Digging into mining royalties – what are they and how are they are used?

At a very basic level, a private mining royalty is a right to payment from the owner of a mining project in connection with the extraction and/or sale of minerals.

To be clear, private royalties are different and separate from statutory royalties payable by a miner to a government body in return for the right to extract minerals that are owned by the State (which are outside the scope of this article). Statutory royalties are akin to a tax that governments use to generate revenue from the extraction of minerals within their jurisdiction.

Contrast this to private mining royalties which are a creature of contract entered into between the miner (the royalty payer) and a third party (the royalty holder).

In Australia, private mining royalties are generally considered to be a contractual right (ie. right in personam) granted to the royalty holder that can be enforced by making a contractual claim against the royalty payer. While a royalty may be considered a proprietary interest in a mining tenement that is capable of registration in other jurisdictions around the world, private royalties do not typically constitute a proprietary interest in the land or minerals in Australia. Thus is because minerals are not generally owned by a miner until they are extracted – until then, the minerals are owned by the State.

Some jurisdictions within Australia (such as Western Australia) may permit the registration of caveats in connection with a contractual royalty. In other cases, security (eg. in the form of a tenement mortgage) over the relevant mining tenements will be required to give the royalty holder a proprietary (registerable) interest.

What are the different types of mining royalties?

There are different ways in which mining royalties can be calculated. The most common types of mining royalties are as follows:

Net smelter return royalty

A net smelter return royalty is a percentage of the sale price received for the sale of minerals minus certain agreed deductions (often referred to as allowable deductions). The allowable deductions in a net smelter return royalty will typically cover transportation charges from the mine to the smelter as well as treatment, smelting and refining costs and associated penalties.

A net smelter return royalty does not necessarily have a generally accepted or prescribed meaning. To that end, the scope of allowable deductions (as well as any costs that are expressly excluded from allowable deductions) will be as per the terms negotiated between the parties.

Net profit royalty

A net profit royalty is a percentage of gross revenue from the sale of minerals minus all costs of production, operations, treatment and selling. In other words, a net profit royalty will typically allow a larger scope of costs to be deducted (including for example capital and financing costs) before the royalty is payable as compared to a net smelter returns royalty.

Gross revenue royalty

A gross revenue royalty is a percentage of the gross revenue derived by the royalty payer from the sale of the minerals, without any deductions. A gross revenue royalty will generally be much simpler to calculate than a net smelter return royalty or net profit royalty (and obviously is a better outcome for the royalty holder than a net smelter royalty or a net profit royalty).

Volume or tonnage royalty

A volume or tonnage royalty is calculated based on a fixed amount multiplied by the quantity or weight (eg. number of tons) of minerals extracted and sold by the royalty payer.

Like a gross revenue royalty, calculating a volume or tonnage royalty will generally be much simpler than a net smelter return royalty or net profit royalty.

How are royalties used?

Mining royalties have been traditionally (and continue to be) granted in relation to the sale of an exploration project. This is comparable to a “finder’s fee” that gives an explorer a return from the project being sold if it is ultimately developed. They may also form part of the purchase price payable by a buyer to acquire an operational project – this allows the buyer to reduce the upfront amount payable to acquire the project.

Other types of arrangements in which royalties are granted by miners include:

• Joint venture agreements: Royalties granted under the terms of a joint venture agreement to convert a minority joint venture interest into a royalty (eg. where a JV interest drops below a mining level).
• Native title agreements: Royalties granted to traditional owners in return for consent to undertake mining activities on their land.
• Mining rights agreements: Royalties granted in return for rights to explore for and mine certain minerals over the mining company’s tenements.

Royalty financing and streaming arrangements

Royalty and streaming arrangements are increasingly being used to finance mining projects, either independently or alongside more traditional project finance debt.

In a royalty financing transaction, the financier will provide upfront funding for a mining project in return for a royalty interest over the project. In a streaming transaction (also known as a resource streaming or a metal purchase agreement), the financier will provide upfront funding for a mining project in return for an agreed percentage of production at a discounted price by way of delivery of physical volumes of minerals. The stream purchaser also makes ongoing payments for each unit of metal delivered under a streaming agreement.

Put differently, a royalty financing transaction gives the financier a share of future revenue or profits from a mining project whereas a streaming arrangement gives the financier a share of future production from the mining project.

These types of arrangements provide an alternative source of funding for mining projects with the following advantages from the perspective of the miner over traditional financing:

• a royalty or streaming transaction will not dilute the miner’s interest in the project (which would be the case if a joint venture is entered into);
• the “debt” is not repayable unless and until production starts;
• royalty and streaming obligations will be based on actual production – if production falls so will the royalty payments or streaming deliveries;
• the royalty holder or stream purchaser may insist on fewer restrictive covenants than traditional financiers; and
• a failure of the borrower to perform under traditional financing agreements may trigger an event of default or review event, a stream transaction usually allows for certain flexibilities. For example, stream arrangements can be structured to allow top-up deliveries to compensate for situations where future product deliveries are expected to be delayed.

From the perspective of the royalty holder or stream purchaser (ie. the “financier”), the following considerations are important when entering into royalty financing and streaming arrangements:

• Protections: The financier should ensure it has appropriate protections, including restrictive covenants and reporting obligations on the miner, warranties given by the miner, the ability for the financier to lodge caveats (if allowed in the relevant jurisdiction), information sharing and audit rights as well as restrictions on assignment/transfers by the miner.
• Security: The miner may grant security to the financier over some or all of its assets (eg. a mortgage over the mining tenements), the project assets and/or its shares in the project vehicle. Security will give the financier a proprietary interest in the secured assets (bearing in mind that in Australia a royalty or a right to production is not a proprietary interest as noted above). The grant of security will provide protection to the financier if the miner becomes insolvent or subject to external administration.
• Intercreditor agreements: Intercreditor agreements may need to be entered into with existing financiers of the miner which will document how the different financing and security arrangements co-exist. This is particularly relevant where a royalty financing is entered into alongside a project financing for the development of the project. In this case, it will be critical to the financier to ensure that it is effectively senior from a cashflow perspective so that account waterfalls allow the royalty to be paid. In addition, given that streaming arrangements are usually in place for life of mine, the stream purchaser will likely outlast traditional and royalty financiers in the financing and security structure. As such, it is crucial to ensure that intercreditor arrangements regulate creditor rights of enforcement and priority appropriately so as to ensure the stream purchaser’s security rights are protected.