The mining sector’s cyclicality, with dramatic swings in equity prices and investment patterns, has created a complex system that has impacted particularly junior and exploratory mining companies to secure financing at the levels required to meet their growth-driven financing requirements, states law firm Bowmans South Africa.

In a statement authored by partners Jason Wilkinson and Wandisile Mandlana, tax executive Adéle de Jager and senior associate Ivan Vorster, they say that low commodity prices and weak equity markets have further negatively impacted on junior miners.

As such, Bowmans points out that the resultant lack of funding from traditional capital sources, such as equity investments and debt financing, has made it necessary for mining companies to access alternative sources of funding.

Also, production-based financing, where companies secure funding by selling a right to future production at a mine, has become an increasingly common feature in the market, through which the funding gaps currently left by traditional capital providers are filled, the firm reveals.

However, these complex models have become more flexible in recent years and have led to innovative departures from the traditional funding model; but still require a carefully thought out legal, commercial and practical strategy to ensure a keen ability to navigate the multi-faceted regulatory, finance, corporate and tax requirements. 

STREAMING & ARRANGEMENTS

Bowmans notes that, of late, streaming transactions have become a significant source of capital for listed and mid-cap mining companies.

A typical streaming arrangement entails a finance provider prepaying an amount (the deposit) to the mining company and agreeing to buy a percentage of future production of a mining operation at a pre-agreed price. The deposit is usually applied by the mining company to fund its mining operations, notes Bowmans.

Structuring of the streaming arrangement is critical from a regulatory perspective to strike a careful balance between preserving the mining right and ensuring the finance provider remains entitled to such future production. 

Meanwhile, Bowmans says a royalty finance transaction typically involves a lump sum upfront capital payment by a finance provider (the royalty holder) to the mining company, similar to the deposit paid in a streaming arrangement, in return for a contractual right to receive a percentage of the minerals produced at a mine, or of the future revenue generated from the sale of such minerals.

However, the firm’s experts point out that there is no obligation to repay the capital and it does not bear interest (in contrast to debt funding). And although a royalty financing can be a useful source of startup capital for junior or exploratory mining companies, Bowmans notes that it is more common in cases where the mining company already owns operating assets and has established and consistent revenue streams.

Since the mining company is under no obligation to pay any royalties or to deliver specified volumes of production, in each case, unless it generates revenue, royalty finance transactions offer a degree of flexibility that has proven to be particularly useful in times of reduced output owing to Covid-19, labour unrest or lower revenue owing to weak mineral prices.

In turn, the royalty holder gains equity-like exposure to commodity price increases without an obligation to make any further capital contributions.

LOOKING AHEAD

The ongoing Covid-19 pandemic has resulted in capital flooding to traditional safe-haven investments, such as gold and platinum, says Bowmans.

The firm highlights that this would have ensured that streaming and royalty finance arrangements that pre-date the recent surge in the prices of these minerals delivered significant upside to the finance providers party thereto.

However, it points out that the price outlook for a number of minerals remains depressed, with financing challenges expected to continue for many in the market and capital flight expected in many commodity markets, such as coal, copper, aluminium, lead, nickel and iron-ore.

As such, Bowmans says alternative financing transactions will continue to be relevant in meeting the funding needs of relevant entities in commodity markets that, at the moment, are not fully attracting the attention of investors, whilst offering opportunities to finance providers to capitalise on an eventual upturn in the commodity price cycle.