Role Of Royalty In Hindalco's Novelis Buy

Role of royalty in Hindalco's Novelis buy

TIMES NEWS NETWORK

14th FEBRUARY 2007

There's much action on the metals front. Hindalco, India's biggest aluminium producer, has wrapped up a $6 billion all-cash deal to acquire the US-based Novelis, which is heavily into downstream products. The move would seat Hindalco at the global high table in aluminium. The biggest Indian takeover in non-ferrous metals ought surely to focus policy attention on a host of incongruities in the sector.

Take for instance the fact that the domestic royalty rate on bauxite ore is far too low and has remained unrevised for years. It is actually a tiny fraction of going international rates and a key reason why there is a general lack of transparency in prospecting, mining and ore evacuation. Also, it needs to be asked why the tariffs on aluminium needs to be higher than that for other metals.

Now, aluminium is labelled the wonder metal. It is malleable, ductile and lightweight and is highly resistant to most forms of corrosion too. Also, aluminium production is the highest among non-ferrous metals, with global annual output put at just over 33 mt. It is also 100% recyclable and its recycling adds another 50% to annual production. The total capacity of the Indian aluminium industry is just over 1 mt, with quite a few brownfield expansion and greenfield projects in the works. Meanwhile, in these times of heady growth global aluminium demand is buoyant.

It is actually projected to grow by as much as 5% this year on the face of strong worldwide demand. Besides, the upside in India is huge. Per capita consumption here is lowly, less than a kilo. Abroad, the usage levels are at least 20 fold higher. But then, when the chips are down, things can only look up! So the outlook is bright and sheeny if we can get the policy environment right to substantially step up aluminium output.

Hindalco is cash rich with strong balance-sheet numbers. It is known to be one of the more efficient, least-cost producers anywhere and with a focus on downstream, value-added products. It has been able to leverage its fast-paced topline and bottomline growth to take over Novelis, which incidentally has sales turnover almost 10 times larger in dollar terms. But then, Novelis is actually in the red and has mounting debts on its books.

And despite its strengths in high-margin, downstream products and large global marketshare estimated at 19%, it has had erosion in margins due to hardening aluminium prices. After the takeover, Hindalco would need to be pro-active and build upon the technological edge and the brand strength of Novelis to make innovative products and so stride the world stage as a truly integrated aluminium major. Novelis would need to access metal and ingots at more reasonable prices to put its finances on sounder footing. This requires stepped up production at Hindalco which calls for revision of royalty rates on bauxite ore and the ironing out of other policy glitches.

India has some of the best bauxite deposits in the world, rich in metal content and estimated at over 3 billion tonnes. But the norms on royalty, cess and other rates on bauxite mining have little changed over the years and remain at rock-bottom levels. The central rule is that the mineral royalty on bauxite accruing to the state would be 0.35% of LME aluminium metal price chargeable on the contained aluminium metal in ore produced. So the effective royalty on bauxite ore would be even lower than 0.35% of LME quotes. This is much too low.

Abroad, royalty rates at 5% of metal prices are an established standard. Now that domestic aluminium prices are very much linked to LME rates, there is no reason why those for royalty should remain an anachronism from the days of autarky, disregarding international prices. Also, given that domestic output would be a small fraction of the world total, ore prices surely need to reflect international scarcity value.

Proper pricing of ore and reasonable royalty rates would incentivise value-addition at home. Since much of the bauxite deposits are concentrated in Orissa, Jharkhand and Chattisgarh with high poverty ratios, revised rates would be welfare enhancing too if there is earmarking of the funds and channelling for the local development. Further, import duties on aluminium need to be no more than 5%, as already the case say for steel. Greater openness does pay.