Can royalty financing for mining projects endure a crisis like Covid-19?

Alternative models for financing mine projects have become more prevalent in the past decade, with the 2008 financial crash making loans harder to secure, then the 2014 commodities crash compounding miners’ difficulties in securing project funding via the traditional methods. Particularly for junior miners, crowdfunding, production-based financing, or royalty financing have become attractive propositions to get projects off the ground.

Royalty finance in particular has grown as a proposition, with companies offering funding for mine projects in return for regular royalty payments in the form of cash or the mined commodity. London-headquartered Anglo Pacific Group is a royalty and streaming company that has 15 royalty and streaming-related assets across five continents.

For Anglo Pacific and its shareholders, this business model, receiving royalties from a diversified portfolio across continents and commodities, provides a de-risked exposure to the mining sector. For mining companies, it provides the upfront capital needed to get projects off the ground or fund expansion work.

“We acquire a share in the output of various miners,” Anglo Pacific CEO Julian Treger explains. “Sometimes it’s physical if it’s a stream and then it could just be a share of revenues, if it’s a royalty.”

A royalty is a right to receive payment in the form of a percentage of the commodity produced or of the revenue or profit generated from the sale of the commodity. The royalty holder typically provides an upfront payment to finance an aspect of a mine’s development, in return receiving a contractual royalty.

92% of Anglo Pacific’s portfolio by value is producing, but some investments made by Treger’s company, like BHP’s South Flank iron ore project in the Pilbara region of Western Australia, are still being developed. Anglo Pacific has a 1.5% life of mine gross revenue royalty over three exploration tenements that form part of South Flank.

“A big portion of our business is also second-hand royalties, where you’re not necessarily financing the construction of a new mine but you are monetising somebody else’s royalty or streaming stake in a mine that’s already up and running, or indeed is still going to be developed.”

The advantages for Anglo Pacific and its shareholders are clear. Anglo does not itself operate any mines so it is somewhat shielded from the risks a mining company takes on, doesn’t have a traditional mining company’s operating expenses, and a diversified portfolio – running the gamut from coking coal, iron, copper, uranium, and more – provides more resilience against volatility across commodities and markets. But what’s in it for the miner?

“I think there are many reasons [for a mining company to pursue royalty financing],” Treger explains. “One might be that the other parts are not available, which is an obvious one, but actually the royalty instrument is an interesting one… you don’t have any equity. You don’t have to worry about shareholders, from the perspective of a miner. But it’s also not really debt, there’s no repayment requirement. They’re not covenants. It’s a sort of flexible, hybrid instrument, which is very much sharing some equity risk components.

“It doesn’t have the same sort of downside of equity or debt, so I understand why it makes a lot of sense for people.”

Anglo Pacific does not have a one-size-fits-all approach to investment, but does look for certain properties or traits when considering its involvement. 

As Treger explains: “Some are project-dependent, but our focus is very much on producing royalties, which already have product and revenues.”

Jurisdictional risk factors into investment decisions – 98% of Anglo Pacific’s portfolio lies within well-established mining jurisdictions. 

The company’s primary focus is acquiring royalties over producing, or near production, mines, but Anglo Pacific is also seeking royalties over highly prospective, earlier stage projects that have significant upside potential.

“The financing squeeze in the sector occurs more with construction projects these days, which require quite a lot of capital,” Treger says. “So we are increasingly being open to that. And then we do have a small proportion of our portfolio which is allocated to longer-term development opportunities, but that’s not a large amount of our annual investment spend.”

On its website, Anglo Pacific says that it targets base metals such as copper, zinc, and nickel, and other commodities used in electric batteries, but will “opportunistically consider other commodities on a case-by-case basis”.

While the royalty model, working perfectly, would provide consistent returns from a diverse array of assets in multiple jurisdictions, without the ongoing operational expenditure of a traditional mining company, it’s not always plain sailing.

“Effectively, you’re taking an equity-type on the mine, and you’re assuming a certain amount of prices, a certain amount of production,” Treger says. “And if neither of those eventuate then you will have a shortfall.”

Those shortfalls can occur for a few reasons. It could be that the particular commodity goes through more volatility than was expected, or there could be unplanned events – a strike, or a mine shutdown, something witnessed often this year with the Covid-19 pandemic.

Treger says that, while Anglo Pacific hasn’t been immune to the effects of Covid-19 on the global economy, the effect “hasn’t been quite as you would expect”.

“I think many countries qualified mining as an essential strategic activity. And so even during the lockdowns in various countries, the mines continued to operate. We saw some shutdowns, but they were for a very small proportion of our portfolio. But the big mines in Australia and Chile continued to operate for us through the shutdowns.

“What we have seen is slightly less production and slightly lower prices for certain commodities – [although] there’s been a recovery now. But coal, which we continue to be exposed to particularly the coal that’s used for steelmaking, has been affected recently by the Chinese trying to put pressure on the Australians and not import their coal, which is a secondary effect of Australia’s desire to understand what happened with Covid-19 in China.”

Treger is optimistic, and cites the company’s diversified portfolio as enabling Anglo Pacific to not be hit as badly as other businesses: “It’s affected us. Not in obvious ways, but hopefully with Q4 we’ll have a much stronger quarter, and then next year will be a more normalised year – particularly if we have the vaccine working.

“I think the relative resilience of our portfolio through the coronavirus illustrates the benefit of the diversified nature of our portfolio – not only are we diversified in terms of numbers of royalties and counterparties, but also geographically. So I think we’ve not been as badly hit as, for instance, a single operating model might be exposed. I think the diversification has definitely helped us.”