In today’s market conditions where banks remain “very selective” and equity valuations are volatile, resource companies may be well served to seek to generate competitive tension amongst their capital providers by considering alternatives to traditional bank loans, equity and convertible debt.
Structured commodity finance is a collective description given to various methods of funding the pre-production of, or providing working capital for, natural resource projects by tying the production of resources to repayment obligations.
The market for such funding methods has been an increasingly active and useful alternative to traditional finance over the last few years, particularly as the purchasers of natural resources have become frequent providers of such capital.
Purchasers ranging from state-owned enterprises, to utilities and trading companies such as Nobel Group and MRI/CWT have demonstrated the willingness to secure future off-take of commodities by paying upfront, and often taking on considerable pre-production risk in the meantime.
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- The producer is a company with a project that is up and running or potentially as early as in pre-bank feasibility study stage. The producer requires capital to invest in infrastructure and capital expenditure or provide working capital.
- The trader is a company that is interested chiefly in taking delivery of some or all of the project’s output and is willing to provide the capital to obtain the future off-take.
- The parties enter into an agreement whereby the producer receives a “prepayment” and undertakes to deliver over a specified period (usually one or two years) a minimum amount of production.
- Product deliveries are set to be sufficient to amortise the prepayment, usually by requiring more product to be delivered than the expected spot market prices would suggest necessary. If during a period the value of the product delivered is more than required to amortise that portion of the prepayment, the trader pays the producer for the additional product at pre-agreed discount to the spot price.
Other structures may be used to suit the particular producer or the project. For example, if the product requires refining and the producer wishes to retain some exposure to the refined product’s spot market price, an off-balance structure could be put into place that might appear as follows:
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- The trader/financier agrees to purchase or prepay for the delivery of some portion of the project’s product at the refinery gate on an on-going basis.
- The trader/financier contracts with the processor to refine the raw product into its market-ready form.
- The trader/financier then sells some portion of the resulting refined product back to the producer (or more likely markets that portion on behalf of the producer) and sells the rest to the market on its own account.
Going one step further, the transaction could be structured in advance to allow the trader to refinance its prepayment on a limited recourse basis once production is achieved. The bank would take an equitable assignment over the trader’s contractual rights with the producer and require a payment account to be secured in its favour.
Traders often seek to enter into marketing contracts with producers. They generally prefer exclusive rights to bring the product to market to avoid competing with the producer in the market.
Traders may also be convinced to take small equity stakes in a producer, however most trading companies do not want to be long-term shareholders, preferring to use their capital to trade. That being said, Japanese and Chinese trading companies have been seen to prefer just such a long term shareholding, with the Chinese perhaps preferring larger stakes as well as being interested in learning operational lessons.