Approach for Long Term Imported Coal Contract - A brief overview 20 November 2012 4 th Coal Summit 2012, New Delhi 1.

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Approach for Long Term Imported Coal Contract

- A brief overview

20 November 2012 4th Coal Summit 2012, New Delhi

220 November 2012

Approach

4th Coal Summit 2012, New Delhi

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Long Term is a relative term.

In International Coal market, 2 to 3 years is considered long term but requirement of IPPs is different due to funding by Financial Institutions/Banks. They require 15 years Fuel Supply Agreement if not more

20 November 2012

Long Term


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Indonesia

South Africa / Mozambique

Australia

United States/Canada/Columbia

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Likely Sources of Imported Coal


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Are we short of Coal Reserves ? NO

Are we short of Production ? YES

Did we know about it 10 years back? YES

Are we Myopic ? NO (We have Coal Vision 2025)

Are our Bureaucrats who are Policy makers not aware

OR

just plain Incapable ? WRONG QUESTION

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Question is Why Imported Coal


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Is Political Class capable of sorting out this issue of shortage of domestic coal in National interest ?

If YES, then is there a vested interest in not doing it ?

If NO, then isn’t it time for Bureaucrats and Technocrats to rein in their hands and be counted so that our Nation can prosper ?

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Which brings into the Question


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Domestic Production figure in Million MT

Year 2000 2010

INDIA 343 480 CHINA 950 3,522

(3.5 Billion MT)

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Food for thought


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What difference does it make ? Do you still believe in it ?

What happened to Coal Vision 2025 ?

Are we just visionary on paper ?

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Supply / Demand Gap by Planning Commission


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Instead of Exporting washed coal and earning foreign exchange we are Importing coal

Even after 65 years of Independence, 46% of Indian population is not covered by Electricity

We need to correct this situation and only way forward is to prudently plan our Coal Import Strategy

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Import instead of Export ?


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Simply going by figures of Ministry of Coal, projected Supply Demand Gap of Coal is as follows:

120 MT in 2012-13

149 MT in 2013-14

180 MT in 2014-15

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Lets work on Bridging the Gap


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At present only Option to meet the gap is to Import the Coal, for at least next 10 years

Unless and until we open up our Coal Mining Sector to foreign participants with condition to develop mine of 50 Million MT / annum capacity in 5 years time frame

At least 5 such foreign ventures should be allowed which will bring in capital and latest mining technology

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Imported Coal – Mid Term Option


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Global Economy is wobbly and China is growing at a Slower rate and so does India. Miner is feeling the pinch and this is the time to strike and reach for that long term Contract which till now was not easy to forge

Even Shipping Freights are at bottom and industry is tottering

Flexibility and Understanding of International Work Culture and Macro scenario is the KEY

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Its all about TIMING…….you sure know your CRICKET


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Miners were riding on a high wave and were not interested in Long Term Contract of 15 years. They wanted to sell on Spot or at the most Annual Qty Contract i.e. 1 year with price based on Quarterly Index if not Monthly.

In some rare cases where Miner agreed to sign 20 years Contract with delivery starting 4 years from Contract date, the Power Plant approvals in India took so much time that in 4 years, construction did not even start, forget commissioning. So now many miners are cautious of dealing with Indian IPPs

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Timing…………


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Instead of 15 years Contract, try to work on 5 years Contract with Options for another 5 + 5….. ………Yes, I hear you. We all know that Financial Closure requires 15 years CSA (Coal Supply Agreement) BUT Think Out of Box.

There is massive liquidity in International market waiting to be tapped

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Take Baby Step instead of leap to No-where


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5 Year Horizon is easy to work with and this will open the dialogue with miner that can be explored further for 10 years or 15 years Contract

This will also give time for IPPs to understand the working in International market and take corrective steps if required or entering into Contract with other Suppliers OR Joint Venture Partnership to leverage its position in the market

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Baby step to Adult-hood is all I ask


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Customer is important but like ups and down in the global economy, we also have Seller’s market. So its important that Buyers/IPPs when negotiating a Contract should not look at it from a higher pedestal and should equally recognize the view points of Seller

Remember Contracts are supposedly ‘MUTUALLY AGREED’ and not shoved into the throat like it is being done presently by some of the Buyers.

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It has to be WIN-WIN


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Buyer maybe happy negotiating a One sided Contract (also called Strong contract) by showing its position of Strength but this will definitely give rise to discontent over a period of time and either the miner will default or will supply sub-standard material.

It has to be a collaborative efforts and hence demands understanding on both sides. Once the Contract has been signed, it has to be backed by creating a coordination team for day to day Operations.

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Win – Win……..


Security of Supply

Consistency in quality adhering to the Contractual specification

Reliability of Delivery

Best price and minimal price risk

Ideally a fixed price for term of the Contract

Back-up supply for emergencies or in case of Force Majeure with that particular mine

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Let us see what is Buyer looking at ?


Country Counterparty Price (including Shipping freight) Volume & Quality Credit Operational Legal Political Force Majeure (Weather, Labour, Riots etc)

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What Risk does a Buyer face ?


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Buyer can define, manage and mitigate the Risk while meeting its objective to procure the coal in an efficient manner so as to maximize the returns

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Mitigate your Risk


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First and foremost risk to evaluate on macro level in buying imported coal is to consider Country Risk and Political Risk

Basic Fundamental – Never put all your eggs in one basket. One should always consider multiple coal supply source to spread the risk. This should be from at least 2 countries if possible

Political Risk can be in the form of Policy changes by the government or change in government. In an environment where every country wants to protect its Natural Resources we have to be cautious

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Country and Political Risk


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If above is not workable, then it is imperative that you should have at least 2 sources of supply within the same country but preferably different regions.

This is very important especially in case of coal supply from Indonesia due to variables not under the control of mankind. One simple example being Rain which are incessant and due to poor infrastructure it leads to multiple problems like mine flooding, cargo movement, loading operations (which is mainly anchorage), increasing the Total Moisture in Coal and hence reducing the Calorific Value etc.

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Multiple Supply Source


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If we are signing a 15 yrs Contract for Coal which we know is paramount to run the Power Plant then why don’t we bring our long term supplier(s) into the fold as our Partner or stakeholder?

Bring in the miner/supplier as a Partner and concentrate on Generating and Selling the Power which is the core competence of IPPs

This will also mitigate Counter Party Risk

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Are Long Term Contract Supplier not actually a Partner ?


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Current Capacity and Capability to raise the production

Past Performance and Reputation in the market

Reserves – Life of Mine

Ability to meet the Specifications consistently

Current Infrastructures including equipment's like loaders, excavators etc., ownership of Jetty in case of Barge loading, Loading by conveyor, barge ownership and so on.

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Evaluation of Suppliers


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Operational Capability

Further Exploration potential of current tenement

Contract Mining or Owner Mining

Relationship of Mine Owner with locals and if any CSR project implemented

Financial capability to manage production on sustained basis

Current markets being served

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Evaluation of Suppliers……


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Terms of Import is important as it allocates the Risk, Responsibilities and Cost.

ICC Incoterms 2010 is Standard for the Industry

Two most common Delivery terms are - FOB (Free on Board) & CIF (Cost Insurance and

Freight) Or CFR (Cost and Freight)

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Delivery Terms


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In case of FOB - Seller’s responsibilities ends at Loading - Buyer takes risk of Shipping - Buyer will require a Logistic team to oversee the

operations and coordinate with Vessel Owner starting with Vessel Nomination to loading and

till the time the Vessel has discharged at Disport - Buyer takes freight market volatility risk but may

hedge thru Long Term COA or thru FFA

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FOB Term……


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In case of CIF Seller takes risk of Shipping Seller’s responsibility is up to Disport Buyer’s logistics needs are reduced and hence the

cost overheads goes down Buyer does not face any Shipping freight volatility risk

as it is transferred to Seller No Ugly Surprises on the Contractual price

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CIF Terms……


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Miners’ in general (except for big boys) are interested in selling on FOB basis

IPPs would like the coal to be delivered at their doorstep or at least at Discharge Port (CIF or CFR Basis)

To bridge this Gap, IPPs should consider outsourcing this services to specialized Trading Companies who are willing to own the risk and responsibilities that comes with it. It can be done at a fixed fee and comprehensive Term Contract should be signed to make it binding.

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How to manage the Gap ?


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The Trading Company or Outsourced Company will not only finalize the Shipping Terms with Vessel Owners but also oversee the Operations right from stage of Vessel Nomination to coordinating with Miner for Loading operations up to Discharge

The scope of Trading Company can be further increased so as to serve as Buyer’s Protecting Arm and supervise the loading and sampling operations to ensure that quality, quantity and other Contractual terms are not compromised

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Mind the Gap


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Clearly define the Specifications and its governing Standard (ISO or ASTM) in the Contract

The Sampling Analysis Report by Inspection Agencies generally provides for Proximate Analysis but you can ask for Ultimate Analysis, Ash Analysis and others like AFT, Size and HGI

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Quality and Quantity


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Independent Inspection Agencies to be mutually agreed and preferably same Agencies to be used for both Load Port and Disport for purpose of consistency

Sampling at Load port shall be at Supplier’s cost

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Inspection agencies to be mutually agreed


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Sample to be divided in 3 parts. 1st part for testing by laboratory 2nd part retained by Supplier 3rd part to be retained by Laboratory for 60 days and

marked Umpire Sample and sealed in presence of Buyer (preferably)

This is a mined product not manufactured product so expect variations but within limits

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Remember ..Umpire is always the key


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The Sampling Report at Load port is usually generated by 5th day of Vessel Sailing and hence Buyer gets the result of the cargo before Vessel reaches destination port

Buyer has the right to reject the cargo falling under Rejection Limit Analysis

Buyer and Supplier may negotiate reduced price for rejected cargo

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Right to reject the cargo


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Buyer has the right to appoint Inspection Agencies at the Disport to check for quality

If Calorific Value of Discharge Port and Calorific Value of Load Port varies by amount greater than allowed by International Standard or an agreed tolerance, then Umpire Sample to be tested by another Independent laboratory or in 3rd country

If Umpire Sample confirms the difference then Umpire Analysis result is final and binding for Payment purpose.

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Disport Sampling


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The weight of Coal as determined by Independent Inspection Agency at the Load Port through the process of Draft Survey Report is Final and Binding for the purpose of Invoice

Draft Survey are very accurate and we don’t find much variation from Load port to Discharge Port

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Quantity


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Now we come to the most crucial part of the Contract i.e. Price. Buyer has to keep 3 important things in mind while looking at the price.

Firstly, Landed cost of coal consist of FOB + Shipping Freight. So apart from FOB price SHIPPING FREIGHT is equally important. Today the Shipping Industry may be soft but even couple of years back upto 40% price of CIF coal consisted of freight price. It does not take much for market to change so book freight on 5 yrs + 5 + 5 Buyer’s Option COAs. (Contract of Affreightment)

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Price Price Price


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The Freight negotiated for COA will be Base Price with provision for Bunker movement linked to index. This is the standard industry norms

Second component is FOB Price. Forward Coal prices are extremely difficult to predict in today’s situation and volatility is high. Days of annual Contract at Fixed Price is over

Stake Holders prefer companies that perform as planned without giving hiccups.

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Shipping + FOB Price


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Secure company’s objective by locking in the required quantity at an Indexed Price or at a Fixed Price

We have reputed Index in the market like Platts, ARGUS, API4, RB1, RB3, NEWC, globalCOAL etc.

These indices are being used for sale and purchase of Billions of Tonne of Coal per annum globally and hence liquidity is very high

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Index Pricing


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Buyer can enter into a Quantity Contract of say 5 or 10 to 15 years with price to be fixed quarterly based on mutually agreed Index or basket of Index. This should be fair to both the parties (remember WIN-WIN)

Problem faced by IPPs is that they have to sell the electricity at a Fixed Tariff and it is not linked to Fuel Cost variation proportionately

This anomaly need to be sorted out by Policy makers

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Index Pricing


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To obtain Fixed price, Buyer can buy the underlying SWAPS linked to Index going forward 3 years and on other side have a normal Quantity Contract with Miner with price based on Spot

However, the market presently only supports SWAPS of 2 to 3 years going forward and its not a Perfect Hedge

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Fixed Price using SWAPS


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The Third component of Pricing that hits the costing is Currency Fluctuation

We can only hope that Indian economy will strengthen going forward and so cost of Imported Coal will be cheaper

Hedging is one way of tackling it but one has to take informed decision because market can turn against you in a short time

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Currency Fluctuation


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My personal belief is that in Asian way of Trading, relationships are very important and even the most difficult situations can be sorted out across the table

However things can go wrong and it DOES especially in a Long Term Contract

Please ensure that Contract is governed by Laws that are workable, fair and delivers quick justice

My view is that there is nothing better than Singapore Law to govern the Contract and its also based in Neutral country so neither supplier or buyer should have objections

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Governing Law


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For a Power Plant, coal cost represents 80 to 90% of variable operating cost

Without the coal, the plant cannot operate and revenue is Zero

Coal Price and availability is important but Buyer is not in the Coal business

The Buyer does not want Coal procurement matters to distract from real business of generating Power

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Conclusion


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Therefore its important to conduct due diligence on miner and to source coal from reliable supplier with consistent quality and reserves

If the situation demands then please outsource the procurement, logistics and quality control process to a Trading Company or Fuel Management Company who have core competence in this field (Bridging the Gap)

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Conclusion


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Thank you for your time

20 Collyer Quay# 09-01 Tung CentreSingapore 049319T: +65-6225 2291F:+65-6221 2291E: [email protected]

www.synergyglobal.sg

20 November 2012

Till we meet again…..


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Approach for Long Term Imported Coal Contract - A brief overview 20 November 2012 4 th Coal Summit 2012, New Delhi 1.

Documents

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