It hardly needs to be said that the fortunes of the mining industry are intrinsically linked to the rise and fall of commodity prices. As such, the year has been a tale of two halves for mining projects and legal practitioners. Commodity prices began the year strongly, with indices indicating average increases in value across for most metals. However, around July of this year, the majority of commodities slumped. This has had significant consequences for the establishment of new mining projects, project finance opportunities and therefore legal practice around the world. It has not all been bad news, however. Nickel and lithium mining projects in Latin America have fared well, driven by the industrial scale production of car batteries for electric vehicles. Among the other trends that practitioners were keen to tell us about in this year’s research is “streaming”, which has become even more ubiquitous as a project finance mechanism in the mining industry.
The solid performance of metal values in the first half of the year ensured the continuation of the bullish mining market of 2017. In July though, many mining practitioners noted “a slump in commodities values” which has persisted during the second half of the year. The most noticeable commodity downturns have been seen in aluminium, iron ore, nickel, tin, copper, lead and uranium. Price indices indicated an average loss of 7.13 per cent in metal prices from October 2017 to September 2018. A significant factor behind this has been the ongoing trade war between the US and China; with two of the world’s largest economies fighting over raw materials crucial to their industrial prosperity, it is hardly surprising that commodity prices dropped with such a bump. The tariff wars have generated instability in the mining market, with steel and aluminium sanctions being the most obvious influencers. All of this has translated into “a contraction in the legal market, as there hasn’t been a huge amount of work to go around".
Practitioners reported several other effects of lower commodity prices. Price devaluation has “made it difficult for clients to implement mining plans, as there is now nervousness in the market surrounding potential losses due to commodity prices falling”. Furthermore, in conjunction with a slow-down in equity markets over the last year, price volatility has caused both traditional and new sources of project financing to diminish. The resultant disappearance of new mining business in the second half of 2018 has been felt by legal practitioners, with some lawyers reporting that their work has consisted “largely of the management of pre-existing mining projects”. Secondly, sources reported an increase in M&A work “as people are of opinion that prices will be unsettled, and thus they want security and be able to move assets globally easily”. This has been achieved by moving to capture larger market shares and easy access to new markets through mergers. Several specialists noted with curiosity that “despite the ructions in the world, including Brexit and US trade policies, we are not seeing a recovery in the gold price; this removes financial viability for a lot of mining projects”.
The most notable exceptions to the depression in commodities values, and “one of the most exciting mining trends” has been lithium and nickel. Lithium in particular is considered “a very hot mining topic in the market”. Its value as a metal has been driven by the massive demand for battery minerals, driven primarily by tech companies and “battery development for vehicles in China”, who have reportedly generated a “significant market shortage of lithium”. The reserves of these minerals are largely found in Argentina and Chile, where practitioners highlighted the increased interest of several of the world’s largest commodities traders, automobile manufacturers and financial institutions. However, establishing lithium mining projects in these jurisdictions presents a raft of unique challenges and pitfalls. For instance, Argentina is divided into 23 legislative provinces, each with their own control over regional mining laws which are governed by overarching federal mining laws. Therefore, the viability of lithium projects in this country very much depends on an individual province’s laws regarding mining. In Chile, meanwhile, challenges are presented by the fact that lithium is the only mineral over which the Chilean state has retained definitive control over exploration and mining operations. Nevertheless, with battery-powered vehicles now poised to replace conventional combustion engines, lithium and nickel reserves will continue to be a highly sought after and exploited.
The rise and fall in the price of copper has also been of particular interest to mining practitioners and market players across the globe. As a material that is resistant to corrosion and is an excellent electrical conductor, it is an extremely important metal. Markets took notice when the global supply of copper started to reduce, and prices correspondingly rose dramatically. This rise has been put down in part by interviewees to the Chinese government stockpiling copper reserves, and “a Chinese policy of shorting copper”. Some commentators put this down to China sending a message reminding other states of its economic clout.
Perhaps the most radical change in the international mining market in recent years has been how mining projects are financed. Practitioners from Canada, London and the US all report that “for five years now, we rarely see banks financing mining projects”. Instead, it appears that “players in the equity markets, investment funds, private equity funds and family offices are now some of the chief investors in the mining sector”. Investors from the Middle East are singled out in particular for their increased activity in the North American mining market. This development has fundamentally changed the nature of mining project finance. Before, “traditional bank financing was there for a project’s whole duration, whereas private equity firms are only there for five years to turn them around then get out”.
However, this rate of investment has slowed down due to the volatility of commodity prices. Indeed, since private equity investors are often “sophisticated and market aware”, they are more hesitant to invest given the higher volatility. With “more alternative funders coming into financing market”, they are increasingly “replacing the predominant project finance model”, interviewees told us. The most talked-about alternative finance mechanism is known as “streaming”, most frequently seen in gold or silver mining projects. Streaming is a form of futures transaction, where an investor offers a capital lump sum to a mining project in exchange for the right to buy the commodity at a fixed value over a set period of time. This is beneficial to both parties: the mining project receives immediate access to funding which more traditional sources such as banks and capital markets may not be willing to provide at advantageous terms. At the same time, the investor achieves access to commodities in a way that insulates them to a degree from market volatility, and frees them of the risk of running their own mining operation. However, sources told us that streaming is “not always the first choice of finance mechanism” for several reasons. Firstly, cross-border elements to such projects means that “the technical tax treatment is tricky”. Secondly, streaming is often described as “quite an expensive alternative” to the more established and straightforward royalty mechanism which remains prevalent in the market. Nonetheless, according to interviewees, it has become “a very popular method of financing mining projects” over the last year or so.
Another significant recent change to mining project financing comes at the hands of Chinese investors. Previously, these investors took direct equity stakes in projects and remained fairly passive. Now, sources tell us that they “are lending under much more vigorous terms to mining projects, and once a default arises they take control of the project very aggressively”. Practitioners acknowledged that this is an innovative way of potential project acquisition through lending.
The sudden emergence of a trade war between China and the US has once again shown the dangers of making predictions (PwC’s Mine 2018 report from the start of the year stated, “In 2018, we expect that favourable market conditions, higher commodity prices and strong internal discipline will produce increased liquidity and balance sheet strength.”). However, practitioners made a few of their own in our interviews with them. From their comments, it seems that lithium and nickel projects will only become more numerous and attract more investment with the rapid development in battery technology across many different sectors. Meanwhile, the traditional cradle-to-grave project financing by banks is fast being overshadowed by alternative sources of capital such as private equity firms, family offices and state investment. It will be interesting to see, given the volatility of prices, whether “streaming” continues to emerge as a financing mechanism to rival royalties or falls away.
That commodities prices will rise again, resulting in a proliferation of mining activity and exploration, is certain given the cyclical nature of global markets: the question is when this will happen and how the market and its legal practitioners will respond until it does.