Beneath the Surface: Royalties and Streams – What You Need to Know

While streaming and royalty agreements are well-established instruments in traditional mining jurisdictions, a constrained market for senior bank debt, lacklustre equity markets and an accelerated demand to develop and secure supply of critical minerals as part of the energy transition mean they have increasingly become prevalent in the capital stack, particularly of junior miners. The prevalence of these sources of finance is encouraging new participants in the market and resulting in further developments of some areas of market practice.

This article looks at recent trends, including in relation to intercreditor principles, protection of financier rights and new participants in the market.

1. New providers and opportunities

1.1 Growth in investors

Initially, streams and royalties were limited to precious metals such as gold and silver and were frequently used solely to monetise mine by-products to raise funding for project development. The most significant providers of stream and royalty finance were mostly North American companies such Franco-Nevada, Wheaton Precious Metals and Royal Gold.

As the market for royalty and stream financing evolved, private capital funds such as Red Kite, Orion Resource Partners, Resource Capital Funds and Appian, as well as listed entities including Osisko Gold Royalties, Triple Flag, Sandstorm Gold and Elemental Altus Royalties, began seeking de-risked commodity linked returns for investors by providing streams and royalty finance amongst their product offerings.

Streams and royalties offer significant flexibility for mining companies. They allow for upfront financing which can be used to fund greenfield development or project expansion and are less dilutive than equity. They offer better cashflow alignment than debt, as returns to the credit provider are linked to production, rather than an inflexible schedule of principal and interest repayments which may not match the realities of production.

Whilst some market documentation conventions can be recognised, there are no universally applicable terms for stream and royalty financings. Terms can vary according to the stage of project development, perceived project risk, the size of the financial accommodation and other factors.

1.2 Demand for minerals driven by the energy transition

Stream and royalty instruments are no longer restricted to specialist financial institutions and are being used by a number of market participants who are entering metal markets directly to acquire metals for their business needs and provide much needed funding for greenfield development and expansion.

The Minerals Council of Australia has estimated that more than 260 new lithium, cobalt, nickel and copper mines will be needed to meet global demand by 2030 with investment in mining required to double by 2050 to meet demand for green technology.

Examples of where streams and royalties have been provided by less traditional entities include:

• Original equipment manufacturers (OEMs):

End users of critical minerals products, such as OEMs and energy companies, are entering into the upstream and midstream sectors as strategic investors to secure offtake of the products required for their supply chains.

Mercedes, Stellantis and Tesla are just a few of the OEMs that have publicly acknowledged entering into offtakes with miners, and we are aware of instances where OEMs have used streams as a means to acquire metal directly. In order to secure metal over the long term at stable prices, both prepayment agreements and potentially streams are attractive products.

• M&A and Special Purpose Acquisition Companies (SPACs):

M&A and SPAC activity in the critical minerals space remains strong, despite some high-profile failures such as the proposed ACG acquisition of the Santa Rita nickel and Serrote copper mines, supported by Glencore, Stellantis and Volkswagen.

In New York, for example, Metals Acquisition Limited (a SPAC) completed its acquisition of the CSA Copper Mine in New South Wales from Glencore in June 2023; the acquisition is notable for the involvement of stream and royalty financing. The purchase consideration of circa US$1.25 billion included a 1.5% life of mine NSR copper royalty for Glencore. Osisko entered into silver and copper streams for life of mine with a combined deposit amount of US$150 million. Both Glencore and Osisko subscribed for shares in Metals Acquisition Limited.

The IEA's latest critical mineral report noted that there was US$20 billion of M&A activity related to critical mineral assets in 2022. In the past year we have seen record valuations for a number of quality assets, including the sale of the Khoemacau Copper Mine in Botswana for an effective enterprise value of US$1.875 billion. We expect this trend to continue as investors and OEMs seek direct access to metals for their businesses, or in the belief that future demand for the 'right' metals will support high valuations.

• Development Finance Institutions (DFIs):

DFIs are a particularly important source of credit for mining companies as commercial lenders have withdrawn from some markets. The ability of DFIs to navigate political risk is especially useful for junior miners in Africa. Where DFIs can also provide a royalty or stream, the increased leverage will be an attractive addition to a miner's capital stack.

Africa Finance Corporation (AFC) has made a number of investments. For example, it invested approximately US$98 million in the first commercial scale gold mining project in Nigeria, the Segilola Gold Mine in Osun State, through a financing package comprised of debt, equity, a stream and structured offtake.

This one-stop-shop approach under which a single provider funds a project with multiple forms of financial product follows the example of Orion and other private equity funds. A similar instance is FG Gold's Baomahun project, where AFC provided a US$45 million stream and US$55 million mezzanine loan.

2. Key Considerations

2.1 Protecting the stream or royalty

A fundamental issue for stream and royalty holders is protection of their rights against a transfer of the underlying mining tenure by the mining company, in circumstances where the transferee has not first agreed to continue to perform the stream or royalty obligations.

• In certain jurisdictions, such as some provinces of Canada, it may be possible to structure a royalty in a way which creates an interest in the relevant land, so that the royalty will 'run with the land' and be enforceable against a subsequent transferee.
• Elsewhere, local legislation may provide a means of protection of the relevant instrument. In Western Australia, there is a system of registering a 'consent caveat' under the Mining Act, which affords a measure of protection. The caveat will prevent a transfer unless released with the consent of both parties (or removed for cause by the Mining Warden).
• However, in other jurisdictions, for example most of those with a civil law system, neither of these options is available. In these jurisdictions, other forms of protection for the relevant instrument are required.

Unless the instrument can be fashioned as a true proprietary right which 'runs with the land' (as opposed to a contractual right), in the case of insolvency of the relevant mining company, the instrument may be open to challenge or disclaimer by an insolvency official. This is the case in Western Australia if the royalty holder only holds a consent caveat.

In recent times, the increasing size of and expanded jurisdictions for royalties and streams has renewed the focus on insolvency risk and, as a result, the potential protections afforded by security over the applicable mining rights and/or a comprehensive lender-style security package. However:

• even where security is sought, solutions can be imperfect. For example, in some newer mining jurisdictions in Europe, it is not possible to encumber the mining right to protect a royalty and so a royalty holder may need to take security over other assets, such as over the shares in the local mining company;
• given the long-term nature of royalty and streaming instruments, mining companies often resist providing comprehensive security packages for the full tenor of the instrument resulting in the negotiation of step-down provisions for the security package once the upfront deposit and/or internal rate of return has been recouped; and
• as discussed in the next section, if the stream or royalty instrument is to sit alongside senior debt, a number of intercreditor issues will need to be agreed between the parties.

2.2 Intercreditor considerations

As a result of the presently constrained market for senior bank debt and increasing project construction costs, borrowers have looked to maximise the amount of finance which may be made available under streams and royalties. The result has been that, whilst a traditional NSR royalty is usually in a range of 0.5% - 1.5%, royalties which merit up-front payments in the hundreds of millions may be priced at levels around 6.0% - 7.0%.

The smaller royalty could in the past be accommodated by senior lenders without much impact on usual credit assessments and intercreditor considerations. However, senior lenders view larger royalties and streams as being more in the nature of mezzanine debt, for which a different analysis is required.

The nature of the instrument and corresponding intercreditor issues become particularly acute in the context of lender enforcement. A 'true' royalty survives enforcement whereas mezzanine debt, if not satisfied by any enforcement proceeds remaining after senior debt is satisfied, is extinguished. If a large royalty is required to be passed on to a buyer, it will likely have a significant impact on asset value and in practice result in a preference to the royalty holder over the senior lender.

It has always been a difficult task to accommodate streams and royalties alongside senior lenders, and these large instruments are pushing market practice in new directions. While this may still be challenging for some royalty and stream providers, the market appears to be moving to the position that senior lenders will attempt on enforcement to preserve the royalty or stream interest, but if that attempt fails, will be entitled to enforce security over mining assets unencumbered by those interests. 

The parties will need to navigate a number of other intercreditor issues, which will contribute to execution risk on debt packages. Matters for consideration with senior lenders include:

• the treatment of ongoing commitments under streams and royalties as operating costs coming out of the top line of the cashflow waterfall in priority to senior lenders – investment committees will need to accept this level of preferential treatment and be satisfied as to the impact;
• the ability of the stream or royalty provider to terminate the instrument and demand the reimbursement of the deposit or substantial termination sums (for example, the net present value of the future payments under the instrument) – the ranking of these payments needs to be agreed;
• dealing with any buyback rights the mining company may have in order to terminate the stream or royalty (potentially for significant amount);
• sharing of the security package between the stream or royalty provider and senior lenders, having regard to the need to agree priority of ranking of the amounts referred to above;
• as part of the overall balancing of interests between the parties under the intercreditor, a right of the stream or royalty provider to buy out the senior lenders for their full amount owed; and
• standstills and control of the security enforcement process.

Streams and royalties are frequently agreed and sometimes drawn down before senior project finance debt has been committed. The mining company therefore often needs to agree intercreditor terms with the stream or royalty provider before mandating senior lenders. Great care needs to be taken in preparing intercreditor principles which anticipate the needs of the senior lenders, and an element of execution risk is introduced by the potential for senior lenders to require terms which differ from those agreed.

Conclusion

Recent developments in the royalty and streaming market are a consequence of their increasing use in mining finance, in particular as an important source of capital to fund much needed greenfield and expansion projects. Market terms are constantly evolving and we expect the high pace of change to continue. As with any finance transaction, well informed advisors can help cut through complexity. In addition, sufficiently detailed term sheets reduce the risk of deal breakers emerging during negotiation of long-form documents.

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, see our Mining insights hub here, which will include future articles in our Beneath the Surface series.