On 6 September 2016, the Minister of Energy and Mineral Resources (MEMR) issued a new regulation amending the existing regulation on mine-mouth coal pricing, i.e. Regulation No. 24 of 2016 on the Amendment to Regulation No. 9 of 2016 on the Procedures for the Supply and Determination of Coal Price for Mine Mouth Power Plants (Reg. 24).
There are two key changes introduced under Reg. 24:
- a removal of the right of the mine owners to enjoy a profit margin on the coal production royalty element of the coal price, and
- a move away from a "prior MEMR approval" system to a self-compliance system – where mine owners and mine-mouth power companies are free to reach a mutual commercial agreement on certain aspects of the coal price, and report the results to the MEMR.
Another significant impact of Reg. 24 lies in its transitional provisions – which require that existing approved mine mouth coal supply contracts with prices approved under previous pricing regimes must be amended to conform to the new arrangements set out under Reg. 24.
New Coal Pricing Formula
The process of arriving at a coal price under Reg. 9 involved:
- taking all of the mining costs, which included not only the cost of producing the coal, but also a 20.3 percent royalty allowance (to arrive at the Production Costs);
- adding on a margin of 15-25 percent to the Production Costs (to arrive at the Coal Base Price); and
- then escalating the Coal Base Price (based on an agreed combination of fuel prices, labour indices and inflation) to arrive at the "Coal Price to Mine-Mouth Power Plant".
The result of this pricing structure was that the price payable by the mine mouth power plant owner included a margin on the royalty cost element of the coal sales.
Reg. 24 has changed the way in which the coal sales price is built up, with the aim of bringing the coal price to the mine mouth power plant owner down. This is achieved by the following:
- taking all of the mining costs, but excluding any production royalty costs (to arrive at the Production Costs);
- adding on a margin of 15-25 percent to the Production Costs, and then applying the agreed escalation factors (to arrive at the Coal Base Price); and
- then adding on the production royalty (to arrive at the Coal Price to Mine-Mouth Power Plant).
It is unclear whether the royalty will be calculated based on the Coal Base Price (which has included the 15 percent to 25 percent margin), or by the Production Costs, however, we would expect the royalty to be based on the Coal Base Price.
The determination of what constitutes acceptable "Production Costs" will be set out in benchmark rates issued by the MEMR from time to time. The most current benchmark Production Costs are set out in Decree of Director General of Minerals and Coal No. 953.K/32/DJB/2015 (Reg 953) - which itemizes the types of costs for calculating the Coal Production Costs. However, as Reg. 953 includes royalty as part of the calculation of Production Costs (whereas the new Reg. 24 has stripped out royalty as a Production Cost), we expect that MEMR will issue a revision to Reg 953.
Move to Self-Compliance Approach
Reg. 24 eliminates the requirement for the MEMR, through the Director General of Minerals and Coal (DGMC), to approve the Coal Base Price. Under Reg. 9, mining companies were required to first obtain approval on the Coal Base Price from the MEMR prior to making an offer to supply coal to mine mouth power plants. Reg. 24 only requires coal mining companies to report their Coal Base Price.
Reg. 24 also removes the authority of the DGMC to set the margin in case a mining company cannot achieve an agreement with a mine mouth power plant company on the coal price. Accordingly, the determination of the final price is left to business-to-business discussions between the mine owner and power plant owner.
The removal of the DGMC role in relation to these matters of arriving at a coal sales price indicates the Government's intention to expose the mine mouth coal price determination to more of a free market based mechanism without intervention from the DGMC. For mine mouth power plants where there is a high degree of common ownership between the owners of the mine and the owners of the power plant, these changes should greatly expedite finalization of coal price arrangements for mine mouth power plant bids (as the coal price determination can be dealt with as an "in-house" matter). However, where this common ownership does not exist, the removal of the DGMC's role as a final arbiter may result in prolonged negotiations with no foreseeable end-point.
However the co-dependent nature of mine mouth power projects (i.e. the mine has no revenue without a sales agreement with the power plant, and the power plant has no project without a sales agreement with the mine) may mean that this risk of prolonged negotiations remains a theoretical one only.
Conformity of the Existing Coal Price for Mine Mouth with Reg 24
There have been a number of revisions to the mine mouth coal pricing regulations over recent years. A common principle running through those revisions has been that where an existing mine owner has already put in place a coal sales agreement with a mine mouth power plant, those pricing conditions remain applicable through to the end of the term of the coal supply agreement, despite the regulatory changes.
However Reg. 24 adopts the opposite approach. Reg. 24 requires executed Power Purchase Agreements (PPAs) and/or coal prices for mine mouth power plants that have been approved by the MEMR, tender results and/or direct appointments that have been stated under the existing PPAs, to conform with the provisions of Reg. 24.
Reg. 24 does not further specify the procedures on how these existing arrangements must conform with Reg. 24, nor does it specify a timeline within which mine owners and power companies must comply with Reg. 24. Reg. 24 only mentions that the conformity with Reg. 24 must be based on the agreement of the parties. This means that the existing PPAs and coal purchase agreements will need to be renegotiated between the relevant mining companies, mine mouth power plant companies and PLN.
The revisions to the pricing methodology introduced under Reg. 24 gives mine owners the ability to price coal at a lower price point than was previously the case. The flexibility given to both mine owners and power plant owners to reach a mutual agreement on pricing with very limited involvement on the MEMR should also facilitate more nimble decision making when it comes to participation in new mine mouth coal fired power projects.
Even with this new ability to further lower the coal price, the key question remains whether PLN (as the ultimate bearer of the coal price in any power generation project) is willing to absorb the coal price, particularly in view of the continued depressed state of the seaborne thermal coal market prices.
A significant decree of interest will now centre on the approach that PLN takes with respect to existing projects. There are a number of existing projects that have struck coal prices based on the previous "cost (including production royalty) + margin" regime, and accordingly there is an ability for PLN to push for further reductions in the coal prices for those existing projects. However, there are also a number of projects where the coal pricing is based on a 25 year fixed price (with a fixed annual escalation factor), and moving those projects to the new pricing model may in fact result in PLN paying a higher coal price cost than was previously the case.