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Definition, Measurement, and Drivers of Trade-related IFFs

Metals Streaming and Royalty Financing: A Framework for Assessing Mining Sector Financial BenefitSharing Implications for Governments

Flux de métaux et redevances : Un cadre pour l'évaluation des implications du partage des bénéfices financiers du secteur minier pour les gouvernements
Flujo de metales y financiación del canon: Un marco para evaluar las implicaciones de la distribución de beneficios financieros del sector minero para los gobiernos
Ekpen J. Omonbude

Abstracts

This chapter offers a simplified approach to assessing the potential impact of metals streaming and royalty financing on government revenues. Subject to the availability and quality of information, a revenue impact ratio can be determined by comparing the potential revenues to the government from more traditional forms of financing with potential revenues to the government from metals streaming or royalty financing.

The chapter considers the key features, advantages, and disadvantages of these alternative funding options for mining projects, and then develops an illustrative model to demonstrate their potential impact on government revenues. This forms the basis on which to identify the key challenges, and the policy considerations when addressing them.

While metals streaming provides upfront capital and a potential hedge against price risk for producers, it could also limit the upside potential for both the mining company and the host government. On the other hand, royalty financing offers stable income streams and diversification opportunities for investors but may lack direct exposure to metal price increases.

The ultimate risk faced by resource-rich governments as a result of an increase in the use of metals streaming and royalty financing arrangements is a suboptimal share of the potential benefits that will accrue from the mining operations. Specifically, the risk is of a reduction in taxable income and royalty revenue.

At the heart of the policy considerations pertaining to resolving these challenges and risks is reducing information asymmetry between the government, the mining company and the streaming or royalty company. One important way to do this is to strengthen tax legislation and enforcement mechanisms. Implementing anti-avoidance rules, such as interest limitation rules, can limit the ability of metals streaming and royalty financing companies to exploit tax and other loopholes. Other features with which to strengthen the legislation include clear minerals pricing rules, and clearer provisions regarding withholding taxes.

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1. Introduction

1.1 Background

  • 1 For the purpose of this chapter, critical minerals refer to minerals such as copper, lithium, nicke (...)
  • 2 These metals are chromium, refined cobalt, refined copper, gold, lead, molybdenum, palladium, silve (...)

1Alternative means of financing mining operations, such as metals streaming and royalty financing, are increasing in use. There is significant growth potential for these alternative forms of financing, particularly in light of growing demand for critical minerals.1 For example, an industrial assessment has identified the 12 metals with the greatest potential for streaming or royalty financing, which could yield up to USD 1.4 trillion in secondary revenues by the end of the decade2 (Mareels, Moore and Vainberg, 2021).

2Metals streaming is a term used to describe an agreement in which a company (the streaming company) makes an advance payment to a mining company, either as an upfront payment or in a series of instalments, in exchange for rights to a specified amount or a specified percentage of future mine production, or of a specified metal produced (Vergara and Urrutia, 2019). It is typically long term (more than 20 years or for the life of the mine). Royalty financing, on the other hand, is a form of alternative financing where the mining company grants another company (the royalty company) the right to receive a percentage of the revenue generated from the sale of metals produced from a specific mining operation. In this arrangement, the royalty company also provides upfront capital to the mining company, and in return receives ongoing royalty payments based on a percentage of the gross sales revenue from the metals extracted and sold.

3These alternative financing options will prove increasingly important, especially given the scale at which capital will need to be raised for mining projects to meet the net-zero-by-2050 targets (the World Bank (2022) anticipates USD 1.7 trillion in global mining investment for this purpose). Critical minerals, particularly minerals required for energy transition technologies such as batteries for electric vehicles and wind turbines, are often by-products or co-products of the mining operation (Bellois and Ramdoo, 2023; UK Government, 2023). The relevance of these alternative financing options is further increased given their historical tendency to focus more on financing mineral by-products (McLean and Page, 2016, note that the stream is often the by-product of the core mining operations).

  • 3 It is important to note that not all metals streaming or royalty arrangements are linked to illicit (...)

4The anticipated increase in demand for critical minerals will inevitably result in an increase in exploration and production activity, beyond jurisdictions with known ore reserves and with a history of large-scale mining activity, in jurisdictions with less known resource abundance and limited historical mining experience. For the governments of these jurisdictions, especially in countries with limited tax administrative experience in dealing with such non-traditional financial arrangements for mining operations, this raises the risk of suboptimal shares of the financial benefits that could accrue to them mainly in the form of tax revenues. This risk could be more pronounced due to potential opportunities for financial secrecy and money laundering inherent in transactions of this nature. These transactions—like any other—can be exploited to disguise the origins of their funds and make them hard to trace, thus increasing attractiveness to illicit financial flows.3

5The International Energy Agency (IEA) predicts that transitioning economies to net zero by 2050 could lead to a sixfold increase in demand for critical minerals by over 30 million tonnes (IEA, 2021). A study conducted by the German development agency, Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ, 2023), projects that there could be an additional USD 100 billion to USD 260 billion in annual revenues to resource-rich governments with energy transition minerals. This raises the stakes for the administrative systems of countries with these resources, which often are low- to medium-income countries with a traditional prevalence of suboptimal financial benefit sharing from mining operations.

1.2 Objective

6This chapter contributes to the growing discussion on metals streaming and royalty financing for mining operations, but from the perspective of the host government of the country where the mining takes place. It offers the determination of a framework for analysing the impact of metals streaming and royalty financing on government revenue and offers policy considerations via which to address the potential challenges and risks posed by the expected growth in demand for minerals in the energy transition.

7The chapter considers the key features, advantages, and disadvantages of these alternative funding options for mining projects, and then develops an illustrative model to demonstrate their potential impact on government revenues. This forms the basis on which to identify the key challenges, and the policy considerations when addressing them.

2. Metals Streaming and Royalty Financing: Overview and Key Features

8Alternative financing methods for mining projects, particularly metals streaming and royalty financing, have grown significantly over the past decade, and are understood to represent over USD 8 trillion in assets under management (Mareels, Moore and Vainberg, 2021). Their origins are not necessarily new, but the notable application of royalty financing for large mining operations is said to have emerged in the 1980s, through the establishment of companies such as the Franco-Nevada Mining Corporation, which, in 1986, acquired their first royalty stream (Careaga, 2012).

  • 4 It is useful to note that, in practice, the principles and features of metals streaming are similar (...)

9Both metals streaming and royalty financing have become increasingly relevant in the mining industry over the past few decades, with metals streaming becoming more popular since the turn of the twenty-first century. These financing mechanisms have gained popularity among mining companies, particularly small- and medium-scale companies, and during periods of economic uncertainty and volatile metal prices. For these companies, these financing options provide an alternative to traditional debt or equity financing, allowing them to access capital while minimising financial risks.4

2.1 Key Features of Metals Streaming and Royalty Financing Arrangements

Metals Streaming

10In a metals streaming agreement, a streaming company provides upfront financing to a mining company. In exchange for this capital infusion, the streaming company gains the right to purchase a portion of the mining project’s future metal production at a predetermined fixed price (Carmichael and Edmonson, 2015). This fixed price is often set at a significant discount to the prevailing market price of the metal, allowing the streaming company to lock in a cost advantage. The mining company continues to operate the mine and is responsible for exploration, development, and production activities. The streaming company does not participate in operational aspects but may have certain off-take rights to purchase and market the metal production.

11Once the mining project is operational and begins producing metals, the streaming company receives its predetermined share of the metal produced. This continues until the streaming company has received the agreed quantity of metal, as specified in the contract.

12Metals streaming arrangements are usually long term, with agreements spanning several years or even decades. The streaming company’s revenue primarily comes from the difference between the fixed purchase price and the market price of the metals when sold. If metal prices rise above the fixed price, the streaming company benefits from the upside potential.

Royalty Financing

13Royalty financing, also known as mining royalties or metal royalties, involves a mining company granting a royalty company the right to receive a percentage of the revenue generated from the sale of metals produced from a specific mining project.

14Unlike metals streaming, the royalty company provides upfront capital to the mining company but typically does not receive its reward in metals. Instead, it receives a royalty based on a percentage of the gross sales revenue from the metals produced and sold. The royalty rate remains constant, but the actual royalty amount varies depending on metal prices and production levels (Hill, 2013).

15The mining company retains full control over the mining project’s operations and decision-making. The royalty company does not have ownership or participation in exploration, development, or production activities. Royalty payments are typically made on a regular basis (monthly, quarterly, or annually) and are calculated based on the gross value of metal sales. The royalty is treated as an expense for the mining company, reducing its taxable income.

16While metals streaming and royalty financing are similar in terms of the provision of an alternative source of capital for the mining company, they have distinct characteristics and contractual features. These are highlighted in Table 4.1.

Table 4.1 Distinguishing features of metals streaming and royalty financing.

Metals streaming

Royalty financing

Nature of the agreement

The streaming company provides upfront capital to the mining company in exchange for the right to purchase a percentage of the future metal production at a predetermined fixed price. The streaming company becomes entitled to receive a portion of the mined metal (usually at a discount to market price) until the agreed quantity is delivered.

The mining company grants the royalty company the right to receive a percentage of the revenue generated from the sale of metals produced from a particular mining project. The royalty company typically does not receive any metal from the mining operation. Instead, it receives a share of the revenue (royalty) based on the gross sales of the metals.

Degree of involvement in operations

Streaming companies often have greater involvement in the mining project. They may participate in off-take agreements, have a say in certain operational decisions and provide technical expertise to optimise the extraction process.

Royalty companies typically do not participate in the operational aspects of the mining project. They do not have ownership or control over the mining operation and are not involved in day-to-day decision-making.

Price determination

In streaming agreements, the price at which the streaming company purchases the metal is fixed at the time of the agreement. This fixed price is often set at a discount to the prevailing market price of the metal.

Royalties are typically based on a percentage of the gross sales revenue from the sale of metals. The royalty rate remains constant, but the actual royalty amount received by the royalty company varies with changes in metal prices and production levels.

Risk–return profile

Metals streaming offers more direct exposure to the mining operation’s production levels and metal prices. The streaming company shares both the upside potential and the downside risks associated with fluctuations in metal prices and production.

Royalties provide a more stable income stream for the royalty company, as the royalty is based on revenue generated from metal sales. The royalty company does not bear the same level of operational and commodity price risks as the mining company.

Tax treatment

From an accounting perspective, metals streaming arrangements are often treated as a form of debt for the mining company. The upfront payment from the streaming company is considered a liability, and the future metal deliveries are treated as repayments of this debt.

Royalty payments are treated as expenses for the mining company, reducing its taxable income. For the royalty company, the received royalties are treated as revenue.

Source: Adapted from Monk, Edwards and Bray (2014) and Turner (2015).

17The following examples provide more insight into how metals streaming and royalty financing agreements work. They are hypothetical examples drawn from known metals streaming and royalty financing agreements and are simplified for illustrative purposes.

Illustrative example—Nickel streaming agreement.

The mining company (MiningCo): MiningCo operates a nickel mine with substantial proven reserves. The company requires additional funding to expand its mining operations.

The streaming company (StreamCo): StreamCo is looking to invest in mining projects and gain exposure to the potential upside of nickel production without directly engaging in mining activities.

Terms of the streaming agreement:

  • Streaming percentage: StreamCo agrees to provide MiningCo with USD 50 million upfront in exchange for the right to purchase 20 per cent of the nickel produced from the mine over a specific period, say ten years.

  • Fixed price: the price for the nickel is set at USD 10,000 per tonne, regardless of the prevailing market price during the streaming agreement’s duration.

Mining operations and production: over the next ten years, MiningCo successfully operates the nickel mine, producing a total of 500,000 tonnes of nickel during the streaming period.

Metal price movement: At the start of the streaming agreement, the market price of nickel is USD 10,500 per tonne. Over the 10-year period the market price of nickel fluctuates, and increases to USD 11,000 per tonne.

Revenue calculation: MiningCo delivers 100,000 tonnes (20 per cent of total production) of nickel to StreamCo under the streaming agreement. StreamCo resells the nickel in the market at the prevailing market price.

MiningCo generates revenue of USD 1 billion from selling 100,000 tonnes of nickel to StreamCo (100,000 tonnes x USD 10,000 per tonne). However, if MiningCo had sold the same 100,000 tonnes of nickel at the final market price of USD 11,000 per tonne, it would have earned USD 1.1 billion in revenue. StreamCo resells the nickel in the market at the final market price of USD 11,000 per tonne, generating revenue of USD 1.1 billion, and achieving a profit of USD 100 million.

The host government’s royalty revenue will be based on MiningCo’s revenue from selling nickel to StreamCo at the fixed price.

Illustrative example—Nickel royalty financing agreement.

MiningCo is the same as in the streaming example above.

The royalty financing company (RoyaltyCo) is a financing company that specialises in providing royalty-based funding to mining projects, aiming to earn a return based on a percentage of the revenue generated by the mining company.

Terms of the royalty financing agreement:

  • RoyaltyCo agrees to provide MiningCo with USD 50 million in financing in exchange for a royalty payment of 2 per cent on the revenue generated from nickel sales for a specific period of ten years.

  • Unlike the streaming agreement, there is no fixed price at which the nickel is sold under the royalty financing agreement. The royalty is calculated based on the actual revenue generated from nickel sales.

Over the next ten years, MiningCo produces 500,000 tonnes of nickel during the royalty financing period, and at the start of the royalty financing agreement the market price of nickel is USD 10,500 per tonne. Over the 10-year period the market price fluctuates, and increases to USD 11,000 per tonne. MiningCo sells nickel in the market at prevailing market prices and generates USD 5.5 billion in revenue from the sale of 500,000 tonnes of nickel. Based on the royalty percentage of 2 per cent on revenue, MiningCo pays RoyaltyCo a total of USD 110 million in royalties (2 per cent of USD 5.5 billion) over the 10-year period.

The host government’s revenue is based on the actual revenue generated from selling all the 500,000 tonnes of nickel irrespective of the prevailing market price.

18The above illustrations highlight some of the possible advantages and disadvantages of either financing arrangement, particularly from the perspective of the mining company and the host government seeking a fair share of the financial benefits from the extraction of its minerals.

2.2 Advantages and Disadvantages

19Metals streaming and royalty financing offer distinct advantages and disadvantages to mining companies, investors, and to government owners of the mining assets. These alternative forms of financing provide needed early—and potentially cheaper—capital for project development, and typically do so without having to dilute the ownership of the mining company. On the other hand, and in addition to other factors, they potentially limit the extent to which both the mining company and the government benefit from increases in profitability due to higher prices. The following tables, Tables 4.2 and 4.3, describe these advantages and disadvantages in more detail.

Table 4.2 Advantages and disadvantages of metals streaming.

Advantages

Disadvantages

Non-dilutive capital: Metals streaming provides mining companies with upfront capital without diluting existing shareholders’ ownership. This allows mining companies to finance their projects without issuing additional equity, preserving shareholders’ value. Metals streaming provides mining companies with an attractive financing option, as it offers upfront capital without the need for diluting equity or incurring debt. For the streaming company, it presents an opportunity to secure a consistent supply of precious metals at discounted prices.

Loss of upside potential: If metal prices increase significantly above the fixed price specified in the streaming agreement, mining companies and, by implication, governments may miss out on potential profits they could have gained by selling metals at higher market prices.

Convenience: Streaming companies typically offer financing at a discount to the prevailing market price of metals. As a result, mining companies may secure easier access to funding, sometimes at a lower cost, compared to traditional debt financing.

Reduced profit margins: Streaming companies benefit from purchasing metals at a discounted fixed price, which may reduce mining companies’ profit margins compared to selling metals at market prices.

Predictable revenue streams: For streaming companies, the fixed-price arrangements ensure predictable future revenue streams based on the agreed-upon quantity of metal to be purchased. This offers stability and predictability in their income streams.

Complex contractual arrangements: Negotiating and executing streaming agreements can be complex and time-consuming, involving extensive legal and financial due diligence. The terms of the contract must be carefully evaluated to ensure fair and equitable terms for all parties.

Operational flexibility: Mining companies can retain control over their mining operations and decision-making. The involvement of streaming companies is often limited to the off-take rights and technical expertise, allowing producers to manage their projects independently.

Ongoing commitment: Metals streaming agreements often span multiple years or even decades. Mining companies are committed to delivering the agreed-upon quantity of metals, which may impact their future operational flexibility.

Hedge against price risk: For mining companies, metals streaming can act as a price hedge. By selling a portion of future production at a fixed price, producers can reduce exposure to fluctuating metal prices, mitigating revenue volatility.

Source: the author.

Table 4.3 Advantages and disadvantages of royalty financing.

Advantages

Disadvantages

Stable income stream: Royalty financing offers a stable income stream for royalty companies as royalty payments are based on a percentage of metal sales revenue. This consistently provides some measure of consistent cash flow, regardless of metal prices. They also provide early (and arguably stable) funding for the mining company to carry out its development programme.

Limited potential for upside gain: Similar to metals streaming, royalty financing restricts the gains to the mining company from potential price increases as a result of having to pay the royalty company a fixed percentage of sales revenue, irrespective of changes in metal prices.

Minimal operational involvement: Royalty companies do not participate in the mining project’s operational activities, reducing their exposure to operational risks and complexities. This also works to the mining company’s benefit in the sense that there is less operational interference.

Risk of production decline: If the mining project’s production declines, the royalty company’s revenue will also decrease, potentially affecting its income stream.

Volatile cash flow: While royalty financing offers stable income, it may still be subject to variations in production and metal prices, leading to fluctuations in cash flow.

Tax benefits: Royalties paid by mining companies are considered expenses, reducing their taxable income, which can result in tax benefits for the producer.

Source: the author.

20While metals streaming provides upfront capital and a potential hedge against price risk for producers, it could also limit the upside potential for both the mining company and the host government. On the other hand, royalty financing offers stable income streams and diversification opportunities for investors but may lack direct exposure to metal price increases.

21For the governments of resource-rich countries where the mining operations take place, the advantages of such alternative forms of financing include increasing momentum for mining activity, stimulating investment, and the related potential multipliers from such investments. Another advantage for governments is the potential for earlier revenue flows if these forms of financing result in earlier investment and earlier production. This can prove significant especially in low-income countries. In addition to the potential for reduced revenue and participation in the upside, the disadvantages include potential reduction in oversight capability for the project, and exposure to challenges and risks ranging from a lack of transparency to risk of pricing manipulation (see Section 4).

3. Framework for Analysing the Impact of Metals Streaming and Royalty Financing on Government Revenue

3.1 Government Revenue Impact

22The net impact of these alternative forms of financing, from a government perspective, is a limit on the government’s ability to participate in the upside when mineral prices rise. This may not necessarily always be the case for metals streaming or royalty financing compared to the more traditional forms of equity and debt funding, or compared to other opportunity costs that may be particular to each country’s circumstance.

23Each option has implications and trade-offs for policymakers to consider, particularly with regard to the incidence of fiscal burden—so, when the financial benefit–sharing instruments take effect. Metals streaming typically reduces the government’s share of early revenues from mining royalties, while the impact of royalty financing is typically felt later on in the process and on pre- or post-tax profits.

24This section offers a simplified approach to assessing the potential impact of metals streaming and royalty financing on government revenues. Subject to the availability and quality of information, a revenue impact ratio can be determined by comparing the potential revenues to the government from more traditional forms of financing with the potential revenues to the government from metals streaming or royalty financing.

25Consider a mining investment model whose anticipated production profile, anticipated costs, forecast mineral prices, expected revenues, financing structures and costs and government fiscal impositions (fees, royalties and taxes) have been analysed for the life of the project using the discounted cash flow (DCF) method. Such models can be analysed in scenarios that include the investment being funded by equity only, and with varying combinations of debt and other alternative forms of financing.

26A revenue impact observation can be made from such analysis by comparing the total revenues to the government in a base case (e.g. assuming full equity financing or assuming a conventional combination of debt and equity) with total revenues to the government with the alternative form being considered (in this case, the metals streaming or royalty financing option). All things held equal, the higher number in the comparison could be deemed more favourable to the government.

3.2 Illustrative Example of Metals Streaming’s and Royalty Financing’s Impact on Host Government Mining Revenues

27Using the illustration provided in Section 2.1, a simplified framework can be developed to demonstrate the revenue impact. Tables 4.4 and 4.5 summarise the calculation of the impact of a metals streaming financing option. It assumes costs, prices and revenue streams for the life of the mine, but for illustrative purposes is captured as if it were in one period.

Table 4.4 Distribution of royalties and taxes based on a metals streaming arrangement.

Key assumptions

Amount

Description

Volume of mineral produced

500,000

Assumed volume of minerals produced, in tonnes

Fixed price per tonnes

USD 10,000

Assumed agreed fixed price per tonne for the streaming volumes

Stream percentage agreed

20%

Assumed agreed percentage of minerals produced to deliver to StreamCo

Stream volume agreed

100,000

Calculated volume of minerals (in tonnes) based on stream percentage agreed

Price (per tonne) at the end of period

USD 11,000

Assumed market price of mineral (per tonne) at the end of the period

Government royalty rate

5%

Ad valorem royalty rate assumed

Corporate tax rate

30%

Corporate tax rate assumed

Costs and allowable deductions

40%

Assumed costs and allowable deductions as a percentage of minerals produced

Calculation of total revenues to the government

Gross revenues (total)

USD 5,500,000,000

Volume of minerals produced multiplied by assumed market price at period end

Streaming revenues from stream volumes at agreed price

USD 1,000,000,000

Agreed fixed price multiplied by agreed stream volume

Streaming revenues from stream volumes at period end price

USD 1,100,000,000

Agreed stream volume multiplied by assumed market price at period end

Streaming profit for StreamCo

USD 100,000,000

Difference between streaming revenues at agreed price and at period end price

Available revenues for benefit sharing between MiningCo and the government

USD 5,400,000,000

Difference between gross revenues (total) and streaming profit for StreamCo

Less government royalty

USD 270,000,000

5% of available revenues for benefit sharing

Net revenue

USD 5,130,000,000

Available revenues for benefit sharing less government royalty amount

less Costs and allowable deductions

USD 2,052,000,000

Costs and allowable deductions fraction multiplied by net revenue

Taxable income/profit

USD 3,078,000,000

Net revenue less calculated costs and allowable deductions

Less corporate tax

USD 923,400,000

Corporate tax rate multiplied by taxable income/profit

Net profit

USD 2,154,600,000

Taxable income less corporate tax amount

MiningCo share of profits

USD 2,154,600,000

Net revenue, less costs and allowable deductions, less corporate tax

Government share of profits (R1)

USD 1,193,400,000

Royalty plus corporate tax

Source: the author.

28A similar calculation can be carried out for the royalty financing option.

Table 4.5 Distribution of royalties and taxes based on a royalty financing arrangement.

Key assumptions

Amount

Description

Volume produced

500,000

Assumed volume of minerals produced, in tonnes

Initial mineral price per tonne

USD 10,500

Assumed initial price per tonne at the start of the agreement

Royalty payment percentage agreed

2%

Assumed percentage of revenue generated from mineral sales for the agreed period

Royalty volume implied

10,000

Calculated volume of minerals (in tonnes) based on royalty payment agreed

Price at the end of period

USD 11,000

Assumed market price of mineral (per tonne) at the end of the period

Government royalty rate

5%

Ad valorem royalty rate assumed

Corporate tax rate

30%

Corporate tax rate assumed

Costs and allowable deductions

40%

Assumed costs and allowable deductions as a percentage of minerals produced

Calculation of total revenues to the government

Gross revenues (total)

USD 5,500,000,000

Volume of minerals produced multiplied by assumed market price at period end

Royalty revenues to RoyaltyCo from royalty volumes at prevailing price

USD 110,000,000

Agreed fixed price multiplied by agreed stream volume

Royalty revenues to RoyaltyCo from royalty volumes at period end price

USD 110,000,000

Agreed royalty volume multiplied by assumed market price at period end

Available revenues for benefit sharing between MiningCo and the government

USD 5,500,000,000

Unchanged. Government revenue is based on gross revenue from total volumes

Less government royalty

USD 275,000,000

5% of available revenues for benefit sharing

Net revenue

USD 5,225,000,000

Available revenues for benefit sharing less government royalty amount

Less costs and allowable deductions

USD 2,200,000,000

Costs and allowable deductions fraction multiplied by net revenue, plus royalty payment to RoyaltyCo (which is a deductible cost for tax purposes)

Taxable income/profit

USD 3,025,000,000

Net revenue less calculated costs and allowable deductions

Less corporate tax

USD 907,500,000

Corporate tax rate multiplied by taxable income/profit

Net profit

USD 2,117,500,000

Taxable income less corporate tax amount

Mining company share of profits

USD 2,117,500,000

Net revenue, less costs and allowable deductions, less corporate tax

Government share of profits

USD 1,182,500,000

Royalty plus corporate tax

Source: the author.

  • 5 Also not included in this illustration is the potential impact of different discount rates for the (...)

29A third scenario can be considered, using traditional equity/debt financing. This is not included in this simplified illustration.5

30A simple comparison of the government share of profits from each option would suggest that the metals streaming option yields a higher share of the financial benefits to the government than the royalty financing option. It is, however, important to note that both approaches can be calibrated to yield the same government share of profits. For example, changing the agreed royalty payment percentage from 2 per cent to 1.3 per cent will yield the same government share of profits as would the metals streaming option illustrated here. Both options can yield the same level of fiscal burden, but they differ in incidence.

31In this illustration, and typically, metals streaming reduces the royalty income to the government compared to royalty financing, which does not. This is, particularly in the context of early fiscal receipts assurance, key to the design and implementation of fiscal regimes, especially for developing countries.

32Corporate tax receipts to the government appear higher with the metals streaming approach than with royalty financing, due also to the incidence of their occurrence. However, neither financing approach negates the possibility of the project cost profile being higher or overstated and thus reducing the tax base.

33Both the metals streaming and the royalty financing approach could reduce the tax base for a resource-rich country and could increase the pressure on tax administrations to limit tax leakage. In dealing with base erosion and profit shifting risks, governments are aware of the challenges associated with metals streaming and royalty financing agreements and many have taken steps to address these concerns, if only in a more general sense. Many countries have transfer pricing regulations, for example, that require companies to use arm’s-length prices in their transactions with related parties. However, enforcing these regulations can be complex, as metal stream financing and royalty agreements generally have unique features and there are few publicly available for benchmarking to help define and strengthen their regulation.

34The challenges and risks that governments must mitigate in this regard are not new. They are summarised in the following section. They are, however, arguably likely to be more pronounced given the background provided in Section 1.1 with regard to growing demand for critical minerals and the potential revenue streams that would likely be created as a result of rapid increases in exploration and production activity. The more alternative financing tools such as metals streaming and royalty financing are introduced, the more resource-rich governments are exposed to the risk of losing out on potential revenues, particularly in the event of high metals prices.

4. Challenges and Risks for Governments

35The ultimate risk faced by resource-rich governments as a result of an increase in the use of metals streaming and royalty financing arrangements is a suboptimal share of the potential benefits that will accrue from the mining operations. Specifically, the risk is of a reduction in taxable income and royalty revenue. This risk arises due to the specific structures and pricing mechanisms of these financing arrangements. It can occur through a number of channels, most of which are widely covered in the literature on base erosion and profit shifting (BEPS) (see, for example, the extensive work by the Organisation for Economic Co-operation and Development (OECD) on the Inclusive Framework for BEPS, including OECD 2022 on transfer pricing guidelines). These channels can be summarised as follows:

  1. Absence of clear legislative rules: This pertains to the extent to which metals streaming or royalty financing (or indeed any other form of financing) agreements are clearly catered for in the relevant legislation, particularly the income tax law. This is not immediately obvious in mining taxation laws in resource-rich countries. There is room for more clarity regarding such questions as whether the streaming or royalty transaction is to be treated as debt, if the transaction is a financial derivative contract (Turner, 2015), or what price will prevail for all minerals produced irrespective of the agreed price between the streaming company and the mining company. Depending on the jurisdiction and tax treaties in place, the structure of metals streaming and royalty financing may impact the application of withholding taxes on payments made to foreign entities. If royalties or streaming payments are structured in ways that reduce or avoid withholding taxes, the host government may lose an essential revenue source.

  2. Lack of transparency: Most of the challenges governments face in dealing with the ultimate risk from metals streaming and royalty financing can be characterised as an information asymmetry problem. The complexity of, and lack of transparency in, metals streaming and royalty financing arrangements can make it difficult for tax authorities to assess and monitor the appropriate tax liabilities of mining and financing companies. Insufficient reporting may lead to underreporting of income and erosion of the host government’s tax base. This lack of transparency may lead to difficulties in identifying potential tax risks and ensuring compliance with tax regulations. Furthermore, in jurisdictions with relatively weak regulatory and institutional frameworks for metals streaming and royalty financing, loopholes can be exploited for illicit financial activities such as money laundering.

  3. Risk of transfer pricing manipulation: In metals streaming and royalty financing, the pricing of metals or royalties can be a point of contention, especially if there are related-party transactions within multinational corporate groups. There is a risk of transfer pricing manipulation, wherein the streaming or financing company (if a related party) sets prices at non-arm’s-length levels to shift profits and reduce taxable income in the host country, leading to lower tax revenues. Also, streaming companies may engage in contractual arrangements that give them influence or control over the mining company’s operations. This control can allow the streaming company to influence the cost structure of the mining operations or dictate sales and marketing decisions, further impacting the profitability and revenues of the mining company.

    • 6 Thin capitalisation refers to excessive debt financing relative to equity, allowing companies to de (...)

    Risk of profit shifting and thin capitalisation: Metals streaming deals can be used as a mechanism for BEPS, wherein multinational companies exploit gaps in tax rules to shift profits to low-tax jurisdictions (Grynberg and Singogo, 2021). Streaming companies may establish subsidiaries in tax havens to receive streaming revenues, diverting profits away from the jurisdiction where the mining operation takes place and reducing the tax base for the host government. Streaming companies may structure financing arrangements using complex intercompany transactions, which could lead to profit shifting and thin capitalisation.6

  4. Artificially reduced taxable income: In metals streaming agreements, the mining company may receive upfront payments at a fixed or discounted price for future metal production. This can result in an artificially reduced taxable income for the mining company, as it recognises less revenue compared to what it would have received if it had sold metals at market prices, as illustrated in Section 3.2. The reduced taxable income leads to lower corporate income tax payments, eroding the host government’s tax base. In royalty financing arrangements, the royalty payments made by the mining company to the financing company are typically deductible as operating expenses for tax purposes. However, the deductibility of royalties can result in reduced taxable income and lower tax payments for the mining company, leading to a decrease in the host government’s tax base.

36Governments might face challenges in predicting long-term revenue stability from metals streaming or royalty financing deals due to uncertainties in metal prices and production levels. The fixed-price nature of streaming agreements may not allow governments to fully participate in the upside during periods of high metal prices, potentially impacting budget planning and fiscal management.

37In addition, the upfront payments made in metals streaming or royalty financing arrangements could be vulnerable to money laundering schemes, where funds are illicitly transferred through complex financial networks to conceal their origin. There is also a risk of bribery and corruption in the negotiation and execution of these arrangements, which could lead to the diversion of funds for personal gain whilst bypassing regulatory scrutiny.

38In general, resource-rich governments risk receiving a lower share of the economic rent from mining operations through streaming and royalty arrangements. By selling future metal production at a predetermined price, mining companies can potentially retain a greater share of the profits generated during periods of high metal prices, reducing the government’s ability to capture resource rents. By deducting repayments in accordance with the royalty financing deal, the government’s tax base is limited and the financial benefit–sharing outcome is potentially suboptimal. The following section identifies possible policy considerations for governments.

5. Conclusion and Policy Considerations

39As previously stated, the financial benefit–sharing challenges potentially exacerbated by an increase in the deployment of alternative financing methods such as metals streaming or royalty financing are not necessarily new to governments. What is different is the scale at which these challenges will manifest themselves, particularly given the growing demand for critical minerals to fuel the energy transition.

40To address these challenges, governments need to strengthen their regulatory frameworks, enhance tax enforcement, and foster greater transparency in the negotiation and execution of metals streaming agreements. Collaborative efforts between governments, international organisations and mining companies remain crucial to the mitigation of the risks associated with metals streaming and royalty financing and ensuring fair and sustainable outcomes for all stakeholders.

41At the heart of the policy considerations of efforts to resolve these challenges and risks is reducing information asymmetry between the government, the mining company and the streaming or royalty company. One important way to do this is to strengthen tax legislation and enforcement mechanisms. Implementing anti-avoidance rules, such as interest limitation rules (see, for example, the OECD list of countries with various forms of interest limitation rules), can limit the ability of metals streaming and royalty financing companies to exploit tax loopholes. Other features that would strengthen the legislation include clear minerals pricing rules, and clearer provisions regarding withholding taxes.

42Governments can impose robust transfer pricing documentation requirements on mining and financing companies engaged in related-party transactions. This includes maintaining detailed documentation supporting the arm’s-length nature of pricing in metals streaming and royalty financing agreements. Adequate documentation reduces the risk of transfer pricing manipulation and enhances tax authorities’ ability to assess transactions fairly. This also includes incorporating transfer pricing methodologies featured in such instruments as advance pricing agreements into the regulatory framework.

43The growth in demand for critical minerals for the energy transition, and the increasing importance of resource-rich governments ensuring they do not miss out on the financial benefits to be generated from this growth, raises the importance of natural resource taxation instruments outside of the conventional royalty and tax framework. For example, state participation (through equity ownership, state-owned enterprise direct involvement, and production sharing) is considered as one of the policy choices that could feature more prominently in the future of mining taxation (Readhead et al., 2023).

44Lastly, regular audits and requests for detailed documentation from all parties (mining companies and streaming and royalty companies) to substantiate their pricing decisions are necessary to mitigate transfer pricing risk. Such documentation would include comparable transaction data, financial analyses and evidence supporting the valuation of metal prices in streaming contracts. The application of such simple assessments as the government revenue impact ratio could prove a useful additional tool in this regard. Active modelling of scenarios, using statutorily required information such as mining plans or mine development plans, can be utilised in the determination of the government revenue impact analysis or in other means of comparing options in advance of approving these transactions where the government is able to do so. This, in combination with other policy measures, could mitigate the ultimate risk of a suboptimal outcome from metals streaming or royalty financing.

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References

Bellois, G. and I. Ramdoo (2023) Searching for Critical Minerals? How metals are produced and associated together (Winnipeg: Intergovernmental Forum on Mining, Minerals, Metals and Sustainable Development - IGF), https://www.iisd.org/system/files/2023-04/searching-critical-minerals-how-metals-are-produced-together.pdf (accessed on 17 July 2023).

Careaga, A. (2012) Mineral Royalty Stream Financing (Bellingham: Wealthmark LLC).

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Notes

1 For the purpose of this chapter, critical minerals refer to minerals such as copper, lithium, nickel, cobalt and rare earth elements that are essential components of clean energy technologies. The term ‘critical minerals’ is used interchangeably with ‘energy transition minerals’ in the chapter.

2 These metals are chromium, refined cobalt, refined copper, gold, lead, molybdenum, palladium, silver, uranium, vanadium, zinc and zirconium.

3 It is important to note that not all metals streaming or royalty arrangements are linked to illicit financial flows, as many are legitimate and commonly used practices, oftentimes through publicly listed companies. However, the complexity and confidentiality associated with some of these financial arrangements may create opportunities for abuse, especially given the anticipated growth in mining activity.

4 It is useful to note that, in practice, the principles and features of metals streaming are similar to the practice of resource-backed loans in the oil and gas industry. For example, commodity traders act as financiers where they offer loans either using future oil shipments as collateral or using a portion of the oil shipments as a form of repayment. See, for example, George and Zhdannikov (2016), Farchy and Blas (2021) and Trafigura (2020).

5 Also not included in this illustration is the potential impact of different discount rates for the government and the investor. These are excluded for simplicity.

6 Thin capitalisation refers to excessive debt financing relative to equity, allowing companies to deduct interest payments and reduce taxable income. This practice could result in reduced tax revenues for the host government.

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Cite this article

Electronic reference

Ekpen J. Omonbude, Metals Streaming and Royalty Financing: A Framework for Assessing Mining Sector Financial BenefitSharing Implications for GovernmentsInternational Development Policy | Revue internationale de politique de développement [Online], 17 | 2024, Online since 27 May 2024, connection on 16 June 2024. URL: http://journals.openedition.org/poldev/6233; DOI: https://doi.org/10.4000/11q98

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About the author

Ekpen J. Omonbude

Ekpen J. Omonbude is a senior policy adviser for the Intergovernmental Forum on Mining, Minerals, Metals and Sustainable Development in the Economic Law and Policy team. His work involves leading the research pillar of the Global Mining Tax Initiative and contributing to the delivery of technical assistance for governments. Omonbude is an energy and mineral resources economist with over two decades of experience in commercial banking, research, management, strategy, and capacity building for infrastructure development. A decade of this experience was gained at the Commonwealth Secretariat and devoted to managing and delivering economic and policy support to Commonwealth countries in the mining, energy and infrastructure sectors. Omonbude holds a PhD in Petroleum Policy and Economics from the University of Dundee, Scotland, a Master’s in Business Administration from the University of Abertay, Scotland, and a Bachelor’s degree in Economics and Statistics from the University of Benin, Nigeria.

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