Balancing Risk for Royalty Companies vs. Mining Companies
Risk is at the forefront of every company’s decision-making, especially for mining companies that operate large-scale mines in various jurisdictions.
While producing precious metals naturally carries a variety of risks, there is another way to get exposure to precious metals production with much lower risk: royalty companies.
Royalty companies provide up-front capital to miners in exchange for royalties on future mine production, providing a steady stream of revenue and precious metal exposure with far less risk attached to the company.
This graphic sponsored by Nomad Royalty looks at the risks royalty companies and mining companies face, and how royalty companies are able to mitigate and diversify with more flexibility to deliver stronger returns.
Trimming from the Top Line
By providing capital in exchange for a royalty or stream on a mine, royalty companies are an essential part of mine funding across the world. Along with competitively priced capital for mine developers, the lifetime royalties or streams received in return ensure royalty companies are invested in a mine’s lifelong success.
Mining royalty: A recurring percentage (typically between 0.5% to 3%) of revenue generated from a mine’s ore and mineral sales, paid out to the royalty holder.
Mining stream: An agreement for a recurring purchase of a percentage of a mine’s produced metals, at a previously agreed upon price (typically lower than the metal’s current market value). Typically mines will offer streams on metal by-products of the mine.
Royalties and streams are known as non-participating interests, meaning that the holders (royalty companies) have no obligation or expectation to further fund or assist with the mine’s production.
Along with this, royalties are from a mine’s top line revenue, meaning that the percentage given to royalty holders is calculated before operational expenses, sales costs, and other expenses are deducted. The difference between top line revenue and profit after expenses can be massive, changing the value of a royalty by millions of dollars.
| Year | Veladero Mine Revenue | Profit after AISC Deducted | 2.5% Royalty of Revenue | 2.5% Royalty of Profit |
| 2015 | $720M | $106M | $18M | $3.7M |
| 2016 | $685M | $252M | $17M | $6.3M |
| 2017 | $788M | $219M | $20M | $5.5M |
| 2018 | $732M | $90M | $18M | $2.3M |
| 2019 | $772M | $166M | $19M | $4.2M |
| 2020 | $666M | $62M | $17M | $1.5M |
Source: Mining Data Online
Both of these factors have a massive impact on the value of a royalty, as they ensure steady revenue shielded from the mine’s operational costs while requiring no maintenance or upkeep from the holder.
Sleeker Business, Lower Expenses
The nature of royalty companies naturally enables them to be lightweight businesses with incredibly low expenses. Compared to the many employees with varying skills needed to manage orebody exploration, project construction, and daily mine operations, royalty companies only require a tight team of specialized individuals.
While the top three gold mining companies (Newmont Goldcorp, Barrick Gold, and Newcrest Mining) have an average of around 15,500 employees each, the top three precious metals royalty companies (Franco-Nevada, Wheaton Precious Metals, and Royal Gold) each have less than 50 employees.
With minimal G&A expenses and no exposure to fluctuating operational costs, royalty companies skirt large amounts of operational risk compared to mining companies. Setting up a royalty agreement carries far less risk and takes much less time compared to developing a mine, meaning royalty companies can be much more nimble and lock down future revenue more easily.
This protection from operational risk allows for steadier revenue to ride out the bumpy market cycles commodities can have, and royalty companies typically have dividend policies to reflect this operational and financial stability.
More Freedom to Diversify Risk
The lightweight nature of royalty companies allows them more freedom and flexibility to diversify a variety of risks. By spreading out their capital properly, many of the risks mining companies struggle to avoid can be easily sidestepped by a royalty company.
While many mining companies tend to cluster their operations in single regions based on the assets they own or can purchase, royalty companies can more freely decide on which jurisdictions to set up royalty agreements. This also includes the perk of spreading out counterparty risk, as royalty companies can choose to work with a diverse selection of mine operators.
Along with diversifying royalties across jurisdictions and counterparties, royalty companies can carefully tune their portfolio’s exposure to specific commodities, unlike mining companies who cannot change what they find underground.
Royal Rewards for Reduced Risk
If having reduced exposure to this variety of risks wasn’t enough, royalty companies reap a variety of benefits compared to mine operators. Since royalty and stream agreements often last for the life of a mine, royalty holders receive the benefits of resource extension and mine expansion at no additional cost.
They also benefit from increases in precious metals prices, as increases in a mine’s revenue is reflected for royalty and stream holders as well. In times of metals price downturns, royalty companies are protected by their high margins and can use their cash reserves and credit to invest in royalties at a discount.
With far more freedom and flexibility in diversifying their risk, precious metals companies like Nomad Royalty provide investors exposure to gold and silver while protecting them from the many risks that plague the mining industry.
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