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Sector update: Mining - Awaiting clarity on Odisha mine auction

We present key takeaways of the meeting hosted by us between Mr. Vijay Jhanwar, President of Chhattisgarh Sponge Iron Ore Producers Association, and our institutional investor clients on 15 Mar 2019 in Mumbai.

Clarity on auction of merchant mines in Odisha to emerge by Jul 2019

• Auction of iron ore mines with production of ~74mt (in FY18) is due in Mar 2020. Mr. Jhanwar believes that the lease of the mines will not be extended beyond Mar 2020.
• We see the likelihood of merchant miners filing a PIL against the decision made in 2015, when extension was given for 5 years for merchant mines and 15 years for captive mines. We expect several PILs from Q2FY20, which could create uncertainty in the auctioning process.
• There could be ~10% increase in iron ore supply from Odisha merchant mines in FY20. Steel producers could pile up iron ore inventories, keeping in mind the possibility of short-term disruption in supply. A massive supply of domestic iron ore is not expected in FY20 due to logistic issues.
• All mines will have to be evacuated by Mar 2020, unless there is an extension, which means miners will have to exhaust inventories within this time frame. As a result, miners will need to halt production by Nov 2019 and liquidate inventories, if everything goes as per plan.
• Industry is awaiting clarity on allocation of mines to be auctioned for captive and merchant purpose. Mr Jhanwar believes while JSW Steel will be a major beneficiary of the Odisha auction (the company does not have any mine in the state), new players such as Adani group, Vedanta, Triveni Earth Movers (MDO), etc, would also venture into the auction.
• The Central government has guided for the auction process of the mines to be started from July 2019. All statutory permissions would be seamlessly transferred to the new lessee for 3 years, unlike coal, so no major disruption in iron ore supply is expected if the auction process starts on time.
• However, if the State government does not start the process by Sep 2019, we could see a delay in the re-auctioning of the mines, which would lead to massive disruption in iron ore supply in the domestic market in FY21. However, iron ore is expected to be in surplus after FY21E.
• Merchant miners may demand for first right of refusal in the auction of mines, as is available for captive miners. In such a situation, merchant miners could give a tough fight to steel producers bidding for captive purpose.
• Post auction, the base price for Indian iron ore will increase substantially, as Odisha mines are expected to be auctioned at a premium of more than 50% of price (a premium of 80-100% is not expected as in the case of Karnataka). The higher premium (v/s nil currently) and mining cost of ~Rs500/t will restrict Odisha miners to sell below Rs1,500/t ex-royalty. This may act as a floor price for iron ore fines prices (63% Fe iron ore fines at Serajuddin mines is currently priced at Rs2,000/t and the same fell to Rs920/t in 2016- ex royalty). The sustainable high base price for iron ore will be beneficial for Central PSUs like NMDC, in our view.

Views on NMDC’s Donimalai mine at Karnataka

• Mines and Minerals (Development and Regulation) Act, 1957 allows a state government to impose special conditions at the time of renewal of the mine leases. However, the Act does not define the ambit of the special condition. The High Court is to decide on the legality of the condition imposed by the Karnataka state government. Mr Jhanwar expects the decision to come in favour of NMDC, a PSU, as the special condition need not be in the form of charging premium at the time of renewal of mines. It could be in the form of setting up a value-added plant, a JV with other state PSUs, etc. The Central government is expected to incorporate a change in the MMDR Bill to remove ambiguity on the above subject, likely by Jul 2019, in our view.
• However, if the decision comes against NMDC, the concept of merchant mining could end in India. This will not only impact merchant miners, but may also have a bearing on captive miners at the time of renewal. However, as Tata Steel’s mines are due for renewal in 2030, we see no issues for Tata Steel until then.
• Mr Jhanwar believes merchant mining is unlikely to go away from India, as several small companies are dependent on it. Hence, he believes the government is unlikely to take any action that would affect small industries.
• His view is that even if NMDC were to have lost the case, the outcome will not have a similar effect (imposition of lease rental as 80% of sales value) on its Chhattisgarh mines, which are due for renewal in Mar 2020. He strongly believes that the Chhattisgarh government is unlikely to follow in the footsteps of the Karnataka government, as the mines are located in Naxal-hit areas and NMDC carries out immense CSR activities in the region. However, there does exist a possibility that the Chhattisgarh government may renew the lease in name of NMDC-CMDC JV to benefit the state-owned enterprise, unlike the Karnataka government.

Others

·       Currently, in case of a mine auction, the successful bidder has to produce 100% of committed quantity, else pay a penalty. The industry has demanded the cut-off rate at 70-80% of production, and penalty imposition in case of failure to meet the cut-off rate.