South Africa: Alternative financing for young miners – bringing the preamble to the Petroleum and Mineral Resources Development Act to life

In short

Novice and junior miners find it difficult to raise traditional debt capital when acquiring or developing a mine. However, the successful implementation of a variation on the streaming contract theme offers an attractive alternative for miners who lack the balance sheet capacity required to attract traditional debt financing. This form of alternative financing can ensure that junior miners have enough cash to acquire, operate and generate profits from a mine. As such, it is possible that the ideals set out in the preamble to the Mineral and Petroleum Resources Development Act can be realized, in particular that minerals from South Africa can be used as a vehicle for social betterment. economic.

The preamble to Law 28 of 2002 on the development of mineral and petroleum resources (MPRDA), South Africa’s main piece of legislation governing the administration of and access to the country’s mineral wealth, states in understandable and idealistic tones the following:

“RECOGNIZING that minerals and petroleum are non-renewable natural resources;

RECOGNIZING that the mineral and petroleum resources of South Africa belong to the nation and that the state is their custodian;

AFFIRMING the obligation of the State to protect the environment for the benefit of present and future generations, to ensure the ecologically sustainable development of mineral and petroleum resources and to promote economic and social development;

RECOGNIZING the need to promote local and rural development and the social upliftment of communities affected by mining;

REAFFIRMING the State’s commitment to reform to ensure equitable access to South Africa’s mineral and petroleum resources;

COMMITTED to eradicating all forms of discriminatory practices in the mining and petroleum industries;

CONSIDERING the obligation of the State, under the Constitution, to take legislative and other measures to remedy the results of past racial discrimination;

REAFFIRMING the commitment of the State to guarantee land tenure security for prospecting and mining operations; and

EMPHASIZING the need to create an internationally competitive and efficient administrative and regulatory regime,

BE IT THEREFORE ENACTED by the Parliament of the Republic of South Africa, as follows:-…”

Without the need to delve into a treatise on how the common law position was altered by the MPRDA or the well-intentioned intentions behind it, one runs the danger of having a piece of legislation that does not remains only an aspiration or mere words on a page unless access to capital reinforces the ideals set forth therein. It is in this context that other forms of non-traditional financing should be urgently and meaningfully considered so that, for example, “the state’s commitment to reform to ensure equitable access to South Africa’s mineral and petroleum resourcescan come to life and the South African socio-economic floor can begin to rise.

Among a number of other factors, one of the most pressing, which keeps the barrier to entry high for novice and junior miners, is their access to capital to acquire or develop a mine for which they have been granted or acquired a mining right. Based on little or no tangible balance sheet strength, these industry entrants will find it difficult to raise traditional debt capital from commercial banks.

While ongoing contractual arrangements have been a feature of the alternative mining finance landscape for some time, they are not always suitable for the type of miner who hopes to be able to establish themselves at a reasonable scale and pace. We have seen a variation on the streaming contract theme emerge, which offers an attractive alternative for miners who lack the balance sheet capacity required to attract traditional debt financing.

The structure usually involves at least three but usually four parts, as follows:

  • the holder of the mining right/producer (“Producer“)
  • the purchaser of the goods produced by the Producer (“Buyer“)
  • the financial institution financing the transaction (“Funder“)
  • the insurer issuing a performance bond (“Guarantor“).

The Producer generates three to five years (“Term“) value of invoices (regarding the goods to be delivered by the producer to the buyer) reflecting a certain future date for the payment of all invoices. The face value of each invoice is determined by reference to a fixed price for the goods, multiplied by the quantity to be delivered for the period concerned.

The aggregate value of all invoices over the Term represents the gross financing potential of the transaction. On day one, the funder purchases these invoices, without recourse, from the producer at a discount, which discount equals the funder’s margin and risk premium. Producer enters into an off-take agreement with Buyer on normal trade terms for the Term, agreeing to deliver to Buyer during the Term the full quantity of merchandise underlying the invoices sold to Lender.

The funder enters into an agreement with the buyer, essentially putting the buyer on terms that it will collect the full face value of all of the buyer’s invoices at term, without any reference to whether the producer executed purchase agreements; that is, the buyer will be obligated to pay the lender forward on a “hell or flood” basis.

The implications of this structure are that:

  • The funder will want to know that the buyer has sufficient balance sheet strength to be able to meet its payment obligation when due.
  • The buyer will want to know that the producer is capable of producing/processing the required quantity of commodities to enable him to make sufficient sales to meet his payment obligation to the forward lender.
  • The Producer will have all of its cash in advance (under the sale of invoices to the Lessor) to acquire and/or develop the mining asset.
  • The Buyer will be able to trade and sell goods during the Term without having to pay upfront and may, therefore, use any cash functions it deems appropriate to ensure that it can perform payment to the Financier at Term and retain any potential increase in cash.

Off-take agreements require careful consideration by both producer and buyer because, depending on real-time commodity price fluctuations (and in the absence of any ISDA protection), the buyer’s ability to meet its payment obligation to the forward funder depends on the market price. of the goods over time, bearing in mind that the face value of the invoice will have been determined and fixed by reference, perhaps, to an average of ten for the goods in question.

Off-take agreements can be structured to ensure that the producer is obligated to “over-deliver” a certain quantity of product in the face of a price drop, so that the buyer can make up the difference caused by such a drop. price by being able to sell more goods.

In the event that the price recovers and the Producer continues to deliver the contractual quantity, the parties may agree to share the resulting increase on a basis agreed between them.

Although the above provisions may be written into a contract, the real risk, in particular that the Buyer faces, is the failure of the Producer to execute the removal provisions. The risk could be more acute in circumstances where the Producer is a novice or junior miner inexperienced in the type of operations he undertakes to manage, a risk which the Buyer will ultimately bear. A good deal of these types of issues should be broken down in the due diligence phase, but it goes without saying that exercising due diligence can only get the buyer so far in compensating for their liability to the customer. ‘coming.

At this point, enter the fourth part of the structure, the guarantor, usually a highly rated insurance company comfortable and experienced in issuing performance guarantees in the mining industry. The Guarantor undertakes towards the Buyer that, insofar as the Producer has not delivered a sufficient quantity of the goods to the Buyer at the Maturity, so that the Buyer is not able to pay the Lessor the total nominal value of the invoices, the Guarantor will make the payment of this shortfall to the Lessor. The funder may insist that it has a security on the performance guarantee and is endorsed on the underlying policy. This is how he has a clear view of the performance bond and the claim for proceeds from any call under the performance bond.

Apart from the premium payable to the Guarantor for the Performance Bond, and depending on the Producer’s assets available to secure any compensation it may grant to the Guarantor for a call under the Performance Bond, the Guarantor may require that a cash guarantee account is funded. This would be structured on a clawback basis such that, as the goods are delivered to the Buyer and all parties have acknowledged that such delivery by the Producer has (partly) fulfilled its obligation under the removal, a corresponding portion of the collateral money may be recovered by the producer for working capital purposes.

By issuing the performance bond, the funder and the buyer are de-risked against failure to deliver a sufficient quantity of commodities by the producer, at the time that would allow the buyer to fulfill its payment obligation towards the financial backer when the financial backer comes to collect under the invoices.

Given the interconnected nature of such a structure, it is advisable to establish a risk committee composed of members of the four stakeholders, namely the financier, the producer, the buyer and the guarantor, who will meet at intervals regular. This would ensure that the performance of the Producer Over the Term can be sufficiently monitored (and, if applicable, cash collateral can be returned to the Producer) and that all parties can remain aware of their respective risk profiles throughout. the transaction.

A successful implementation of this structure ensures that the novice or junior miner will have access to sufficient liquidity to acquire, operate and generate profits from a mine in circumstances where they could not have done so from normal sources of loan capital because of its relative balance. leaf weakness. In this way, the possibility arises that at least the ideals of the preamble of the MPRDA are economically viable, but the disparate parties to such a transaction would need to cooperate closely throughout the life of the transaction. , a feat made easier if all of these parties share the same values ​​in wanting to see South African minerals used as a vehicle for socio-economic upliftment.

Michael J. Birnbaum