Banks and other financial institutions have become cautious about lending to the mining sector. Poor returns for gold miners in the past and concerns over ESG issues has meant that many traditional forms of finance are not always available, especially to junior and mid-tier mining companies. Many mining companies have turned to streaming contracts as an alternative source of finance.
In short, streams seek to monetise expected future production and assets from a venture. Of course this could be for anything that generates a predictable flow of assets and doesn’t have to be a commodity. Although typically applied to commodities, they could equally be applied to intellectual property assets such as music or books.
In the mining sector a streaming contract is an agreement to purchase all or part of a mine’s future production at a predetermined price, usually well below market value at the time of the contract.
The best way to think of it is an agreement to provide finance but the capital and interest is paid in gold. This gives them flexibility as they can then either sell the gold or store it to speculate on the price going up. In contrast, a royalty contract usually just gives holders a simple cut of the revenues from a mining operation. The royalty company never takes delivery of the gold but receives the proceeds from its sale.
Streaming deals typically start off being well protected. Contracts are based on the streaming company paying only between 20% and 30% of the prevailing commodity price for the ‘stream’ as it is delivered – so that their product ‘cash cost’ provides a very large profit margin when re-sold to recoup their loan. However, any subsequent reduction in the commodity price will reduce the absolute value of that margin.
Streaming contracts were originally used against the byproducts of a mine (e.g. gold is often a byproduct from copper mining) but which tends to be undervalued by traditional sources of finance. Initially focused on the precious metals markets, streaming has expanded into base metals like copper, nickel and zinc; energy opportunities including oil, gas and coal; and even rare earth metals and diamonds.
Streams have traditionally been negotiated for the life of a mine, with the terms of the deal based on a mine’s proven reserves. That means streamers get a windfall when companies successfully develop new reserves. As competition in the market has heated up mining companies have had mor room for negotiation. Increasingly, mining companies are adding buyback options on the streams or caps on the metal deliverable to streamers. This helps the mining company preserve more of the upside potential.
For the mining company, a streaming contract has both pros and cons. The upside is that the mining company has cash upfront which can mean the difference between the project being successful or not. The drawback is that the contract limits the potential upside in the commodity price, and it could reduce the perceived value of the mine to a prospective buyer somewhere down the line.
The value to investors is that they get exposure to the underlying commodity but without the risks of developing and operating a mine. Cost overruns hurt investors in precious metal miners. Cost overruns are irrelevant for stream holders; as long as the mine is producing then the streamers get their income stream.
In 2004 the first streaming deal created the streaming company Silver Wheaton, now known as Wheaton Precious Metals. Wheaton and Franco Nevada are focused on silver and gold projects in North and South America. The other three major streaming companies are Royal Gold, Osisko Gold Royalties and Sandstorm Gold. These large streaming companies hold a portfolio of different streaming opportunities so the risk of any particular mine not performing is mitigated.
Investing in the largest mine streaming companies has been a ridiculously good investment. The pioneer in the field, Wheaton Precious Metals is up 1,600% since 2004. In contrast, the largest publicly traded streaming company, Franco-Nevada has risen a mere 1,200% since it floated in 2007. The entire company is staffed by just over 40 employees making them more profitable than Apple or Google when assessed by earnings per employee.