Treasure trove: Financing the solid minerals sector in Nigeria

As the non-passage of the Petroleum Industry Bill (PIB) continues to stall new investment in the oil & gas sector, there appears to be a shift in focus in the investment trends in the natural resources sector with renewed interest by foreign investors in the country’s solid minerals sector. This sector, though richly endowed with diverse minerals, has stagnated over the years due to under investment and the preference for the quicker returns on investments associated with oil and gas projects.

As part of China’s expanding economic transition, construction  of major infrastructure projects such as building bridges, roads, airports and other fixed assets are ever increasing.  These projects consume vast amounts of primary materials made from iron ore and copper and it is this consumption that has fuelled mining investments in the iron-ore rich belt of West Africa, with Nigeria not being an exception.  Thus the mining sector in Nigeria continues to witness unprecedented growth with inflow of investments from mainly the Oceania countries particularly from Australia and China.  Most of these foreign companies have acquired interests in already producing mining assets albeit that majority of the productions from these mines are still at the surface level.  Expectedly, the ramping up of production and expansion of these mines will be challenging and would require considerable financial capital from both local and international financiers.

Typically, financing of mining assets like any other infrastructure financing, can be achieved either through equity funds or by debt financing.  Given the dearth of equity funds globally for the development of mining project, debt financing in its various forms are being utilised to support the development of the mining assets and same can be said for such assets being financed in Nigeria.  

Perhaps the most appropriate financing solution for these new mining projects in Nigeria is the traditional project finance. This involves one or several lenders making available, long term bank debts to a mining project vehicle with limited recourse only to the income and assets of the mining project.  The loan is disbursed progressively during the construction stage and is repaid from the income generated from the sale of minerals obtained from the mine.

There are a number of critical elements which require consideration in mining project financing;

Due diligence 

Given that recourse is only to the project assets, lenders would require thorough due diligence both on the project itself and its sponsors before committing the funds. The   lender would have to be confident of the reputation of the sponsor(s) as well as its management team and that of the borrower.

Commercial contracts

Central to any mining project finance is the various commercial contracts between the borrower and numerous counterparties.  These agreements allocate risks amongst the project parties and include but are not limited to the loan and security documents, offtake agreements, operating agreements, construction agreements, equipment lease agreements, maintenance agreements and power purchase agreements.

Security

Lenders to a mining project would typically require security over all of the assets (present and future) of the borrower (i.e. the project vehicle). These includes but is not limited to security over real property; minerals deposits, mine output; mining licences and lease; project agreement (as mentioned above); bank accounts and insurance proceeds.  Additional security may be required in the form of step in rights under direct agreements.  

Hedging

Some lenders may require that the borrower establish hedging programmes and enter into hedging arrangements with the lenders.  This arrangement essentially protects the mining project against market risks such as changes in currency and interest rates and commodity prices.

Insurance

It is important to ensure that the lenders insurance requirements do not impose excessive costs and or obligations on the project.  Lenders will require the assignment of all insurance policies with the security agent being named as additional insured and loss payee.

Key issues in mining project finance documentation 

The structure of a loan agreement for a mining project finance is similar to non-mining project finance.  However, some additional provisions which are peculiar to mining project finance include:

Independent engineer

An independent engineer should in consultation with the borrower be appointed for the purpose of conducting technical due diligence review of the borrower’s feasibility study and financial model.  Terms of reference for such an engineer should include initial project due diligence, a review of project documents monitoring of construction, ramp up of operations and confirming satisfaction of drawdown conditions and completion test.

Representation and warranties

These typically include representations and warranties to cover the necessary authorisations for the mining project, feasibility study, life of mine plan, financial model and development plan, title to project and project assets and compliance with environmental laws.

Negative covenants  

Lenders will seek to protect themselves by limiting financial indebtedness, disposal of assets, taking of security and the incurring of liabilities by the borrower.

Account arrangements/financial covenants

These may include the following: Financial covenants; debt service coverage ratio; loan life coverage ratio; project life coverage ratio and reserve fail ratio.  It is important that a balance is achieved between the concerns of the lenders in monitoring and controlling cash flow and the borrower’s ability to incur costs necessary to operate the project. 

Events of default

These would typically include events of default relating to (i) failure to satisfy financial tests (ii) breach of representation and warranties (iii) breach of finance documents (iv) failure to achieve completion by the stipulated completion date (v) breach of material project documents (vi) cancellation or repudiation of mining or authorization (vii) abandonment or unscheduled stoppage or disruption of mining / production for a greater than a stipulated period of time.

In negotiating these provisions, it is important that some issues such as cure periods and financial thresholds be subject to appropriate qualification.

Completion test

The completion test would cover the technical aspects of the project such as the physical facilities, production tests (such as mining recovery, unit costs and concentrate quality test’s), financial matters and legal compliance.  The satisfaction of the completion test usually triggers the release of the project sponsor from guarantee and other obligations and may also entitle the borrower to make certain permitted payments.  It is important, that the parties are clear as to when the completion tests are to be deemed satisfied.  

Sponsor requirements 

The sponsor will be subject to many of the same representation and warranties and affirmative reporting and negative covenants that apply to the borrower as well as certain financial covenants.  The sponsor may be released from these obligations as well as its guarantee once the construction of the project is complete.

In addition to traditional project finance, other innovative alternative financing methods for financing the development of mines have come to the fore in the past few years and these include streaming finance and royalty financing.   Streaming finance is raised by selling a right to the commodity to be produced from a mine in exchange for an upfront payment.  The terms and conditions attached to such facilities are far less extensive and onerous to the traditional project finance discussed above and consequently are an attractive alternative to equity and debt financing.  

Royalty financing is a means of financing mining projects by providing the funds required for mine construction and or expansion in exchange for a share in the mining project’s future revenue.  Unlike traditional debt finance, there is typically no obligation on the mining project company to repay the capital and neither does the capital bear interest.  Its non-dilutive nature is a distinct advantage, as it allows the mining company to retain control over its interest.

A publication of Energy & Natural Resources Group at Advocaat Law Practice

A publication of Energy & Natural Resources Group at Advocaat Law Practice. Advocaat Law Practice recently advised a lender on its $12Milion facility for the expansion of the Zurak Mine located in Plateau State Nigeria.