Royalties and Streams Explained

Royalties are ongoing 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 prices as well as increases in Mineral Reserves and production.
• In some cases, they provide an interest in new discoveries made on a property which can result 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 energy 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 allow the holder of the agreement to purchase all or a portion of the gold, silver or other products from a mine in exchange for an upfront payment and an additional payment on each delivery. 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.

How we Estimate “Royalty Ounces” 

Franco-Nevada’s mining properties that have reported Mineral Reserves and Mineral Resources are tabulated in the Mineral Reserves and Resources appendix of the 2021 Asset Handbook. Unless otherwise noted, the figures are tabulated based on the publicly disclosed reports of each operator for each property on a 100% basis. However, the tabulation does not provide a specific measure for Franco-Nevada’s interest in such Mineral Reserves and Mineral Resources for the following reasons:

• Not all of Franco-Nevada’s assets cover the entire property associated with the operator’s publicly reported figures and Franco-Nevada is not in a position to report separate Mineral Reserves and Mineral Resources figures for those properties.
• As demonstrated on the previous pages, royalty and stream interests have different economics than an operator has for its stated Mineral Reserves and Mineral Resources. In addition, the economics differ between NSR, NPI and stream interests and by property and would need to be factored to be comparable to each other or to an operator’s interest.
• Directly attributing specific Mineral Reserves and Mineral Resources to Franco-Nevada may not be appropriate if the operators are not in turn deducting royalty and stream interests from their own publicly reported numbers and may lead to two companies quoting the same Mineral Reserves and Mineral Resources.

Franco-Nevada is providing guidance to analysts and investors on how the Company estimates the Royalty Ounces on a broad range of its assets. The objective of a Royalty Ounce for any property is that it should be a reasonable comparison to a calculation of the number of attributable NSR royalty ounces that Franco-Nevada might have with a typical straight forward gold royalty covering all of the reported operator Mineral Reserves and Mineral Resources. The use of Royalty Ounces provides a common basis of comparison between different asset types and royalty property coverages. To achieve comparable Royalty Ounce figures, guidance and adjustments are required from Franco-Nevada management in the following circumstances:

1. The royalty or stream property does not cover all the operator‘s reported Mineral Reserves or Mineral Resources.
Franco-Nevada’s management will provide its best estimation for each asset as to the appropriate percentage of Mineral Reserves and Mineral Resources that should be factored to estimate the equivalent Royalty Ounces.

2. A stream interest with an associated ongoing cost per ounce.
The number of attributable stream ounces will be factored to make them economically equivalent to an NSR ounce. In the example demonstrated in the previous section, for a $1,750 gold price and a $400 cost per ounce, the stream ounces are factored by 77% to become comparable to NSR equivalent ounces of Royalty Ounces. The factor depends on cost per ounce or % margin written in the agreement.

3. An NPI royalty.
An NPI is subject to the operating and capital costs specific to each asset. For planning purposes, Franco-Nevada’s management generates its own internal mine life projections for each of its assets in order to determine its own reasonable estimates. Franco-Nevada management has provided its best estimation as to the economically equivalent NSR rate using a $1,750 gold price assumption.

4. An asset producing silver, PGM or base metal.
The number of attributable silver, platinum or palladium ounces and attributable base metals pounds are converted into Royalty Ounces. The pricing assumptions for conversion include: $1,750 per ounce gold, $25 per ounce silver, $1,100 per ounce platinum, $2,200 per ounce palladium, $3.0 per pound copper, $7.00 per pound nickel and $0.95 per pound ferrochrome. In addition, NSR deductions can be more material for certain assets subject to deductions such as smelting and refining charges. For copper, nickel and ferrochrome Royalty Ounce calculations, deductions are more material compared to a typical gold NSR asset.

Why we Measure “Royalty Ounces” 

The traditional royalty on a mining property provides Franco-Nevada with a simple percentage of the revenue or gold-in-kind produced from that property. As operators report Mineral Reserves and Mineral Resources on their properties, it is useful to consider how much gold Franco-Nevada might ultimately receive. For instance, Franco-Nevada has a 2% royalty on the Detour Lake property. The operator of Detour Lake currently reports a Mineral Reserve of 15.78 million ounces and a Measured & Indicated Mineral Resource that includes the Mineral Reserve of 20.43 million ounces. The royalty ounces attributable to Franco-Nevada’s 2% are between 316,000 to 409,000 ounces. Multiplied by a $1,750 gold price, Franco-Nevada can realistically expect to realize going forward $553 to $716 million from its Detour Lake royalty on an undiscounted basis. Already owned royalty ounces are effectively “cost free” ounces to Franco-Nevada. We refer to these as “Royalty Ounces”.

Technically, some adjustments should be made for recoveries and refining fees. However, our experience is that operators continue to drill their properties over the life of their mines and each year add further ounces more than offsetting such adjustments. Also, our experience is that operators will, on average, convert more than the original Mineral Resources into Mineral Reserves over the life of an operation. For instance, over the 13 years from our IPO, the original royalty portfolio of 176 assets we acquired has seen Mineral Reserves increase by approximately 236% including depletion. We believe that measuring our Royalty Ounces associated with the Measured & Indicated Mineral Resources is a conservative estimate of what Franco-Nevada is likely to realize from a property.

Adding up these Royalty Ounces from all of Franco-Nevada’s mining properties that have measurable Mineral Reserves and Mineral Resources provides an investor the ability to apply their own gold price assumptions to determine the potential undiscounted value of Franco-Nevada’s portfolio. The risk associated with any one property is mitigated by the fact that the risk is diversified with 67 different mining projects included in Franco-Nevada’s current estimates in the 2021 Asset Handbook. Also, there are a further 252 advanced and exploration projects not included in the estimates that add considerable optionality for further ounces in the future. Our experience is that each year some of these projects will advance enough to be included as Royalty Ounces.

Compared to a gold exchange traded product, an investment in Franco-Nevada provides the opportunity to get gold exposure at a discount as well as a yield and gold exploration optionality. Franco-Nevada also has an energy segment that has historically more than covered overheads, cash taxes and part of the dividend.

Some royalties and streams are not “cost free”. Net profit royalties have substantial deductions. Streams often require a significant per ounce payment. The following sections describe the differences between various royalties and streams and the steps we have taken to convert those assets into comparable “cost free” Royalty Ounces.