Generally 

In this current market where raising capital is difficult, particularly for bulk commodity projects requiring significant capital to fund infrastructure development, the entry into of off-take agreements ahead of production can represent a key component in developing a funding structure for such projects.

The off-take agreement can perform a number of functions, namely:

  1. provide comfort to the project lenders and other participants that the product is capable of being sold;
  2. provide a method by which a project sponsor can receive an upfront payment to assist in the funding of the project either from the sale of the off-take rights or via a prepayment for ore to be produced in the future;
  3. provide a basis on which equity participants can support project development where the off-take party provides a form of security for payment for the off-take; and
  4. provide credibility to the project, should the project be in a jurisdiction which is not known to have a mining culture.

Ultimately though, the off-take agreement must have financial credibility if it is to be of any value to the mining company. The commitment of the off-take will result in the project being less appealing to a range of potential project investors, usually industry participants, given they themselves invest in project developments to secure the off-take rights.

We have seen over the recent past, the eagerness of the Chinese to get involved in projects in order to secure their raw material supply chain. This is consistent with stated China policy on resource security and otherwise moving China’s dependency away from BHP, Rio and Vale as the source of iron ore for example. Therefore, there has been some competitiveness in the market to secure off-take.+

Trading companies have been active participants in the market to obtain off-take. Some are already well established in iron ore while others have been striving to secure their entry and so they have been courting potential iron ore producers in order to secure their off-take in advance of project development.

In negotiating the off-take, the focus should be on price and the adjustments for impurities. When negotiated in the early stages of development, these factors require the parties to be flexible, given there will not have been close spaced drilling of the deposit, to ensure a predictable mine grade. At such a point in time, the variability of the ore body is not that well known and so agreeing to tight perimeters around grade and impurities, creates risk for the mining company. 

Another key factor to consider when entering into off-take agreements at an early stage is knowing what level of production can be committed to the off-taker. Invariably for the off-take agreement to have value there needs to be a commitment to take a particular quantity and a financial consequence for not doing so. This has a down side in that if the mining company fails to produce the contracted quantity then it is in breach and as such will expose itself to damages.

Finally, for the off-take agreement to be valuable, the off-taker needs to provide some form of financial security to the mining company to support the agreement to acquire production. The mere commitment to acquire iron ore without there being certainty around payment devalues the commitment and as such, this will have implications for the project financing as the banks will invariably focus on the ability of the off-taker to pay for its purchase as the failure to pay will expose the mining company to default under their project facility.

Recent Agreement

Sundance Resources Ltd (Sundance) through its subsidiary companies Cam Iron SA and Congo Iron SA recently announced their entry into off-take agreements with Noble International Resources Pte Ltd (Noble International) with respect to their first 10 years of total production out of the proposed Mbalam Project in the Republics of Cameroon and Congo.

Some of the key issues identified above were the subject of detailed negotiation in order to ensure a balance between the commitment of Noble International as the off-taker and trader and the need for certainty and security which will assist Sundance to finance the Mbalam Project, a project requiring something in the order of $4.5B to develop.

Key features of these Iron Ore off-take agreements are:

  1. the off-take agreements are for a defined term and they commit all of the production to Noble International, subject to the subsidiaries having the right to clawback up to 50% of the production in order to make it available to parties that wish to invest equity in the Mbalam Project;
  2. the payments due under the off-take agreements are supported by advance payments from the off-taker, a parent guarantee and other potential credit support;
  3. the price is referenced to the Platts index with negotiated adjustments for impurities.  These negotiations focussed on the likely impurity levels identified in the feasibility study, with flexibility to take account of the level of impurities encountered through detailed mine planning and drilling; and
  4. Noble International taking the product, credit and shipping risk.

With the advent of commodities being priced to an index such as Platts, the mining company is exposed to the true market price for the commodity it is producing. Therefore, in negotiating the off-take, the mining company needs to identify the various risks it is facing and either accept those risks in order to maximise its return or trade off some of those risks for an adjustment in the return.