Production-linked lending has become a staple of mining finance – particularly for base and precious metals. The two dominant production linked models are often described as "Royalty" arrangements and "Streaming" arrangements.
The origin of the Royalty goes back centuries,1 but emerged as a method of private finance in the 1980s. The origin of the Streaming arrangement is much more recent, with the earliest deals emerging in the 2000s2.
Royalty and Streaming finance has been popular in Canada for many years now but we are seeing an increased interest for royalty and streaming solutions in the UK through UK-listed investors such as Anglo-Pacific Group and Trident Royalties. Vancouver-based Wheaton Precious Metals also recently completed its third listing on the London Stock Exchange, in addition to listings on the New York and Toronto stock exchanges.
What is a Royalty?
The earliest Royalties date from medieval Europe and involved the delivery of a portion of the mined mineral or a payment to a landlord and/or sovereign in return for the granting of mining rights. This concept was later adapted by the private sector whereby those with a mining right sometimes retained a contractual right to a Royalty upon selling or transferring an interest in that mining right to a third party.
The term 'Royalty' is still used in this sense – many nations rich in natural resources collect a royalty from international mining companies in return for exploration rights. Ghana's state gold producer, Agyapa Royalties, receives approximately 76% of the Royalties at Ghana's largest mines3.
The concept of the Royalty has been adapted to provide mining finance, and it is this 'Royalty' that we are focusing on. Under a simple Royalty finance arrangement, a funder (or 'Royalty holder') provides financing by way of lump sum payments to the mining company (or 'grantor') in return for periodic payments based on the production of mined minerals. The right to the periodic payments constitute the Royalty. Such Royalties can be structured in a variety of ways:
- The Royalty is likely to last over a long period (potentially up to the life of the mine). Depending on the jurisdiction in which the mine is located and the specific terms of the arrangement, the Royalty holder may also gain an 'interest' in the land on which the mine sits, binding future purchasers of the mine to the Royalty holder's Royalty interest. Such Royalties are said to 'run with the land', which gives the Royalty holder added protection compared to a purely contractual royalty between the Royalty holder and the grantor (which does not run with the land).
- The Royalty may be capped in value.
- The Royalty can be secured over the mining assets, or be unsecured.
- The Royalty may be guaranteed by the operating company's holding company and/or ultimate parent.
Royalties are flexible. They can be adapted to replace or sit alongside many other sorts of capital raise. They have been used in place of early equity investments to fund exploration, project financings during the construction phase, and working capital facilities during the operational life of a mine. Consequently, there is no market standard deal, with Royalties being bespoke to each grantor. Gowling WLG has experience across a wide variety of Royalty deals and can help you create a bespoke finance package to achieve your goals.
The way that the amount of the Royalty is contractually calculated can vary. Some of the most common include the following:
- 'Unit Royalty': the Royalty payment is based on the price per unit (e.g. $ per KG) the grantor achieves in the open market or under offtake agreements, without accounting for costs.
- 'Gross Royalty': payments are based on a percentage of gross sales revenues.
- 'Net Smelter Returns Royalty': this is similar to a Gross Royalty, but is based on the 'net smelter return' achieved by the grantor through sales revenues, with certain deductions allowed for production costs such as transportation and refining costs.
- 'Net Profit Interest Royalty': this goes one step further than a Gross Royalty, with payments based on the profits achieved by the grantor in selling the minerals. This is less attractive to both parties as it is based on the actual profitability of the mine and places higher administrative burdens on the Royalty holder.
Common terms include: reporting obligations, site visits, comingling (if relevant), operational covenants, confidentiality, events of default, transfer provisions and rights of first refusal. We can help you strike a balance between your needs and those of the Royalty holder.
Why is a Royalty agreement useful?
As an alternative to equity or traditional debt funding, there can be benefits for a mining company in raising capital by way of Royalty:
- Unlike equity funding, there is typically no dilution in ownership or control.
- A Royalty often carries less regulation than equity funding - so can be cheaper and faster.
- Unlike debt funding, the obligation to make Royalty payments typically only begins once production has started and the business is cash-generative – although hybrid arrangements may apply such that this is not always the case.
- The covenant and default package achieved is often less onerous than in debt funding as the Royalty holder typically requires less control than a bank.
- Raising capital by way of Royalty can leave the door open for future capital raises.
There are, however, drawbacks which need to be taken into consideration too, including:
- Pricing is usually more expensive than traditional debt finance.
- Royalties can dilute the net present value of a mine, making the mine less attractive to purchasers.
- There can be an administrative burden in calculating the periodic Royalty payments, and there is potentially greater scope for disputes over how these calculations have been made.
- The Royalty financing market is quite small.
Streaming arrangements involve the forward-purchase of the minerals produced, rather than payments based on production metrics. The arrangement is often for a by-product of the mining operation, rather than the main mineral being produced (which could also be subject to a Royalty), but can be for the main mineral.
In return for the up-front payment (the 'deposit'), the grantor agrees to sell, and the purchaser agrees to purchase, in the future, a specific percentage of the minerals produced for a fixed price (the 'stream'). The fixed price will likely be below market price at the time of execution. 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.
Like Royalties, Streaming arrangements may be secured and / or guaranteed. The nature of the security for both Streams and Royalties will depend on the jurisdiction in which the mining assets are located.
Streaming arrangements have similar advantages to Royalties:
- Streams are useful during mine development as the grantor can monetise deposits in advance of production.
- The terms of the arrangement are typically less restrictive than traditional debt-finance.
- There is typically no dilution in ownership or control.
- The agreement is usually less onerous than in debt funding, with the grantor retaining more control over operations.
Streaming arrangements also have certain advantages over Royalties:
- Unlike Royalties, the grantor does not usually have to apply revenue towards re-paying the deposit once the mine is cash-generative.
- The difference between the fixed price and market price is typically credited towards repayment of the deposit, thereby reducing the principal amount.
Pricing is a key risk in Streaming arrangements – if the grantor agrees to a fixed price that is too low it will fail to benefit from any increase in the market value. As such, Streaming agreements often contain buyback options for the grantor.
Having inherently similar risk sharing and other characteristics to Islamic Istisna'a or forward leasing structures, Streaming and Royalty arrangements lend themselves to Sharia'a compliant structures – potentially opening another source of capital for mining companies.
Production-linked loans - a new way?
Gowling WLG, led by project finance partners Andrew Newbery and Nath Curtis, recently acted for AIM-listed Bushveld Minerals on a new deal structure: a US$30m Production Financing Agreement ('PFA').
The PFA is structured as a US$30m non-revolving term loan facility but bears little resemblance with typical debt-finance agreements. Interest is calculated by reference to the production of vanadium at Bushveld's South African mine – not by reference to a base rate and margin. Repayment amounts are calculated using both a gross revenue rate and a unit rate. These production-linked payments are then applied towards repayment of the principal amount and interest payments.
The PFA was paired with a US$35m Convertible Loan Note under which the lender can make an equity investment. Gowling WLG corporate partner and Head of Natural Resources (UK), Charles Bond, led on the equity investment.
Andrew Newbery said of this new approach: "Royalty and Streaming financing models have become a staple for Gowling WLG's mining clients over the last few years. Bushveld's Production Financing Agreement is another innovative example of how we've helped our clients to raise long term capital".
Another example of our structuring advice on production-linked mining loans is the work we undertook advising Bacanora on the development of its Sonora lithium project in Mexico4. The Sonora facilities were structured as two separate Eurobonds. One bond had an interest rate reference to LIBOR whilst the second had a 20-year term repayable by reference to monthly production of lithium at an agreed US$ rate per tonne of lithium produced.
1. Early medieval royalties date from the 12th century Holy Roman Empire - local bishops granted mining rights to syndicates of miners from across Europe in return for a 'tribute', being a portion of the metals mined. This adapted over the centuries into a sovereign's participation in the profits of exploration. For example, King Phillip II of Spain granted sovereign exploration rights by decree on 10 January 1559 in return for a 'royalty' of 66.66% of net profits resulting from the exploration.
2. The earliest streaming agreements are usually attributed to the financings of Franco Nevada, Silver Wheaton and Royal Gold in the early/mid 2000s.
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