Alternative methods of financing mining projects received renewed attention during 2020 as commodity prices rose, with royalties and streams becoming ever more popular.
Royalty and streaming finance has been used in the North American markets for many years, but we are now seeing growing interest in royalties and streams from investors in London. 2020 saw Wheaton Precious Metals (LSE: WPM) join Anglo-Pacific Group plc (LSE: APF) and Trident Royalties (LSE: TRR) on the London Stock Exchange. Such companies have a strong track record of investing in Africa, typically in precious metals but increasingly in base and battery metals. In addition to these public companies which give access to a broad range of investors, there are also a growing number of private royalty and streaming funds to which mining companies turn, such as Orion Resource Partners and Sprott Resource Lending. Private debt funds are also increasingly providing borrowers with more standard term loans and project finance facilities.
Royalty and streaming groups make an attractive investment for institutional investors who are looking for strong returns during a time of record-low interest rates. Investors do not have to invest directly into the mining company but can take advantage of potential upside and income generation from a portfolio of mining projects. These vehicles are contributing to the increased investment in African mining from investors without historic exposure to the metals and mining markets in Africa. We saw this trend improve during 2020 given the renewed focus on African precious metals thanks to rising commodity prices, and we expect it to extend to African base and battery metals as nations move towards renewable sources of energy.
All of this presents junior and mid-tier miners across Africa with a renewed opportunity to access the capital necessary to adapt to the rapidly changing landscape without diluting existing shareholdings or increasing leverage. In this article, we explore exactly what royalties and streams are, and assess why miners should consider them as part of their capital structure
Royalties involve the financier (or "royalty holder") purchasing a right to a percentage of the future revenues of a mine (the "royalty") from the miner (or "Grantor") in return for an upfront payment. This concept is not uncommon and has been used for several decades now - it differs from the royalties (essentially taxes) collected by sovereign governments in return for mining rights.
Royalties are an excellent source of development capital for junior miners because, unlike debt funding, repayments typically only begin once production has started and the business is cash-generative. This upfront capital is available for the development of the mine without the need to immediately service debt.
The most common royalty structures are:
- Unit Royalty
- Payments based on "price per unit" the Grantor achieves in the open market or under offtake agreements, without accounting for costs
- Gross Royalty
- Payments based on a percentage of the Grantor's gross sales revenues
- Net Smelter Returns Royalty
- Payments based on the "net smelter return" achieved by the Grantor through sales revenues, allowing for certain deductions (e.g. production costs)
- Net Profit Interest Royalty
- Payments based on the profits achieved by the Grantor
Deal structures can include several royalties and calculating the royalty payments is a complex process. This increases the risk of the parties disputing royalty calculations. A well-drafted calculation clause will reduce the risk of calculation disputes, but the parties should also ensure that the disputes clause of an agreement is properly considered and drafted. Arbitration is commonly used to settle royalty disputes and the parties should consider aspects such as the seat of arbitration and the arbitration rules.
Royalty agreements are usually governed under English or Canadian law, but it is crucial to retain local African counsel to consider the tax and regulatory requirements of the local jurisdiction. Royalty investments are said to be "life of mine" which, depending on the mine's jurisdiction, may create an "interest" in the land for the royalty holder, binding future purchasers of the mine to this interest. Such Royalties are said to "run with the land".
Covenants and security
Historically, royalties were covenant-lite and unsecured, but royalty companies are increasingly requiring stricter covenant packages and broader security nets, especially in the new ESG environment. Grantors should take legal advice on the scope of the covenants and security granted.
Where Grantors have existing bank financing facilities as part of their group funding, then the covenants should match any covenants given to those banks to avoid creating a cross-default under the banking documents by breaching the royalty covenants. Even where there are no group-level banking facilities, care should be taken to avoid an overly strict covenant package which could deter future bank lending or necessitate a future bank lending on similar or stricter terms.
If the security granted is to match existing lender(s)'s security then careful negotiation of an intercreditor agreement will be necessary and must be factored in from the outset of the royalty. In the absence of bank debt Grantors will need to consider the scope of any security, which may deter future bank lending or require additional security be granted to the bank(s). The royalty agreement also ought to include a mechanism by which the royalty holder is obliged to use reasonable endeavours to agree an intercreditor agreement with future banks.
The events of 2020 accelerated the adoption of ESG principles, with countries and companies across the globe committing to net-zero agendas and improving equality between citizens. The major royalty and streaming companies have strong ESG credentials and consequently this forms a major part of their due.
diligence processes. Much like broader finance documentation, royalty and streaming agreements increasingly include ESG commitments and covenants.
Streaming agreements are long-term purchase contracts whereby the streaming company (or "streamer") agrees to purchase minerals from the Grantor in return for an upfront payment (the "deposit") and future payments on delivery of the minerals. The agreement will set a strike price for the minerals at which the streamer agrees to purchase the minerals in the future, which will likely be below the spot price for the mineral.
Streaming allows the Grantor to monetise minerals in advance of production to gain access to much needed capital on deposit and gives it certainty of funds for future production. The Grantor also gains a valuable partner in the streamer who shares in some of the production risk and, because streams often deal with the by-product of a mine's core operation, a partner with expertise in that non-core mineral.
Some streamers are also willing to make pre-feasibility study investments in mines. So called "framework streams" can front approximately 10% of the deposit to finance the early development work and reduce the amount of equity finance required. This can be a useful source of exploration finance for miners across Africa, particularly given the reduced exploration budgets following COVID-19. S&P Market Intelligence estimates that Africa's exploration budget fell by 10% in 2020, representing a drop of US$111.2M from 2019. Exploration budgets for junior miners in particular declined by 7% (US$21.4M). Gold exploration still makes up most of Africa's budget at US$590M, but this is 4% (US$25.9M) lower than gold's exploration budget for 2019.
A key difference between streams and royalties is that the Grantor repays using minerals - the Grantor may be required to physically deliver the minerals to the funder, but the sale is more commonly credited to the funder's metal account at a recognised metals market, such as the London Metals Exchange. This is a key advantage over royalties - the Grantor doesn't have to apply revenue once the mine is cash-generative towards repaying the deposit as investors accept physical deliveries.
Like royalties, streaming arrangements may be secured or unsecured and the same considerations detailed earlier will need to be considered.
Pricing is a key commercial risk in streaming arrangements - if the Grantor agrees to a fixed price that is too low it will fail to benefit from substantial increases in the market value of the mineral. This can be mitigated with buyback options for the Grantor.
An innovative alternative to royalty and streaming finance are debt-instruments with repayment schedules linked to the mine's production. Gowling WLG has recently been involved in two production-linked financings: a US$30M term loan facility for Bushveld Minerals (AIM: BMN) and a US$56M Eurobond for Bacanora (LSE: BCN). Repayments on Bushveld's term loan are calculated using a gross revenue rate and a unit rate linked to the production of vanadium at Bushveld's South African mine, not by reference to a base rate and margin. Bacanora's Eurobond has a 20-year term and is repayable at an agreed US-dollar rate per tonne of lithium produced monthly.
These structures are an interesting hybrid between royalties and bank debt, and we see them as having potential use for mining projects across Africa, in particular once the industry standard base rate (US dollar LIBOR) is phased out by mid-2023. It will be replaced by the Secured Overnight Funding Rate (SOFR) but we see this as a good opportunity to adopt production metrics as a base rate.
Given the long-term nature of royalty and streaming investments, alternative financiers conduct extensive due diligence to ensure they are investing in "management proof assets". That is, assets of such high quality that they can withstand multiple changes of management over the life of the mine. Predictably, COVID-19 has made such due diligence harder (particularly with regards to site visits and management negotiations). Several alternative financing deals have however closed during the pandemic. As things slowly return to relative normality, we expect to see deal volume in this area increase again.
Royalties, streams and other production-linked financings offer junior miners across the mining sector an attractive source of capital. 2020 has solidified the role of royalty and streaming companies in financing junior and mid-tier miners and saw these investors start to diversify their interests away from precious metals. The rising demand for sources of renewable energy and the widespread adoption of electric vehicles are already pushing up demand for base and battery metals - the price of cobalt on the London Metals Exchange has risen steadily throughout January 2021, peaking at almost US$38,000 per tonne in mid-January. We expect royalty and streaming finance to become increasingly important for financing base and battery metal mines across Africa in the years to come, as well as maintaining an important role in the