Offtake agreements and financing mine projects

Traditionally, offtake deals are concluded between fully operational mining companies looking to secure the sale of their mine output and buyers who are interested is satisfying their demand for a particular commodity, such as refiners, smelters or importers. However, over the past couple of years offtake deals have been concluded with increasing frequency between development stage mining companies and financing parties looking to invest in the project (offtake investors and miners). Because these arrangements only work if the mine is put into production, it is common for the offtake investor to also enter into a loan agreement with the miner to help ensure that the mine reaches production.

The result is a mutually advantageous relationship where the miner secures difficult-to-find upfront capital to help build their project and the offtake investor gets optionality on (the choice to store or sell) the mine’s future output with pricing that carries the potential for an attractive return.  Below are some unique features of these transactions for Canadian mining companies and investors to consider.

Loan Component

In today’s  financial climate it is difficult for junior miners to secure loans on commercial terms. In offtake financing transactions, because the loan and offtake are commonly packaged together, the offtake investor is oftentimes able to provide the loan at lower-than-market rates to the miner in consideration for the potential higher of return on the offtake component of the transaction. This is attractive to mining companies who would otherwise be unable to secure such a low cost of capital at their development stage.

Offtake Component

To accurately price the concentrate being purchased, the offtake agreement must account for the costs associated with upgrading the material to a product suitable to end users. Unlike streaming agreements which contemplate the sale and purchase of precious metals, offtake deals are typically used in connection with base metals, which have a more complex and lengthy supply chain involving bulk transport and refining.

The concentrate supply chain has multiple steps, each with its associated costs. Land transport methods from mine to port can vary from truck or rail haulage to slurry pipeline. Once at port, additional handling fees are charged based on the physical properties of the material and ocean freight charges are added based on the specified destination port, moisture content of the material and insurance. If the concentrate requires smelting and refining then treatment charges and refining costs are tacked on.

The various costs associated with the concentrate supply chain provide an opportunity for offtake parties to negotiate pricing. Among the most commonly negotiated clauses are those which deal with:

• when, and at whose discretion, the commodity is priced;
• the selection of destination port; and
• the settlement of treatment and refining costs.

It is imperative that the parties have acute knowledge of the nature of and interplay between these provisions of the offtake agreement and, therefore, the concentrate supply chain generally.

Security

Depending on the maturity of the project, it is not uncommon for financing parties to take security on the project’s assets to protect their investment. It appears that first ranking security interests are being sought more regularly than in the past by offtake investors in these types of transactions. Such security allows the offtake agreement to stay attached to the project upon default under the loan, and, is an important component to mitigating investment risk assumed by the offtake investor.

When security is taken by an offtake investor at an early stage, the ability of the miner to procure additional project financing may be compromised by a disagreement between the offtake investor and future lenders over intercreditor terms. Therefore, to avoid potential intercreditor conflicts and promote additional project financing, it is advisable that the miner and the offtake investor negotiate and agree to bankable intercreditor principles as part of the offtake financing transaction. This should include rights to terminate the offtake investment in the event that the offtake investor fails to agree to sign an intercreditor agreement based on these principles.

Conclusion

Offtake financing deals are providing an alternative to the traditional sources of capital available to junior mining companies looking to fund development. A successful and mutually advantageous transaction of this type will, in part, depend upon the parties’:

• understanding and appreciation of the interplay between the loan and offtake components of the transaction;
• the knowledge of the concentrate supply chain; and
• ability to negotiate workable intercreditor terms.