Mining’s old guard needs strong medicine
A new report details subpar investor returns in the mining industry over the last decade, particularly big cap diversified companies which have not adapted to new realities.
The mutual dependence between man and metals means that we are inescapably bound to mining companies in an inherent social contract: we provide them with capital and they provide us with metals. This social contract is made manifest by entering into actual agreements whereby capital is actually provided so metals can actually be produced. These financial contracts take many forms. One of them is called a streaming agreement.
On the surface, a stream is simple. The streamer advances a capital payment to a mining company in exchange for the right to purchase some share of production at a low predetermined price, usually for the duration of a mine’s life. The streamer then earns a return by collecting the difference between the price at which it purchases streamed production and the prevailing market price.
The basics of these transactions have been well covered, but discourse has never moved beyond vague terminology like “upside” or “optionality” for the streamer, while mine developers and producers seem content to focus their messaging on the capital they secure. But what exactly that upside is, and at what cost does that capital come, does not normally get spelled out.
The world’s increasing attention on metal supply is now forcing the issue. Mining projects must be developed. Capital must be raised. Streaming will be considered. But it is paramount that mining companies understand the true economic complexion of these deals before any solid lines are signed.
Perhaps the biggest misconception about streaming is that the streamer’s financial performance is separate from the miner’s. It is easy to think that because the streamer takes delivery of metal, turns around, and sells it in isolated transactions that it earns its profit independent of the mining company. That is not the case. One, the streamer cannot earn profit on a unit that is not delivered, and two, any sales the streamer makes are sales that the miner would capture if it were not delivering those units to the streamer. It is a direct transfer of profit. The streamer’s earnings come straight out of the miner’s pocket.
Once that realization is allowed to wash over one’s thinking, other myths are quickly dissolved. For instance, it is common for stream capital to be placarded as a nondilutive source of funding. But siphoning revenue away from the mining company has the same outcome for shareholders as issuing shares. It is a different means to the same dilutive end.
Another justification sometimes cited is that the economic effects of the stream are confined to the share of production being streamed. However, selling one portion of a mine’s production at a loss unavoidably affects the whole. Profitability cannot be compartmentalized. The average profit per unit across 100% of the production base will be diminished whenever any of those units is sold at a loss, even if they are a mine’s secondary byproducts.
These effects on profitability are not aberrations that occur perchance. Their boundaries are regulated by the stream’s three essential deal terms—the streaming percentage, the ongoing purchase price, and the initial capital payment.
Take the streaming percentage, for example. This variable is not merely related to production but becomes a primary governor of the mine’s economics.
To illustrate: If we were to calculate the annual revenue the mining company forfeits by selling into the stream and divide that cost by the mine’s total potential revenue each year, we would be stating the stream as a royalty equivalent. Royalties are common in the mining industry. Usually the royalty holder is paid a percentage of revenue less certain charges for handling or treatment.
If a mine has a 2% royalty on it, it will always be 2%. The percentage does not change. A stream is different. The percentage of revenue conceded increases as the market price of the commodity increases, and its upper limit approaches the percentage of production being streamed. So if the miner streams 20% of production, it has granted the streamer the equivalent of a royalty that will converge toward 20% as price increases. A stream is effectively a sliding scale royalty that gets more punitive at higher prices masquerading as a percent of production being sold.
By implication, a mining company cannot tell its shareholders what the stream’s cost is at the time the deal is signed. It will change as soon as the ink on the agreement dries, and will continue changing for as long as the stream is in place. It is as if the terms are being continuously renegotiated, second by second, for the entire life of the stream.
The stream’s purchase price has similar economic repercussions. This deal term effectively positions the streamer as a producer with low fixed operating costs. That concept alone has manifold implications. One of them is that it turns monetary inflation into the streamer’s unseen aide. If the purchasing power of the US dollar erodes over time, the streaming company should, in theory, be paying more dollars per unit streamed to maintain fair value in nominal terms.
But based on the standard terms of a fixed price stream, the streamer does not have to pay those additional dollars. Streamers therefore do not need the commodity price to rise in order to benefit from the stream; monetary inflation alone will translate to expanded margins. The streamer has something of a call option on inflation and it is the mining company that pays out the winnings—the miner pays interest to the streamer at the rate of inflation. This is an additional cost nowhere stated on the term sheet.
These examples are only the beginning of a stream’s reach. The farther into the financials you go, the more consequences you find. With only three key terms, a streaming agreement lays invisible tripwires all throughout the miner’s house.
What then is a miner to do? Should streaming be eradicated? Not necessarily. Streamers offer a service as capital providers. The question is determining fair compensation for those service. As it stands, the cost of conventional streaming agreements can become inordinate since they are uncapped in deliveries and duration while the miner bears the risk and expense of operating, optimizing, maintaining, and expanding the mine.
Though this template has been reinforced through years of repetition, it has not ossified to the point of immutability. It can be changed. Yet simply pounding the table for a higher price or lower production share will not make for a productive meeting. Changes must be approached from oblique angles. Armed with a comprehensive understanding of the deal allows for just that. Then, with a bit of courage and constructive imagination, a new format for financing can be forged.
But there is something even greater at stake than retooling a deal structure. The well-being of the world is directly correlated to capital investment in the mining industry. Metals underpin every course of modern life and give substance to our dreams for what that life could one day become. We therefore have a moral imperative to maintain a healthy mining sector. Imbalanced financings put that in jeopardy. An asymmetric agreement may get the next mine built, but it strips the miner of the means and incentives for the one after that. That is a cost the world cannot afford.
Alex Godell works in mining finance and is the author of ‘The Stream Runs Deeper Still’, a guide to the financial mechanics of streaming agreements.
