CHAPTER 8 PRICE AND PAYMENT TERMS IN MINERAL AGREEMENTS
| Jurisdiction | United States |
(Mar 1985)
PRICE AND PAYMENT TERMS IN MINERAL AGREEMENTS
and Donald E. Wakefield *
Osler, Hoskin & HarCourt
Toronto, Ontario
INTRODUCTION AND SCOPE
In the market-economy countries non-ferrous minerals are sold in the form of ore, concentrates and smelted and refined metals in three major markets, North America, Europe and Japan. Alternating periods of oversupply and shortage in those markets have made prices for the major "old" base metals, copper, lead, tin and zinc relatively volatile.1 These fluctuations in prices have made it necessary for miners of such metals whose ore bodies will not support their own processing facilities to be astute bargainers in order to sell their output on a profitable basis. Conversely, as toll or custom mills and smelters require a continuous supply of minerals, providing that the pricing mechanisms and processing charges result in a fair bargain, there can be mutual benefit to both the miner and the smelter in entering into a long term contract for the upgrading and sale of their output. In fact, most new mines cannot be debt financed without a long term smelter contract.
Using illustrations from typical contracts for the sale of copper and zinc concentrates, this paper will discuss what price and payment provisions the mine and smelter should include to protect each party against an unfair bargain. Smelter contracts are complex and because of the difficulty of anticipating changed circumstances, there are many established mines and smelters who adhere to a policy of limiting the duration of their contracts to one year with a mutual privilege
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of renewal. However, in the case of a new mine a long term contract will usually be required and price terms will be emphasized. Similarly financiers of a new custom smelter would wish to have the smelter enter into long term contracts to ensure a supply of concentrates over the financing years.
In general three methods are used to deal with changes in circumstances: first, recourse to some form of escalator or de-escalator; secondly, recourse to some form of future agreement and finally a combination of the first and second. Unfortunately, lenders to mines and smelters are wary of changes in sales terms and often will not permit any renegotiation of a smelter contract while their loans are outstanding. Otherwise, the parties are free to ignore specific provisions of their contract and, in order to keep their relationship alive on a profitable basis, frequently do not adhere specifically to them. Whenever experience differs from expectations, however, the negotiating power of a party who has carefully framed the contract to provide for future contingencies is increased.
In a number of third world nations integrated mining, smelting and refining operations are government supported and these operations2 must sell their refined metals to obtain hard foreign currency which is necessary if their national standard of living is to be maintained or improved. In order to compete with such integrated operations independent mines and custom smelters must carefully negotiate and draft their agreements. Only exceptional circumstances, such as calculated assistance by a smelter to a new mine, will allow the prices paid to the mine to have any connection with its costs of extracting and milling ore to produce concentrates. A smelter which gives the mine allowances for its extraction and milling costs might be considered to be encouraging inefficiency.
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The base metal miner is not supplying a mineral product which is ready for industrial consumption like coal3 or uranium4 . The smelter and refinery are upgrading concentrate produced by the miner based on a recovery of costs and a profit element and the miner will usually be required to bear most of the risk of decline in the market price for the refined metals. If the smelter contract fixes the smelter and refinery with responsibility for the sale of all or part of the refined metal, as is usually the case, the focus will be on the processing costs of the upgrading smelter and refinery as a deduction from the free market price otherwise obtainable for the refined metals derived from the concentrates delivered by the miner. Whereas in coal and uranium supply agreements overall costs per man hour, increases or decreases in the average costs of heavy fuel oil, industrial firm gas and electricity are used to escalate the seller's price, in smelter contracts these same factors are used to escalate the treatment and refining charges of the smelter and refinery.
BACKGROUND TO PRICE AND PAYMENT NEGOTIATIONS
Before discussing essential terms and contract law principles applicable to what metals will be paid for, what charges allowed, payment times, assignment of risks regarding changes in costs of processing and prices of refined metals, an outline of the provisions of smelter contracts will be helpful. The first step in negotiations is the submission by the mine to the smelter of a representative sample of the type of concentrate
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that the mine will be delivering. The smelter will assay that sample and may refuse to accept it because of the impurities contained therein or because the grade of the concentrate is too low. For certain grades and impurity ratios smelters will demand penalties or give premiums.
In shopping for an appropriate smelter the mine must have careful regard for transportation costs and when its responsibilities under f.o.b. and c.i.f. terms begin and end. It is the tradition of the industry that the smelter always prepares the contract and whether the smelter is landlocked or near shipping lanes its negotiators will likely have had far more experience than the mine's negotiators with transportation costs and problems.
The smelter will require minimum shipping lots and will have the right to defer receipt of tonnages in excess of its current feed requirements. The mine may ship intermittently and by using the concept of constructive delivery the mine and the smelter may space pricing and payment into the future. This continuous pricing in a widely fluctuating market will have the effect of avoiding large purchases and sales at extremely high or low prices. For example, in order to space pricing and payment into the future, the mine and smelter may agree that quarterly deliveries of 6,000 tons at one time shall be dealt with as 2000 tons delivered on arrival and as 2000 tons delivered at the beginning of the next two months.
In the case of copper the upgrading is usually from concentrate to blister copper at a smelter and then to refined copper at a refinery. The smelter is often in a different location than the refinery; however, both are usually under common control and one contract will cover the costs to the mine of producing saleable refined metals. The smelting and refining charges fluctuate independently of the prices for the refined copper but in general depend on the availability of appropriate concentrate feed and the timing of payment.
The structure of the payment terms must be negotiated with an eye on the time value of money. Because of the miner's desire for early payment, most smelter contracts require the smelter to make a provisional payment based on the estimated final payment. Where the smelter is required to make a larger or earlier provisional payment, it will often increase its treatment charges as a way of financing the larger or earlier payment.
In the U.S. copper industry the quotational period or the pricing period (usually 30 days) during which daily prices
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are averaged in order to arrive at a price for the refined copper is often more than 60 days following the time at which the concentrates arrive at the smelter. If actual shipment were to determine the beginning of this pricing period, then a miner who believed the market was strengthening might try to delay shipment. Accordingly, the quotational period is often determined with respect to the time of scheduled shipment. Quotational periods and payment terms for precious metals in concentrate may be negotiated separately from the primary contract metal.5
Not all negotiations are conducted directly between the miner and the smelter. There are experienced ore marketing agents or dealers who either arrange smelter contracts on behalf of the smaller mines or buy from such miners and sell concentrates on their own behalf.6 Furthermore, there are a number of merchants who buy concentrates from mines and may not resell to a smelter for several months. The fact that these merchants are known to be speculating on the direction in which prices will go makes the dealings between the mine and smelter more competitive. For example, if the smelter believes the market price will go down, its negotiators will be less likely to grant the mine better terms as they will look to the speculators to be sellers and make more concentrates available. On the other hand, if the mine believes market prices are going up, it may be less willing to sell to the smelter because in a rising price situation the speculators will be alternate purchasers for their concentrate output.
Many smelters are part of integrated mining organizations and the smelter contract often authorizes the smelter not only to incur refining charges on behalf of the mine but also to pool the metals to be sold with its own or other parties metals in price pools to be marketed by the sales organizations
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connected with the smelter.7 If the smelter is authorized to market the refined metals produced under the contract in price pools, the miner may retain the flexibility to direct a certain percentage of the metals to be priced by subsequent authorization during different periods in varying proportions in different markets, for example 60% in North America and 40% overseas.
Currency Considerations
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