CHAPTER 18 USING LONG TERM INTERNATIONAL CONCENTRATE SALE AGREEMENTS IN MAJOR PROJECT FINANCING
| Jurisdiction | Derecho Internacional |
(April 2003)
USING LONG TERM INTERNATIONAL CONCENTRATE SALE AGREEMENTS IN MAJOR PROJECT FINANCING
McCarthy Tétrault LLP
Toronto, Ontario, Canada
Table of Contents
Background
The Economics of Concentrate Agreements
The Perspective of the Project Lender
The Negotiation Process
Payment Provisions
Proceeds Account
Security for Payment
Waiver of Right of
Insurance
Dispute Resolution Provisions
Umpire
Referee
Arbitration
Miscellaneous Provisions
Assignment to Other Smelters
Force majeure
Governing Law and Consent to Jurisdiction
Acknowledgement and Consent for Benefit of Lender
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This paper is not intended as a primer on concentrate agreements, but rather examines certain issues which may be of concern to lenders when concentrate agreements are being used to support project financing1 . However before starting that examination it may be helpful to provide a brief background of the context in which concentrate agreements are used as, for those who do not work in the area regularly, they may at first appear a bit mysterious.
Background
Concentrate agreements are arrangements for the sale of base metal (e.g. copper, zinc, lead or nickel) concentrates entered into between the mining companies which produce concentrates and the smelters which process the concentrates into usable metal. Unlike precious metals such as gold or silver, which are usually processed at the mine site into a nearly pure state (referred to as dore) which then only needs some slight refining to be put in a form for sale to end users, base metal mines generally produce an intermediate product referred to as "concentrate" which typically may contain anywhere from 15% to 70% metal by weight, with the balance being by- product metals and various impurities. This concentrate requires further significant processing (generally referred to as smelting) to extract the contained metal which only then is followed by refining and the production of saleable metal.
The chemical characteristics of concentrates from different mines are quite unique. As a result, not all concentrates can be treated at all smelters and accordingly concentrates are not considered fungible or interchangeable. As well, concentrates are bulky and heavy and therefore costly to handle, transport and store. As a consequence, while concentrates are traded or swapped on an informal "spot" market among mines, smelters and traders, there is no established trading market for concentrates as there is for the finished metals such as copper, zinc, lead or nickel which are produced from concentrates. A mining company therefore really has only three choices with
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respect to its concentrate production from a particular mine. If it is a large integrated mining company, it may choose to treat the concentrate at its own smelter, assuming the characteristics of that concentrate match the processing capabilities of that smelter and the transportation logistics are favourable2 . Alternatively it may choose to sell or trade the concentrate into the "spot" market Le. based on whatever current processing terms are being offered from time to time by smelters. The third alternative is to enter into long term sale agreements under which the mining company commits to sell specified amounts of concentrate to specific smelters over specified periods of time. Absent the requirements of project financing, most large integrated international mining companies, in order to maintain flexibility and hedge risks, will use some combination of all three alternatives for the treatment of concentrate produced from their various mines.
However where the development of a mine is being financed to a significant degree by project financing, because the sale of concentrate will be the sole source of cash-flow from that mine, the project lenders will generally require, as one of the conditions to the project loan becoming "limited recourse", that a significant percentage of anticipated future concentrate production from the project be committed for sale to arm's length smelters pursuant to long term concentrate sale agreements on terms which are acceptable to the lenders.
The Economics of Concentrate Agreements
While the phrase "long term" concentrate agreement doesn't have any defined meaning, generally any agreement having a term of less then three years would not be considered to be a long term agreement. Normal course concentrate sale agreements between mines and smelters that do not involve project finance typically have terms of from one to five years. Concentrate agreements underlying project financing arrangements will generally have longer terms, usually from 8 to 12 years, the actual term with respect to any particular project being a function of both the anticipated mine life and the length of time over which the project financing must be repaid.
In essence a concentrate agreement is an arrangement under which the mine agrees to sell, and the smelter agrees to purchase, a specified tonnage of concentrate annually for a specified number of years. What always comes as a surprise to persons unfamiliar with concentrate agreements is that one of the most critical terms, i.e. the price to be paid for the concentrate, is generally not fixed for the term of the agreement. Instead, the price to be paid for concentrate is determined in a rather convoluted fashion relating to the market value of the metal contained in the concentrate. Essentially the price to be paid for each shipment of concentrate under a long term sale agreement is based on the amount of metal that is expected to be recovered from that concentrate by the smelter (referred to as payable metal3 ) multiplied by the average market price
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of that metal on a referenced market (e.g. the London Metal Exchange or LME) during a period (the quotational period) around the time the shipment is delivered to the smelter (give or take a few months)4 . The reference price for the contained metal of course fluctuates daily in accordance with the LME metal market prices. From this "Value of payable metal" the smelter then deducts pre-agreed smelting and refining charges and any applicable penalties5 and then, depending on the terms of the particular agreement, may add or subtract an amount for price participation6 . The net amount is remitted by the smelter to the mining company as the "price" payable for the concentrate.
Under a typical long term concentrate agreement, certain of the terms which go into determining the "price" to be paid for the concentrate will only be agreed on by the parties for the first year of the agreement and then will be subject to renegotiation annually in advance for the balance of the term of the agreement. The terms which are most typically the subject of annual renegotiation are the smelting and refining charges, but additional terms, including price participation, quotational periods and the time and percentage of provisional payments7 may also be
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renegotiated annually. For convenience I will refer collectively to these terms which the parties may agree to renegotiate annually as the "treatment charges". The agreement will generally require such annual negotiations to be based on the prevailing market rates for treatment charges in the smelting industry at the time of such negotiations, the desire being that notwithstanding that the concentrate sale agreement is a "long term" agreement, the treatment charges for the coming year are to be adjusted annually to reflect market terms. If the parties fail to reach agreement on these treatment charges by a specified date each year, the outstanding items are usually referred to an expert called a referee, for final determination (see discussion below under "Dispute Resolution").
Accordingly what are commonly referred to in the industry as "long term" concentrate sale agreements do not result in what the casual observer might expect, i.e. a fixed price for the sale of concentrate over the term of the agreement. Instead, the treatment charges are renegotiated annually based on the then prevailing demand for smelter capacity and the price to be paid for the payable metal in the concentrate fluctuates with metal market conditions around the time each shipment of concentrate is delivered. In essence then the major benefit to the mining company and project lender of long term concentrate sale agreements is simply ensuring access to smelter processing capacity for a fixed tonnage of the projects concentrate during the life of the agreement. The benefit from the smelter's perspective is ensuring a steady long term supply of feedstock.
An initial reaction of the uninitiated to this explanation of the inner workings of "long term" concentrate agreements is frequently "How can this be?" Does this not leave the mine, and therefore the project lender, with all of the risks of metal price and treatment charge fluctuations? Well actually this is not as risky a situation as one might initially conclude. Through appropriate hedging strategies (which project lenders will generally insist on) the mining company can protect itself to some extent from the risk of metal price fluctuations. This still leaves the risk of annual fluctuations in treatment charges. This risk is largely self-correcting, however, as in times of high metal prices, while the demand for smelting services will tend to drive up the annually negotiated treatment charges, these higher charges will tend to be more than off-set by the higher metal prices which the mine receives for the contained metal.8
The Perspective of the Project Lender
Financial institutions that are prepared to lend a significant portion of the development cost of a mine on a project (i.e. limited recourse) basis are extremely sophisticated and possess within their organizations extensive...
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