Streaming, royalty agreements novel alternative funding structures for coal juniors

CAPE TOWN (miningweekly.com) – Streaming and royalty agreements are novel financing structures that are useful in medium-risk environments, says legal services provider Strata Legal director Brandon Irsigler.

Speaking at the IHS Markit South African Coal Export Conference, in Cape Town, on Friday, he highlighted royalty and streaming agreements as two possibilities for alternative funding structures, as opposed to the traditional funding mechanisms of equity, debt and joint venture agreements that are available to junior miners.

He explained that royalty agreements and streaming are contractual payments that are usually unsecured, but quickly implemented and negotiated, with the investor entitled to a percentage of the produced product.

“Streaming agreements unlock value in South Africa because they are not particularly concerned with equity investments and the Mining Charter,” Irsigler argued, noting that the streamer investment is not concerned with who holds what equity, and “is not terribly concerned with formal debt problems or shareholder disputes”.

As these deals care only about the operating asset, that somewhat removes them from the charter debate, the equity debate and empowerment issues, he added.

Irsigler further noted that streaming and royalty agreements allow for people to come into an operation quickly and insulates them, to some extent, from those issues that more formal investors have to look at.

In terms of royalty agreements, the finance provider will provide a single, one-off, upfront payment as a mine has entered production or has proven itself through a production phase.

Through this agreement the funder or investor is entitled to receive royalty payments, not dividends, over a set period of time, which can be over a fixed period, or over the life of the mine.

Notably, the agreements are contractual, which means the agreement can be tailored to suit both parties, Irsigler suggested.

Of key significance to Irsigler is streaming agreements, which he explained involved the funder paying an upfront payment in advance of production. The agreement entails a series, or stream, of payments for which the investor is paid a percentage of the company’s production at an agreed benchmark spot price.

Advantages of the agreement to miners include a speedy execution, while the upfront payment is not typically tied to the “use of funds” restrictions. There are also few loan covenants and obligations, looser force majeure provisions, while traditionally no real security is offered.

Advantages to the investor include fast deal execution, access to a physical product, price arbitrage and delivery certainty. Further, there are no capital calls on equity or dividend insecurity.

Streamers and royalty investors can participate in three phases – in greenfield projects, current operations and during business rescue.

Irsigler highlighted that, in terms of streaming, less funds are risked by an investor at any one time, while having “the commodity in hand and arbitrage that value”.

“Notably, the interests of the investor and miner are more aligned than with formal, traditional funding,” he added, noting that investors understand the mining industry more.

Meanwhile, Thebe Investment Corporation independent power producer project manager Johan Bester pointed out that while South Africa was one of the richest countries in terms of mineral reserves and deposits, most of the assets would stay in the ground because there is no new money coming into the mining industry.

He noted that, in terms of new project funding, there were various diverse mechanisms that could be used, such as benefits of contract mining, the use of beneficiation services, legal accessing of the mine rehabilitation funds, agreements with coal traders, as well as using the tax structures of Section 12J of the Income Tax Act.

Although many contractors saw margins squeezed, there has been an increase in mines using contract mining for underground and opencast mining operations, as the contract miner brings labour, equipment and if the partnership works well, the contractor also brings expertise and efficiencies.

Further, with increasingly dwindling and more challenging coal qualities, coal washing and processing services have become a strategic advantage in the market, Bester said.

Bester also highlighted the advantages of the tax structures of Section 12J of the Income Tax Act.

“These structures can be used by exploration companies but they are ideal for junior mining companies that have developed their projects to a bankable feasibility stage and have the relevant licences in place, but require sufficient equity to close their project funding requirements,” he told delegates.

He added that the scheme, in existence since 2009, had been tweaked to such an extent over the past year or two, that there had now been a significant uptake, with about R7-billion apparently raised in terms of 12J structures.

“Particularly for the junior mining sector, the value of the entity that is invested in, once the investment has been made, has to be less than R500-million,” he explained, suggesting that the government has focused on using this tax structure for junior miners.

The Section 12J will be phased out by June 30, 2021, 12 years after its launch.

Meanwhile, MX Mining Capital Advisors director Dr Mike Seeger said that, while there was a growing anti-coal lobby, coal is required as a baseload power source. Despite the negative sentiments towards coal, projected figures show that several million additional tonnes of capacity will have to be financed.

He acknowledged that some financial institutions did not want to finance coal projects and that larger coal companies were diversifying, stressing the focus on alternative types and sources of coal mining finance.

In setting out the practicalities and challenges of coal mining project funding by exploring several case studies, he said project finance has limited scope. The other more traditional forms of financing each have challenges and successes.

In his opinion, equity finance is scarce in coal mining, although there are contrarian investors and coal miners seeking expansion that look at the equity component. Listing is a good method for securing financing but can be challenging, while development finance institutions are moving outside of coal. Engineering, procurement and construction finance, for example, focuses on long-term contracts.

“It is all about offtake and vendor finance – that is really what the coal miner should focus on,” he said.