Regional: Fitch: India directive will not relieve short-term coal shortage

(Fitch Ratings-London-04 April 2012)-- A Presidential Directive requiring state-owned Coal India Limited to sign fuel supply agreements (FSAs) with independent power producers will do little to relieve domestic coal shortages in the near term, Fitch Ratings says. Over the long term, the directive could resolve some of the bottlenecks preventing higher coal production, although this will also require further action from the government. If CIL fails to increase its output to the desired levels it will face penalities.

The FSAs signed under this directive will initially have little effect on domestic coal supply as the reasons for lower output - infrastructure bottlenecks, lack of environmental clearances, problems in land acquisition, high rainfall and labour - need long-term solutions. Indian non-coking coal production grew by a mere 13MT over FY09-FY11, sufficient to fire only 2.3GW of coal capacity, whereas over the same period thermal capacity addition was nearly 16GW. We believe coal will remain the dominant fuel for the Indian power sector due to lower-than-expected gas production from existing fields and no new major gas discoveries.

Over the long term, we believe FSAs signed under the Presidential Directive could help overcome some of the bottlenecks and improve the long-term availability of coal. However, much of the initiative will depend on the government finding a solution to environmental restrictions that prevent extraction of coal lying under forests. It will also depend on the size of fines that could be levied against CIL.

Import of coal by CIL to meet its enhanced supply obligations will be an option but pricing of such coal will need to be worked out. A key minority shareholder of CIL is also likely to contest the directive, fearing the negative impact binding supply commitments could have on CIL's contingent liability. This would shift the action to the legal arena and at the same time highlight the constraints faced by Indian power producers in their efforts to secure fuel supplies and put into perspective the limitations on the options available to the government .

The Indian power sector received strong investor interest during 2008-2010 and this presidential directive is part of the government's efforts to save that investment from going bad. Although improvements in coal supply over the medium to long term could help save investments that were recently completed or are in the pipeline, fresh investments in the coal-fired power generation sector are likely to remain subdued.

Because of supply constraints, CIL has not signed FSAs with power generators since March 2009. The government has directed CIL to sign FSAs with all new power plants commissioned by December 2011 or that will be constructed by March 2015. The directive came after CIL's board failed to sign FSAs by the March 2012 deadline set by the Prime Minister's office.(End of release)