Understanding Royalties

Royalties:

A royalty is an agreement which provides, in exchange for an upfront payment made to the mining company, the right to receive a proportion of the revenue from a mining operation once in production. The royalty can take several forms; the most common are described below.

Royalties may be:

Royalties on early stage exploration projects can represent good value, given the large amount of uncertainty over their future feasibility and development, as well as the often significant time before the asset will come into production. Royalties on later stage projects nearing production will have been significantly de-risked by additional exploration, with the route to production clearer and the time to production shorter. Royalties on mines already in production are usually more valuable as they provide income without a delay.

Royalty Advantages:

Mining royalties have a number of inherent advantages when compared to direct equity investment:

Streams:

A stream is an agreement which provides, in exchange for an upfront payment made to the mining company, the right to purchase some or all of the production from a mine, at a price determined for the life of the transaction by the purchase agreement.

Streaming agreements are often larger than royalty agreements, provide more flexibility in the negotiation of terms and conditions, and generally provide both parties with tax advantages.

Elemental does not yet hold any streams within its portfolio but is actively reviewing potential opportunities.

Background

The mining industry is historically cyclical. The size, complexity and cost of projects mean they require many years of exploration and development before reaching production.

In contrast, demand often changes rapidly as economic growth and technological innovations drive unanticipated growth in some commodities while others lag behind predictions. This can lead to extreme rises in commodity prices as demand continues to outstrip supply for a prolonged period and the lag between short-term demand and long-term supply takes effect.

These prolonged periods of price increases tend to encourage investment in mineral exploration and ultimately lead to the next bust as supply gradually catches up with demand and prices fall, leaving a glut of higher-cost projects unable to operate at lower prices. The resulting lower profit margin results in investors leaving the sector, particularly at the smaller, higher-risk end of the market, with funding for further exploration drying up.

This lack of investment and exploration in turn drives the next boom as the industry fails to replace mined resources, the rate of new discoveries falls and demand overtakes supply leading to an increase in commodity prices and a new round of investment.

As a result of the cyclical market royalties & streams have become an important source of funding for numerous companies within the mining sector in recent years. In the past both royalties and streams were considered specialist forms of funding but have become more widespread, leading to greater awareness of the model from resource companies and an increase in the transactions occurring.