevant in all such circumstances.
As a first step (assuming the date of valuation has been fixed
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and relevant definition of value has been selected ), it is
necessary to assess the stage of development the mineral
property has attained as at the valuation date. This is
particularly important because in mining cases, the stage of
development will most likely determine the valuation
approaches that are deemed appropriate and may have a
significant impact on the final value ascribed to the property.
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The appropriate definition of value may be case specific but “fair market
value” or “FMV” is typically used. FMV is may be defined as “The price,
expressed in terms of cash equivalents, at which property would change
hands between a hypothetical willing and able buyer and a hypothetical
willing and able seller, acting at arm’s length in an open and unrestricted
market, when neither is under compulsion to buy or sell and when both have
reasonable knowledge of the relevant facts.”
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Mining projects follow a broadly predictable development path
from the initial identification of potential resources, to
exploration, evaluation of deposits through geological and
metallurgical work, mine planning and construction, which
eventually leads to production and, finally, to the
decommissioning and remediation phase at the end of the
mine’s life.
Based on this life-cycle, mining properties can be
characterised into four broad categories: (i) exploration
properties, (ii) mineral resource properties, (iii) development
properties, and (iv) production properties. The stage of
development at a particular time can be assessed based on a
review of the technical reports prepared on the project. In
some jurisdictions, public companies must publicly disclose
the necessary information with respect to the reserves and
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resources of its mining projects.
In determining the appropriate valuation approach(es) to use,
it is prudent to be familiar with internationally recognised
valuation standards for mineral properties such as the
Standards and Guidelines for Valuation of Mineral Properties
produced by the Special Committee of the Canadian Institute
of Mining, Metallurgy and Petroleum on Valuation of Mineral
Properties (“CIMVAL”), the South African Mineral Assets
Valuation Working Group (“SAMVAL”) and the Australian
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Institute of Mining and Metallurgy (“AusIMM”).
Three potential ways to value a mining asset are commonly
applied, namely by reference to its replacement cost; or
14
For more details, please see: Valuation of “Start-Up” Oil and Gas and Mining
Projects, Chris Milburn and Laura Hardin, FTI Consulting, The Arbitration
Review of the Americas 2011.
15
For more details, please see: Valuation of “Start-Up” Oil and Gas and Mining
Projects, Chris Milburn and Laura Hardin, FTI Consulting, The Arbitration
Review of the Americas 2011.
Coal-Era: Drivers and Approaches to the Valuation of Coal Properties
invested capital, its market value or the future income that it is
expected to generate:16
Income-based approaches
In valuation theory, discretionary after-tax cash flow is of
primary importance. The most commonly applied income
approach is a discounted cash flow ("DCF") method, which
assess the value of an asset by reference to the amount,
timing and risk of its future cash flows. When implementing a
DCF method, it is customary to follow three main steps:
Valuation on a practical level
The CIMVAL Guidelines set out the valuation approaches that
are generally considered appropriate to apply to each type of
mineral property as follows:
CIMVAL Valuation Approach Guidelines by Stage of
Development
• Estimating future cash flows for an explicit forecast period;
• calculating the terminal value of the asset at the end of the
forecast period (this may not be appropriate for a mining
property as its full useful economic life can usually be
estimated); and
• discounting the cash flows and terminal value to determine
a present value using a discount rate that takes into
account the market risk of the cash flows and terminal
value and the time value of money and summing the total
value of the asset to arrive at the current value.
Extractive industries are unique in some respects: once the
mining resource is established to a sufficient degree of
certainty from a technical perspective and economic viability is
verified via a feasibility study, the processes and technology to
extract the ore and produce the commodity are wellestablished and the costs can therefore generally be
estimated with a reasonable degree of precision. Further, such
products usually have a ready end market (global or regional)
and so revenues can also be forecasted using publicly
available forward pricing curves.
Market-based approaches
Value is inferred from publically-available information
pertaining to transactions and trading prices involving mines
that are deemed to be sufficiently comparable to the target
mine. While mining projects may have unique characteristics,
value data from reasonably similar mines can be used to
determine a reasonable range of their fair market value or to
re-affirm the reasonability of value conclusions reached via
other methodologies including the income approach.
Cost-based approaches
Value is determined based on the principle that a notional
purchaser would not spend more on an asset than it would
cost them to construct the asset themselves. Such costs would
include development costs of a mineral property. Depending
on the circumstances, this may be thought of as a ‘floor’ value
as it would not include any future expected rate of return or
cash flows on this investment.
Mineral
resource
properties
Valuation Exploration
approach properties
Development Production
properties
properties
Income
No
In some cases
Yes
Yes
Market
Yes
Yes
Yes
Yes
Cost
Yes
In some cases
No
No
Source: CIMVAL Standards, p22.
One must therefore take care in choosing a primary valuation
approach for a target mine or mines. When valuing a number
of licences or coal properties (for example for the purposes of
an auction), the valuation analyses may likely need to be done
on a block-by-block basis as each block will likely be distinct in
terms of the characteristics of the resource and its stage of
development. Where appropriate and feasible, it is usually
recommended to apply more than one methodology to help
cross-check the final conclusions.
We note that the Central Mine Planning and Design Institute’s
recent suggestion to ascertain total value of a block by
assessing the block’s net present value based on an income
approach (i.e. DCF) appears consistent with the above
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standards and guidelines.
In the current context, when ascribing value to coal properties
in India, the intricacies specific to the geography and property
should be taken into account. These include the factors set out
above, but also any identifiable issues that may be unique to
the process or context.
For example, when assessing the value and attractiveness of
the coal blocks in India the bidders will likely take into account
market power, portfolio effect (a single buyer might ascribe be
higher to portfolio of coal blocks than if they were sold to
different buyers), ownership caps set forth by the government
and specific end-use limitations that may limit eligibility of
various players and influence the value bidders might ascribe
to the mine.
Furthermore, while specific risks are always present in mining
projects, these may be more prevalent in India. These include
regulatory hurdles (such as seeking and procuring approvals
and necessary documentation to commence exploration,
development and operations of the mine) and other market
and project risks which may affect the cash flows (such as the
realisable coal price).
Such factors and specific should be assessed before inferring
value of the various properties.
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Another approach that may be applied in valuing mineral properties is an
option-based approach. A significant portion (or majority) of the value of a
mineral property may be in the option to develop the property and commence
production when feasible. Therefore, it is possible to model the valuation of
the mining property as a real option that is available to the mining company
and/ or investors. We do not discuss this approach in more detail here.
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17
“Coal block valuation panel seeks assistance from CAG”, the Indian Express,
23 November 2014.
Coal-Era: Drivers and Approaches to the Valuation of Coal Properties
Conclusion
The valuation of a coal project is a vast undertaking that
requires knowledge of the overall mining process, a sound
understanding of the property from a technical and financial
perspective, knowledge of the appropriate valuation standards
and guidelines, risks specific to the geography and project, an
understanding of the context of the valuation and experience
with standard valuation and financial concepts and
approaches.
The recent developments in India have given rise to conflicting
opinions in India and globally but have also reiterated the
strong interest in strategically important minerals and
commodities such as coal.
Whether for the purposes of any damages analysis (that may
arise from any claims pursued by domestic or foreign investors
or for estimating losses to the exchequer) or ascribing reserve
or bid price in the imminent auctions or ascertaining the value
in a more general context like transaction advisory or capital
budgeting, the valuation approaches would generally include a
detailed review of available market data; comparable
transaction data; and the construction of an income-based
analysis where sufficiently reliable information exists to
prepare a financial projection.
NEW DELHI
Montek Mayal
Senior Consultant
+91 11 4122 3344
[email protected]
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