Financing the Energy Transition – Critical Minerals Processing

Introduction

The transition to cleaner technologies such as solar and wind power, battery storage and electric vehicles has prompted a global surge in forecast demand for critical minerals over the coming years. 

The need to increase exploration, extraction and recycling of critical minerals is mostly understood. However, questions of the security of the wider critical mineral supply chain, product provenance and ESG credentials are coming to the forefront, in particular in light of new regulatory developments, including the EU's recent Batteries Regulation and proposed Critical Raw Materials Act.

Critical minerals need to be refined (often using highly complex processes) before they are fit for end use. Processing is currently dominated by a handful of countries. A recent survey by the International Energy Agency found that just three countries controlled between 80 – 99% of the processing of lithium, cobalt and rare earth elements, with China alone controlling 58% of lithium, 65% of cobalt and 87% of rare earth elements global processing capacity.¹

This imbalance creates a serious risk of supply chain bottlenecks, geopolitical risk and price volatility, which has prompted governments around the world to commit to increasing their domestic critical minerals processing capacity. This will create considerable opportunities for both debt and equity investment in new processing projects and technologies, with project finance expected to play a major role. 

In this briefing, we look at some of the key considerations for financing critical minerals processing projects.

"Green refining" and supply chain transparency

There is a clear trend towards "green" refining projects as ESG requirements and geopolitical risk mean that not all product is equal and price is not the only consideration. 

Critical minerals processing is usually very energy-intensive, especially where the underlying feedstock has a low mineral content, and can also require large volumes of water and produce hazardous waste. 

Processing companies are facing growing pressure from stakeholders to address these and various other environmental and social-related issues. Foremost among those stakeholders are the original equipment manufacturers (OEMs) and other end users, who are new entrants into the sector and are bringing a whole new set of commercial objectives to traditional offtake and financing transactions.

Important considerations for sponsors planning a "green" project will include:

• the potential to co-locate the refinery with, or otherwise obtain access to, renewable power sources. Examples include Vulcan Energy's lithium direct extraction and refinery project in Germany, which will primarily use its own geothermal energy to power operations, and Infinity Lithium's San Jose project in Spain, which proposes to use green hydrogen and other renewable power sources for its refinery
• the source of and the transport arrangements for the feedstock, and
• the treatment of waste from the processing operations

Sponsors will also need to be alive to the risk of overstating the project's green credentials, with the potential for litigation and regulatory action in respect of any perceived "green washing".

OEMs are themselves subject to increasingly onerous legislation on supply chain due diligence, such as the German Supply Chain Act (that came into force on 1 January 2023) and the EU Batteries Regulation (that came into force on 17 August 2023). These rules require ongoing monitoring and mitigation of ESG risks throughout critical minerals supply chains, including the processing stage. 

OEMs are also required to produce detailed information on the provenance and carbon footprint of each of their manufacturing inputs. To facilitate this, independent third party certifications, such as Initiative for Responsible Mining Assurance (IRMA) for mining companies, and block chain verification are expected to become the norm for processing companies. 

Requirements of this kind require significant access and information flows between processing companies and OEMs, as well as ongoing operational cooperation on ESG risks. In our experience, both groups are still coming to terms with the challenges – and mutual benefits – of this new relationship.

Sources of funding 

Significant investment will be required to meet the battery metals processing requirements of the European gigafactory build out, and further investment needed for the critical minerals required in other energy transition sectors.

There is potential for funding for processing projects from a variety of sources, including: 

• Government funding: governments are increasingly offering grants, subsidies, preferential loans, guarantees and other financial incentives to critical minerals projects which support their national industries, for example the UK government, through its £850 million Automotive Transformation Fund, has recently provided grant funding to Pensana and Green Lithium for the development of a rare earth elements refinery in Yorkshire and a lithium refinery in Teesside respectively
• Policy banks and ECAs: multilateral / policy banks such as the European Investment Bank (EIB) and export credit agencies (ECAs) such as UK Export Finance (UKEF), often alongside commercial banks, are able to offer a broad range of financial support for projects that meet their investment criteria, including loans, guarantees and direct equity investments. For example, the EIB (which has made loans to several European gigafactory projects in recent years, including Northvolt in Sweden and Umicore's gigafactory in Poland) has recently announced its intention to provide senior debt financing on a number of European processing projects, including Talga's Vittangi integrated graphite anode project in Sweden and Rock Tech's Guben lithium refinery project in Germany
• Commercial banks: there is a general trend for commercial banks to move away from financing traditional oil and gas projects and instead focus on supporting the energy transition, including critical minerals projects – projects that are also eligible for "green loan" or "sustainability linked loan" status will be particularly appealing financing opportunities 
• End users: end users of critical minerals products, such as OEMs (including car manufacturers and gigafactories) and energy companies, are entering into the upstream and midstream sectors as strategic investors to secure offtake of the "right" product for their supply chain. For example ACG (a London-listed company with the backing of (among others) Stellantis (owner of various car brands including Alfa Romeo, Chrysler, Fiat, Jeep, Maserati, Peugeot and Vauxhall) and Glencore) recently announced its agreement to acquire the Santa Rita (nickel sulphide) and Serrote (copper) mines in Brazil, with PowerCo (Volkswagen's battery arm) providing a US$100 million prepayment with respect to nickel produced by the Santa Rita mine
• Other industry participants: we are also seeing other industry participants with strong balance sheets looking to invest in the development of combined mining and processing projects with a view to benefitting from vertical integration. Examples include the joint venture between Albemarle and Mineral Resources for the development of a spodumene mine in Wodgina and a lithium hydroxide refinery at Kemerton, Western Australia and the earlier joint venture between SQM and Wesfarmers for the development of the Mt Holland lithium mine and lithium hydroxide processing facility at Kwinana, Western Australia  
• Private capital: private equity funds (such as French private equity firm InfraVia Capital Partners' "Critical Metals Fund", which aims to invest up to €2 billion in critical minerals supply chains across France and Europe) and other forms of private capital are another major financing source 
• Trading houses: commodity traders also see new opportunities to provide offtake-linked finance products to processing projects, with examples of announced agreements being Rock Tech (with Transamine), Green Lithium (with Trafigura) and Sigma Lithium (Glencore).

Financing considerations 

Feedstock supply

A key concern for any processing plant will be ensuring security of supply of feedstock. 

Processing projects which also own mines for the relevant feedstock are protected against supply risk in a market where long term supply contracts are currently uncommon. Vertically integrated projects are also better placed to manage feedstock price fluctuations, but are subject to "project-on-project" risk if the mine is being developed at the same time as the processing plant. 

For processing-only projects, investors and financiers will want to ensure (among other things): 

• there is a portfolio of suppliers to mitigate the risk of an individual supplier failing to deliver and, in the case of certain metals (such as copper and nickel), with the portfolio ideally including commodity traders, who in turn have multiple sources of supply of the relevant metals and can therefore potentially provide "swing capacity" to make up feedstock shortfalls on short notice
• all suppliers have a production track record (including with respect to quality of feedstock) and are subject to appropriate penalties for failing to supply
• the termination events under the supply contracts are limited and direct agreements are available for key supply contracts

The pricing mechanism for the feedstock will be another important consideration for processing-only projects, since the project will be exposed to a cost / revenue squeeze if price increases for the feedstock are not matched by increases in price for the processed product (as is sometimes seen). 

There are a number of ways to mitigate this potential pricing mismatch, including:

• pricing the feedstock based on its underlying mineral content and movements in the price for the processed product (rather than movements in the feedstock price)
• reducing the pricing time differential between purchase of feedstock and sale of processed product 
• a "cost plus" pricing approach (discussed further below), or
• using tolling arrangements under which the processing costs are passed through to the buyer

Sale of product

Certainty of revenue stream (through the sale of the processed product) is another key bankability consideration. 

Long-term offtake contracts featuring "take or pay" provisions, of the type traditionally favoured by lenders in the mining sector, are not currently widely available in the critical minerals processing market. OEMs have favoured short term supply agreements (or supply agreements which are subject to termination at short notice), an exception being where the OEMs purchase product as part of a broader investment package in the project.

In our view, if the project has a product supply agreement with a reputable, financially strong counterparty and there is a clear and firm commitment to take product and pay for it at designated times, then this may be sufficient from a bankability perspective without requiring the additional contractual overlay of "take or pay" protection. 

Further, if there is resistance from buyers to enter into long term product supply agreements, "evergreen" provisions can be included under which the relevant contract will rollover for a further term unless an extended period of notice is given by the buyer to terminate (that extended notice period would then give the processing company, as seller, time to arrange the sale of product to, and commence product qualification arrangements with, a substitute buyer).

Lenders will usually also wish to see downside protection in relation to the product price, so that the price achieved always supports the revenue assumptions in the financial model. This can be achieved in a number of ways:

• inclusion of a floor price: this prescribes a minimum price for the product payable by the buyer, but will in most cases be resisted by the buyer unless it is accompanied by a ceiling price (which would cap the price upside for the processing company / seller at levels which may be unattractive to sponsors) and may in any event be commercially difficult to obtain from certain types of buyers, such as OEMs 
• "cost plus" pricing: a form of floor can be achieved where the price is a function of variable cost (feedstock) and fixed cost, plus a margin for the seller. The seller retains the risk attached to the fixed cost element, which will often include significant items such as power cost. However, the seller can seek to mitigate this risk by including a mechanism for periodic review of the fixed cost (or specific elements of the fixed cost) or entering into hedging arrangements in respect of certain fixed cost elements (power cost being an example)
• tolling arrangements: these can provide for processing and certain other costs to be passed on to the buyer and a tolling fee to be charged to the buyer

As with feedstock supply contracts, lenders will want the termination events under the product sale agreements to be as limited as possible, and may also require direct agreements for key offtake contracts.

Qualification of product

Buyers will typically require that the processed product go through a series of qualification tests before fully committing to purchase on extended contractual terms. These tests can include matters which are outside the processing company's control, are described only vaguely, and will take an extended period to satisfy. If the product does not satisfy the relevant tests, the consequence can be rejection of product and early termination of the offtake contract.

Having robust technical solutions is the best protection against these risks, but the processing company should also aim to ensure that the qualification tests are as objective (and of short duration) as possible, with appropriate remedy periods for failure to satisfy the tests. 

Product which does not meet the required specification (e.g. battery grade) will most likely be able to be sold as a lower grade material, which should be taken into account in the project cashflows for the purposes of the financial model.

Construction

From a bankability perspective, the construction contracting strategy for the processing plant should:

• be coherent and as straight forward as possible – while a "turn key" EPC contract with single point responsibility will be the preferred arrangement from the lenders' perspective, this is usually not economically efficient (or feasible from a technical perspective). It is not uncommon for processing projects to involve a disaggregated contracting strategy with multiple contractors. The greater complexity arising from this disaggregation is likely to bring increased focus on completion support (including contingent equity / threshold cost)
• have clearly assigned responsibilities and a fully integrated project-wide programme, and avoid unnecessary division of work in order to minimise interfaces and reduce risk of "gaps" in responsibility
• provide a high degree of overall pricing and programme certainty within the envelope of committed funding and project contingencies (e.g. building in time buffers into the project timetable and budget allowances for additional expenditure)
• be overseen by a high-quality and experienced procurement, project and contract management team 
• be supported by a robust insurance programme (which has been scrutinised by the lenders' insurance adviser) addressing the financial impact of risks retained by the project company, including defects and delay in start-up

Use of technology

Lenders (through their technical and market advisers) will want to make sure that the project's chosen processing technology is appropriate, taking into account, among other things, the type (and quality) of feedstock, the processed products produced by the plant, alternative technologies available in the market (for both the processing operations and the relevant manufactured end products) and any product recycling requirements.

Where the proposed processing technology is new (or is established technology that is being used in an innovative manner), conformity to local industry standards and regulations will be an important consideration. In these circumstances, contractors may also be reluctant to accept strict fitness for purpose obligations and may seek additional exclusions from liability (including regarding performance guarantees) or, possibly, lower than usual caps on liability.

By-products

The by-products from the processing operations can be an additional revenue stream for processing companies if there is a market for them. For example, gypsum, which is one of the by-products from the lithium hydroxide production process, is used widely in the construction industry in cement and plaster products. 

Perhaps just as significantly, the sale of by-products can also be a useful way for processing companies to demonstrate their green credentials (e.g. in relation to the disposal of waste).

Future expansion

Sponsors may look to expand the project's processing capacity in the future by adding additional processing lines or "trains", as this can sometimes significantly improve a project's IRR for a comparatively lesser cost. 

Where expansion is contemplated day-one, the finance documents may include in-built accordion arrangements or permitted financial indebtedness for this purpose. Lender consent will be required, and before giving approval, lenders will want to be satisfied the original plant is performing (and has established a firm track record) and the financial ratios will not be adversely impacted by the expansion.

We have considerable experience advising on projects across the critical minerals value chain. If there are any points in this article you would like to discuss, please feel free to get in touch with any of the key contacts below.

For more information on financing the energy transition, see our previous articles in this series on smart meters and battery storage.

1. International Energy Agency "The Role of Critical Minerals in Clean Energy Transitions" March 2022.

A version of this article also features in Project Finance International, attributed to partners Helen Beatty and David Walton, and senior associate Thomas Papworth. Helen Beatty and Thomas Papworth were also quoted in Global Trade Review's article 'Before the white gold rush', which discusses how banks, corporates and governments worldwide are responding to the need for financing as the critical minerals sector develops.