4 th Coal Summit 2012, New Delhi

Report
Approach for Long Term Imported
Coal Contract
- A brief overview
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4th Coal Summit 2012, New Delhi
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Approach
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Long Term

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
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Likely Sources of Imported Coal

Indonesia

South Africa / Mozambique

Australia

United States/Canada/Columbia
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Question is Why Imported Coal

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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Which brings into the Question

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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Food for thought

Domestic Production figure in Million MT
Year


INDIA
CHINA
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2000
2010
343
950
480
3,522
(3.5 Billion MT)
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Supply / Demand Gap by Planning
Commission

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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Import instead of Export ?

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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Lets work on Bridging the Gap

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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Imported Coal – Mid Term Option

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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Its all about TIMING…….you sure
know your CRICKET

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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Timing…………

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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Take Baby Step instead of leap to
No-where

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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Baby step to Adult-hood is all I ask

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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It has to be WIN-WIN

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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Win – Win……..

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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Let us see what is Buyer looking at ?

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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What Risk does a Buyer face ?









Country
Counterparty
Price (including Shipping freight)
Volume & Quality
Credit
Operational
Legal
Political
Force Majeure (Weather, Labour, Riots etc)
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Mitigate your Risk

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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Country and Political Risk



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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Multiple Supply Source

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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Are Long Term Contract Supplier
not actually a Partner ?

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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Evaluation of Suppliers

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……

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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Delivery Terms

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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FOB Term……

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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CIF Terms……

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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How to manage the Gap ?

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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Mind the Gap

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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Quality and Quantity

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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Inspection agencies to be mutually
agreed

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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Remember ..Umpire is always the key

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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Right to reject the cargo

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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Disport Sampling



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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Quantity

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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Price Price Price

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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Shipping + FOB Price

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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Index Pricing

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

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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Fixed Price using SWAPS

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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Currency Fluctuation

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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Governing Law




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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Conclusion

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

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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Till we meet again…..
Thank you for your time
20 Collyer Quay
# 09-01 Tung Centre
Singapore 049319
T: +65-6225 2291
F:+65-6221 2291
E: [email protected]
www.synergyglobal.sg
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