Types of Royalties
TYPES OF ROYALTIES AND OTHER INTERESTS
A royalty is a payment to a royalty holder by a property owner or an operator of a property and is typically based on a percentage of the minerals or other products produced or the revenues or profits generated from the property. The granting of a royalty to a person usually arises as a result of: (i) paying part of the consideration payable to prospectors or junior mining companies for the purchase of their property interests; (ii) providing capital in exchange for granting the royalty; or (iii) converting a participating interest in a joint venture relationship into a royalty.
Royalties are not working interests in a property. Therefore, the royalty holder is generally not responsible for, and has no obligation to contribute additional funds for any purpose, including, but not limited to, operating or capital costs, or environmental or reclamation liabilities. Typically, royalty interests are established through a contract between the royalty holder and the property owner, although many jurisdictions permit the holder to also register or otherwise record evidence of a royalty interest in applicable mineral title or land registries. The unique characteristics of royalties provide royalty holders with special commercial benefits not available to the property owner because the royalty holder enjoys the upside potential of the property with reduced risk.
The majority of revenues that Franco-Nevada receives are royalties based on revenues from the value of production. The key types of revenue-based royalties are described below:
Net Smelter Return ("NSR") royalties are based on the value of production or net proceeds received by the operator from a smelter or refinery. These proceeds are usually subject to deductions or charges for transportation, insurance, smelting and refining costs as set out in the royalty agreement. For gold royalties, the deductions are generally minimal while for base metal projects, the deductions can be much more substantial. This type of royalty provides cash flow that is free of any operating or capital costs and environmental liabilities. A smaller percentage NSR in a project can effectively equate to the economic value of a larger percentage profit or working interest in the same project.
Royalty Stream ("Royalty Stream") is a revenue-based royalty similar to an NSR except that, in the case of precious metals projects, rather than deducting the minimal deductions or charges of the smelter or refinery, a more substantial fixed deduction is applied often comparable to the cash cost of production. For instance, for the Palmarejo royalty, Franco-Nevada is paid for each ounce of gold less a fixed $400 deduction per ounce. A small inflation factor can be applied to the deduction. Royalty Stream structures are effective in co-product mines because they provide the operator with incentive to continue to produce the commodity subject to the Royalty Stream. They are also effective in putting into place financing structures which can support project debt financing. Given the higher deduction than in a typical NSR, these royalties have commodity leverage characteristics similar to low cost operators but without direct operating or capital cost inflation risk.
Gross Royalties ("GR") or Gross Overriding Royalties ("GOR") are based on the total revenue stream from the sale of production from the property with few, if any, deductions.
Overriding Royalties ("ORR") and Lessor or Freehold Royalties ("FH") are based on the proceeds from gross production and are usually free of any operating, capital and environmental costs. These terms are usually applied in the oil & gas industry.
Franco-Nevada also receives a portion of its revenues from royalties that are calculated based on profits, as described below:
Net Profit Interest ("NPI") or Net Proceeds Royalties ("NPR") are based on the profit realized after deducting costs related to production as set out in the royalty agreement. NPI or NPR payments generally begin after payback of capital costs. Although the royalty holder is not responsible for providing capital, covering operating losses or environmental liabilities, increases in production costs will affect net profit and royalties payable.
Franco-Nevada has a small number of fixed royalties. These are royalties that are paid based on a set rate per tonne mined, produced or processed basis or even a minimum for a period of time rather than as a percentage of revenue or profits. These types of royalties are more common for iron ore, coal and industrial minerals and do not have exposure to changes in the underlying commodity price.
The royalty types listed above can include additional provisions that allow them to change character in different circumstances or have varying rates. Some examples are as follows:
Minimum Royalty ("MR") is a provision included in some royalties that requires fixed payments at a certain level even if the project is not producing, or the project is producing at too low a rate to achieve the minimum.
Advance Minimum Royalty ("AMR") is similar to MR except that once production begins, the minimum payments already paid are often credited against subsequent royalty payments from production that exceeds the minimum.
Sliding Scale Royalty ("Sliding Scale") refers to royalties where the royalty percentage is variable. Generally this royalty percentage is indexed to metal prices, grade, capital repayment schedules or a production threshold. Generally, a minimum or maximum percentage would be applied to such a royalty.
Capped Royalty ("Capped") refers to royalties that expire or cease payment after a particular cumulative royalty amount has been paid or a set production volume threshold or time period has been reached.
Royalties can be commodity specific and, for instance, apply only to gold or hydrocarbons or have varying royalty structures for different commodities from the same property. Royalties can be restricted or varied by metallurgy, ore type or even by stratigraphic horizon. Generally, the contract terms for royalties in the oil & gas business are more standardized than those found in the mineral business.
A royalty interest is significantly different than a working interest ("WI") in that a holder of a WI is liable for its share of capital, operating and environmental costs, usually in proportion to its ownership percentage, and it receives its pro rata share of revenue. Minority working or equity interests are not considered to be royalties because of the ongoing funding commitments, although they can be similar in their calculations to NPIs or NPRs.