Royalties & Streams Explained
Royalties are ongoing economic interests in the production or future production from a property and, depending on their terms and the laws applicable to the royalty and the project, in general share the following characteristics:
- They are not subject to cash calls to fund exploration, development, capital, environmental or closure costs and so are lower risk in this respect than an operating interest.
- They provide exposure to the upside of commodity price, reserve and production increases.
- In some cases, they provide an interest on any major discoveries made on a property which has resulted in significant value creation for Franco-Nevada.
- They do not involve operational or development management so a large and diversified portfolio can be assembled without the need for significant corporate overheads.
The two most common royalty types are:
Revenue-based Royalties are based on the value of the production or net proceeds received by the operator with defined deductions as specified by the royalty contract. Some forms of revenue-based royalties in the mining and oil & gas industries are:
- “NSR” Net Smelter Return Royalty
- “ORR” Overriding Royalty
- “GR” Gross Royalty
- “FH” Freehold or Lessor Royalty
Profit-based Interest Royalties are based on the operating profit as defined in the royalty contract. Often, royalty payments only begin after the operator has recovered its capital costs. The net profits interest royalty (“NPI”) is the most common form of these royalties. Similar to an NPI, a net royalty interest (“NRI”) is paid net of operating and capital costs.
In addition to royalties, Franco-Nevada holds stream and working interests:
Streams are metal purchase agreements that provide, in exchange for an upfront deposit, the right to purchase
all or a portion of one or more metals produced from a mine at a preset price. Streams are particularly well suited
to co-product production providing significant value for by-product precious metal production. Streams are not royalties
because they are not an interest in land and there is an ongoing cash payment required to purchase the physical metal.
Working Interest (“WI”) holders have an ownership position in the property and operation and hence are liable for
cash calls on their share of capital, operating and environmental costs usually in proportion to their ownership percentage. Working interests are not considered to be royalties because of their ongoing funding requirements although, for profitable operations, they can be economically similar in their calculations to NPIs.
An example of the financial impact of each different structure is provided below.
Economics of NSR vs. Stream vs. NPI
The following is an example of the impact that commodity prices and cost assumptions have on the various structures that Franco-Nevada currently has. The examples assume:
- Gold price of $1,200/oz
- Stream interest has a predetermined ongoing cost of $400/oz
- “All in” operating and sustaining capital costs of $801/oz for a developed NPI/WI(1)
- 4% NSR, NPI or stream
CONCLUSION: Based on the above economics, a comparable percentage NSR is more than three times more valuable than an equivalent Developed NPI or WI and 50% more valuable than a stream interest. With changes to the gold price, the NPI or WI would demonstrate the most leverage while the NSR would provide the most down side protection. The stream provides commodity price leverage similar to a low cost operating company with more certainty as to future costs.