UNDERSTANDING STREAMING AGREEMENTS AND ROYALTY AGREEMENTS: ALTERNATIVES TO TRADITIONAL FINANCING

• Jurisdiction: United States

51 Rocky Mt. Min. L. Fdn. J. 1 (2014)
Chapter 1
UNDERSTANDING STREAMING AGREEMENTS AND ROYALTY AGREEMENTS: ALTERNATIVES TO TRADITIONAL FINANCING
Alan L. Monk
Partner
Dentons Canada LLP
Vancouver, British Columbia, Canada
Copyright © 2014 by Rocky Mountain Mineral Law Foundation; Alan L. Monk

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I. Introduction^*

The earliest royalties involved payments to a sovereign in exchange for the right to extract minerals owned by the state. This concept was later adopted by prospectors and the owners of mineral rights, who often retained a royalty upon selling, leasing or optioning the mineral rights to another party who may develop and mine them. In addition, royalties are often used in the context of joint venture arrangements when a participant is diluted below a threshold percentage and its participating interest is converted into a royalty. Such royalties commonly include unit royalties, gross overriding royalties, net smelter return royalties and net profits interest royalties.¹ Usually, royalties are payable in cash. However, some royalties (typically, precious metals royalties) provide the holder of the royalty (Royalty Holder) with the option to receive the royalty payment in minerals (that is, "in kind").

In the context of options and joint ventures, the royalty is usually a small part of a larger commercial arrangement. The granting of the royalties under such agreements is contingent on some future event, which may or may not occur. Unfortunately, there is a tendency to pay less attention to drafting the royalty than the main agreement in such circumstances. Often, the royalty provisions are sparse and are attached as a schedule, sometimes without a lot of care taken to integrate the schedule with the body of the agreement or to deal with various contingencies that could occur if the royalty is ultimately granted.

More recently, royalties have been sold to royalty investment companies or other investors in order to provide financing for exploration,

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development and mining operations, as traditional sources of equity and debt financing have become more difficult to obtain. Like streaming agreements, these royalty agreements are likely to be self-contained, internally consistent agreements with more expansive provisions, because the royalty is the focus of the agreement, not an ancillary part of it that may or may not ever come into effect.

Streaming arrangements are a much more recent development, first emerging in their current form around 2004. A streaming arrangement typically involves the payment of a large up-front deposit (or a series of payments upon achieving certain milestones) by a party (Purchaser) to an operator in exchange for the right to purchase all, or a specified percentage, of the production of a specific refined metal at a predetermined price (Fixed Price) below the market price. The Fixed Price is usually set at the estimated cost to produce such metal.

The metal to be purchased is usually a by-product of the mine (e.g., silver or gold from a copper mining operation), but it may also be the primary metal mined (e.g., gold from a gold mine). The deposit can provide valuable financing to the operator in developing, constructing, or expanding its mining operation, or to refinance existing debt. Unlike most royalty agreements, streaming agreements contemplate the delivery of metals (most commonly, gold or silver) or, more typically, associated credits which can be sold on metals markets. Streaming agreements are long and complex commercial agreements, which are negotiated between sophisticated parties and therefore lack the uncertainty that can arise with many royalty agreements that do not deal with many of the contingencies that could occur in the future.

In this paper, royalties will be referred to as "Royalties" (and their associated agreements as "Royalty Agreements") and streaming arrangements will be referred to as "Streaming Transactions" (and their associated agreements as "Streaming Agreements").

II. Royalty Agreements

A Royalty in the mineral exploration and mining industries typically involves a right of the Royalty Holder to receive a cash payment from an operator of some portion of the proceeds from the sale of minerals sold from production of the property to which the Royalty relates. In some cases, the Royalty Agreement can provide the Royalty Holder with the right to obtain payment in the form of a portion of the minerals extracted from the property, which is known as "taking in kind." Royalties may be payable on only one mineral, such as gold, several minerals, such as gold, silver and copper, or on all minerals extracted from the property to which the Royalty relates.

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Royalties may be used in structuring purchase, option and joint venture transactions involving mineral properties, or may be granted on mineral properties and sold to generate revenue for the operator. In the case of an outright sale of a mineral property, the prospector or owner may negotiate the retention of a Royalty on the property, usually in addition to receiving other consideration such as cash or shares of the acquiring corporation (particularly if the acquiring corporation is a publicly traded company). In an option agreement, the optionor may negotiate the retention of a Royalty on a mineral property upon exercise of the option.

In the context of a joint venture, one party usually contributes a property and the other party contributes cash, and the parties are required to contribute pro-rata in financing the joint venture. In the event a party does not contribute its pro rata share of funding, a joint venture agreement will usually provide that the non-contributing party's participating interest is "diluted," and if it is diluted below a certain threshold (usually, 5 to 15%), the non-contributing party's participating interest is converted into a Royalty.

Royalties are non-participating interests in the mining project, which means that the Royalty Holder makes no further investment and has no right to participate in or have any say in the development or mining operations. Furthermore, the Royalty Holder generally does not have the right to review technical information or data, such as exploration results on the property to which the Royalty relates, and may not have the right to review or audit the books and records of the operator to verify the veracity of the operator's calculations of the Royalty, absent express rights granted by Royalty Agreement.

The most common Royalties are unit royalties, gross overriding royalties, net smelter return royalties and net profits interest royalties. There are no "standard form" agreements for any of the foregoing types of Royalties, but there are similarities in respect of how each type of Royalty is calculated that differentiates it from the others.

[1] Unit Royalty

A unit Royalty (Unit Royalty, also known as a "fixed rate" or "production" royalty) is a Royalty based on the price per unit of measure (e.g., $1.00 per tonne) without any deductions for costs. The Unit Royalty is typically used for low-unit-value material which can be marketed after minimal processing and which is relatively homogeneous, such as solid bulk minerals like coal,² iron ore, phosphate, potash, salt or sulfur, and gravel, cobbles, limestone, or other industrial minerals.³

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One benefit of the Unit Royalty is that it is easy to calculate and, therefore, easy to verify. The Unit Royalty works well if inflation is low and commodities prices are relatively stable. However, if there is a significant increase in operations costs or decrease in commodity costs, the Unit Royalty can become a burden on the economics of the project. On the other hand, if operations costs significantly decrease due to technological advances or if the price for which the commodity may be sold increases significantly, the Royalty Holder will not participate in the financial windfall.⁴

To ameliorate these downsides to some extent, some Unit Royalties include an annual increase (or decrease) in the price per unit to be paid to the Royalty Holder based on an index of inflation (or deflation),⁵ or may include more than one price per unit to be paid to the Royalty Holder, which is determined by the market price of the commodity (e.g., $1.50 per tonne of coal if the market price for coal is below $60, and $2.00 per tonne if the market price for coal is $60 or greater).

[2] Gross Overriding Royalty

A gross overriding Royalty (Gross Overriding Royalty) is usually calculated based on the percentage of the value of mineral products produced, without deduction for costs or with deduction for the costs to make the mineral products marketable and to deliver them to market. The Gross Overriding Royalty is best applied to commodities that can be sold with minimal processing, such as diamonds. Gross Overriding Royalties for diamonds are calculated by multiplying the negotiated Royalty percentage by the appraised value of the diamonds at the mine site.⁶ Like Unit Royalties, Gross Overriding Royalties are payable regardless of whether the mine is profitable.

[3] Net Smelter Returns Royalty

A net smelter return Royalty (NSR Royalty) is based on a percentage of the revenue generated from the sale of ore, concentrates or other mineral products produced from mining property, less certain allowable deductions. Usually, the deductions are limited to (1) transportation costs from the mine to the buyer (usually a smelter, refinery or mint); (2) insurance and

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security costs for transporting the mineral product from the mine to the buyer; (3) all costs, expenses and charges paid or incurred in connection with the refinement or beneficiation of the mineral product, including all smelter and refinery charges and all weighing, sampling, assaying, representation and storage costs, metal losses and umpire charges, and penalties for impurities charged by...