Juniors asked to consider royalty, streaming project finance deals

JUNIOR coal mining firms were urged to get creative in securing project finance amid concerns at this year’s South African Coal Export conference in Cape Town that there was an “investment drought” in the sector.

Traditional forms of funding for junior and mid-tier mining companies, such as equity, debt and joint venture structures, were steadily become harder to arrange and secure, delegates heard. This was chiefly the result of coal’s price volatility, domestic grade concerns, and the green lobby.

“Banks aren’t really interested in coal mines anymore, because coal is no longer sexy,” said MX Mining Capital Advisors director Mike Seeger. “Also, some of the big miners, such as Rio Tinto, are diversifying out of coal. Equity finance is fairly scarce in the coal business, and the only ones really interested are the contrarian investors,” he said.

Enter the new breed of offtake-linked and vendor financing by means of streaming and royalty agreements. “There is a growing sense that debt finance and mining don’t mesh,” said Strata Legal director, Brandon Irsigler.

“For juniors and mid-tier miners, it’s getting more difficult to secure cash. In contrast, royalty and streaming agreements involve a sequence of payments, so not a lot of money is risked at one time,” said Irsigler. “It is more in the interest of the lender and the operator than formal lending mechanisms.”

A royalty-based finance scheme sees an investor providing a single, once-off upfront payment, which is normally made as the mine first starts producing and is usually used as capital expenditure. The investor is entitled to receive royalty payments tailored to both parties and based on a bespoke formula that is based on turnover and production.

Simply put, a streaming agreement is one in which an investor agrees to purchase a percentage of the company’s future production at a benchmark spot price – sometimes below market value. The production is paid for through a sequence of payments to the producer, which means the miner can rely on a steady stream of funding, thus monetising future production.

As it is a sequential payment system, it is a more reliable long-term form of financing and it attracts investors with a higher risk appetite than banks. Investors – typically venture capital companies (VCCs) – are also able to make decisions more rapidly than traditional banks, which are beholden to protracted debt approval processes. There are also fewer loan covenants and looser force majeur provisions.

This does however comes at a cost because foreign “streamers” – as Irsigler called them – demand a higher return on investment than the big lenders.

Said Irsigler: “In streaming, the interests of the miner and the investor are more aligned. Banks want their interest regardless of the level of production. As streamers receive value through production, they are more invested in the operational success of the mine.

“It’s also easier for the miner to honour the obligation. If, for example, an agreement is to provide 30% of the run-of-mine (ROM) for that month to the investor, even if the ROM levels for the month are low, the miner is not in breach of contract,” he said.

This funding model is particularly applicable to South Africa, as streamers are not concerned with equity and are thus less deterred by domestic legislative flux.

The streaming model can also be successfully used by existing coal producers wishing to supplement their production over the medium-term, as it guarantees fairly stable production and pricing mechanism. It is especially useful if the mining company looking to invest through a streaming agreement has superior access to logistics network and processing capacity.

“Streaming provides the investor access to the physical product, price arbitrage and delivery certainty,” said Irsigler.