The financial needs of companies that initiate the construction of mining and processing plants are growing as mineral resources are depleted, technologies become more sophisticated and environmental standards tighten.
This dynamic sector, vulnerable to fluctuations in world prices, has faced serious challenges in recent years.
Project finance (PF) for mining and processing plants through the establishment of SPV / SPE is one of the promising approaches to new mining projects.
One of the keys to business success is to align the financial needs of a mining project for continuous implementation and development with the highly variable economic results of mining operations. Flexible use of long-term investment loans, bond issues, leasing or other financial tools allows mining companies to implement large projects in the shortest possible time.
EFG Project Management Services, an international finance company with Spanish roots, is ready to develop a investment model for your project and assist your business in organizing project finance schemes for mining and processing plants in Europe and beyond.
The cost of building a modern large mining and processing plant is currently estimated at billions of euros.
This is a long term investment that should not be made blindfold. Extensive research and development of an optimal financial model lay the foundation for future commercial success.
Investment costs are not limited to the cost of the mining and processing plant equipment, but include numerous categories, such as geological exploration, development of project documentation for the exploitation of natural resources, engineering design of industrial facilities, infrastructure development, environmental protection measures and much more.
The scale of the project can be judged by the cost of the technical documentation of the mining and processing plant, which, taking into account all the components, can exceed 50-60% of the annual production volume.
In general, the process of construction and commissioning of a mining and processing plant often requires an initial investment in excess of 250-300% of the annual production volume. Of course, specific numbers vary widely and are largely determined by the type of deposit and the method of production, as well as the specific need for equipment for processing mineral raw materials.
An important item of investment costs is the technical support of the high competitiveness of the future mining and processing plant.
The foundations of competitive advantages are laid at the design and construction stage of the facility.
We are talking about the rational choice of the field, the optimal location of transport hubs and infrastructure, and the convenient layout of the plant. Also, the correct choice of technology and equipment for the extraction and efficient processing of minerals should not be underestimated.
Maintaining the competitiveness of mining projects requires additional investment. However, in favorable economic conditions, the introduction of innovative technologies usually pays off quickly even for expensive greenfield projects.
Finally, the time period between paying operating costs and receiving the first profits from the minerals sold requires significant working capital funding. These are additional borrowed funds comparable to the cost of the plant’s quarterly production.
With the rapid depletion of mineral resources in many parts of the world, the average annual increase in mining costs in recent years has exceeded the expected rise in prices for many types of mineral raw materials.
For this reason, the structure of capital investment is changing so that new ore mining and processing plants can withstand market fluctuations and maintain high performance.
At the exploration stage, there is a risk that suitable deposits will not be found or become unusable. The word “risk” is the most frequently used word in such reports. Usually the risk is so high that exploration of strategically important deposits is funded by state and local budgets.
According to rough estimates, the cost of exploration work for mining companies reaches 3-5% of the cost of annual production.
Since the exploration of mineral resources allows companies to select the most suitable location for the construction of a mining and processing plant, skilled professionals and modern technology are highly valued in the industry.
It is obvious that the existing investment needs of mining projects are steadily increasing. Ignoring such items of expenses as technology and exploration leads to a decrease in competitiveness and a decrease in the volume of mineral production after a short period of operation of the enterprise.
Financial resources for the implementation of large-scale projects in the field of mining and processing of minerals traditionally come from three main sources.
We are talking about internal financial resources of mining companies, external borrowed funds (usually long-term loans) and government support directed to a limited number of key companies in the sector.
External debt financing for mining and processing industry projects is usually based on long-term loan agreements (maturity up to 20 years), under which the borrowing company undertakes to repay the loan amount with high interest within a predetermined time frame. The significant interest that is paid under such loan agreements is intended to offset the high risk of the project.
Debt financing for the construction of mining and processing plants today requires extreme caution, so commercial banks and other financial institutions have an extensive list of requirements for such projects.
The volume and nature of loan guarantees is a fundamental criterion for debt financing.
It is the most commonly used financial mechanism in the mining industry.
As a rule, the term of such loans reaches 10-15 years or more, depending on the specific project, sector and company.
Given the lack of domestic resources for mining and the surplus of financial resources in the banks, the latter seek to more actively place investments in the mining industry. Since the 1990s, this has led to a situation where the share of loans in large mining projects reaches 50% and even more.
Companies wishing to use credit tools for the construction or modernization of a mine should consider adequate loan collateral and provide alternative guarantees of debt repayment.
These can be various kinds of government guarantees or business guarantees from other companies.
The paradox is that banks provide large loans mainly to those who really do not need them. They lend money against high-value assets that already exist, rather than based on the borrower’s ability to generate future cash flows. However, loans are more needed by companies that do not have enough money, but have the potential to generate income.
In this context, mining companies are at an extremely disadvantageous position. Most banks today are wary of new mining projects, reluctant to adjust debt maturities, set grace periods or make other concessions that borrowers need in the face of market uncertainty.
This issue in the mining industry is partially resolved with the use of project finance tools for the construction of mining and processing plants, which will be discussed below.
If you are interested in a long-term loan for the construction of a mining and processing plant, modernization or expansion of a mining facility (quarry, plant), contact the EFG Project Management Services financial team.
Our company offers attractive business loans with a maturity of up to 20 years.
The practice of leasing refers to the transfer by a lessor of expensive equipment or other assets for temporary use to a lessee for a regular fee.
After the end of the lease, it is often possible to purchase equipment at the current market price or below, depending on the terms of the contract. Leasing schemes are widely used in the mining industry, where the share of technically complex equipment with a long payback period is very high.
In general, leasing has shown the fastest growth among other debt financial tools in the second half of the twentieth century. It was born in the United States in 1941, which began leasing ships and military equipment to the United Kingdom and the Allies.
After the war, in the 1950s, this funding formula penetrated the North American industry and reached Europe over the next several decades.
Financial leasing in the mining industry has grown exponentially in recent years, affecting major projects.
The benefits of leasing equipment for the mining industry include:
• Convenient source of financing for companies experiencing financial difficulties and unable to attract large loans.
• Technological flexibility of the business due to regular renewal of expensive equipment without large upfront payments.
• Possibility of obtaining tax incentives depending on the financial legislation of the host country.
Leasing terms vary depending on the specific company and project.
The lessee’s credit rating plays an important role in setting conditions. Leasing companies tend to specialize in certain industries, so it is important to conduct a research of the leasing market in order to find the right partner.
Another way of financing large projects, although limited in mining practice, is through the issuance of securities.
This involves the issuance of bonds that promise high returns to investors given the high risks of the industry. It is also possible to issue shares of a mining company, which allows investors to generate higher, but variable returns as the business develops.
Transitional tool between the two above is the so-called convertible bond.
These securities can be converted into preferred shares, potentially providing investors with a high fixed income if the ore mining and processing plant achieves positive financial results.
In general, the use of stock market tools is becoming more popular today. Nevertheless, it is important for the companies initiating the project to remember that the procedures for issuing shares and bonds are associated with high costs and require a professional approach to ensure the financial security of the project and the company as a whole.
Also worth mentioning are promissory notes that are suitable for large and reputable companies. Basically, this financial tool provides medium-term financing with a high cost of capital.
Venture financing for the construction of mining and processing plants is distinguished by the attitude of investors to business.
The security of investments in general is of paramount importance for any venture fund, but not the profitability of each specific project.
The advantages of venture capital financing are as follows:
• Lack of collateral and other types of debt repayment guarantees.
• Attraction of resources for the implementation of high-risk projects.
• Possibility of allocating large funds in a short time.
Venture capital accepts some vulnerability in an individual project because of the general belief in the benefits of working on an entire portfolio of projects.
Obviously, some projects will not meet the expectations of investors, but the profit of successful projects compensates for the money lost due to unsuccessful investments.
To avoid the danger of bankruptcy before compensating gains are achieved, venture capital must play on a sufficient number of projects. In fact, this means that the participation of venture funds in each of the projects is relatively small.
This is a special type of loan that applies exclusively to the gold mining industry.
Long-term gold loans are used to finance projects for gold mines and ore processing plants producing this precious metal.
The peculiarity of these loans is that the borrowed funds are issued to a mining company and subsequently returned to creditors in gold. This entails certain advantages for both lenders and the gold mining company.
For banks that hold a portion of their financial reserves in gold, these loans provide a temporary mobilization of these reserves in order to make a profit. At the same time, banks have complete confidence in the return of gold due to the development of the mine.
The gold mining company benefits from the return of the loan funds in precious metal (the company’s product) at the exchange rate on the day the loan was issued.
This guarantees the stability of prices for a certain part of the product, regardless of speculative fluctuations.
Companies often financed successful gold mines on preferential terms (annual interest rate of about 0.5%). This opens up new horizons for mining projects, especially considering the possibility of flexible adjustment of the terms of the gold loan in accordance with the real needs of a developing enterprise.
Typical maturities for gold loans are around 5 years.
However, despite the attractiveness of this type of financing, banks require confirmation of the company’s ability to ensure the planned extraction of the precious metal.
This requires in-depth expert analysis and presentation of the results of the study of gold deposits to potential lenders.
The financial literature describes cases where banks have required reliable collateral to lend to a new mining project, covering up to 125 percent of the current value of the gold provided.
Given the strategic importance of iron ore and other mineral raw materials for the development of national economies, government financing of mining and processing plant projects is now well developed and widely practiced around the world.
More often it is about providing a large loan with government guarantees, which allows companies to attract larger amounts of money on favorable terms (long grace period, low interest rate). State support can be implemented both at the central level and at the level of local governments.
Mining projects have been identified in some regions as the main engines of regional development, supporting this trend.
Grants play an important role in financing mining and processing plants.
However, global business experience clearly shows that grants for “bad” projects will not make them “good,” and that high-performance projects rarely need grants.
Grants can be critical for high-risk projects that are strategically important to the economy and social sphere of a country / region. Of course, the practical use of this tool is usually limited due to the budget deficit.
A third way of government funding for the mining industry is tax incentives. This tool can be applied by the state temporarily, taking into account the real need for a specific project.
In some countries, tax incentives are granted to mining facilities for periods of exploration, that is, in order to support the growth and diversification of mineral production. There are also incentives for the environmental modernization of mining and processing plants.
The classic definition of project finance (PF) refers to the financing of an asset or project, in which the lender focuses primarily on the future cash flows of the project as a source of debt repayment.
This type of financing is gaining importance in capital intensive projects in infrastructure, industry, mining and processing of minerals.
The safety of credit funds is usually ensured by the tangible and intangible assets of a specially created project company (SPE / SPV), which is not formally dependent on the initiator of the mining project.
The sponsors are either not liable for the project’s debts, or are liable for them to a very limited extent.
Depending on this, project finance for mining and processing plants can be carried out according to a non-recourse or limited recourse scheme. This means that lenders (banks) and equity investors are not allowed to require special guarantees from sponsors, unlike traditional financing methods.
In turn, the limited recourse clause means that lenders (banks) have an advantage in obtaining support outside the project.
If the mining project fails, they can claim the assets of the project company.
The loan agreement contains the requirements for the efficiency of the project and the conditions for the proper repayment of the loan. In this way, creditors and shareholders guarantee the safety of their funds. The multilateral contractual structure of the PF is a kind of guarantee for the completion of the project, formed at the planning stage. In practice, most projects have a complex financing structure that distributes risks among the project participants in the most rational way.
The organization of the project finance scheme can be carried out in the following ways:
• Separation of the mining and processing plant project into a separate project company with separate assets, which acts as a borrower and is fully responsible to creditors.
• Signing a special loan agreement with a mining company to finance a specific project on a limited recourse basis.
The first path is the most effective, but following it in practice depends on the requirements of the host country.
The more complex the project is from a technical and economic point of view, the more reasonable it is to create a separate project company. This means that the risk will be shared among several project partners.
Typically, projects of mining and processing plants are so large and require such investments that they exceed all the financial capabilities of the business. For this reason, even large mining companies are forced to organize various PF schemes.
In such cases, the financial structure of the project can vary widely, offering unique solutions for each investment project. Usually, the borrowed capital accounts for 60 to 90% of the project cost, providing high financial leverage.
In the context of investment security, it is important for capital providers to have a correct and accurate risk assessment, which is the starting point for providing financing.
With traditional on-balance sheet financing, credit relations are built directly between the company initiating the project and the bank. In this case, debt financing is displayed in the liabilities of the balance sheet of the company that took out the loan.
With this type of financing, the bank usually needs a lot of information about the financial condition of the company (assets, cash flows, key business indicators for the past, and so on). This allows risk managers to easily assess credit risks and allows the credit rating service to determine a company’s creditworthiness.
The company initiating the mining project or the sponsor is responsible for repayment of obligations with all of its assets.
In the event of a project failure, the bank is protected from possible non-return of borrowed funds using various types of collateral.
In the case of off-balance sheet financing, a debt financing agreement is concluded between the bank and the project company. Thus, financing is carried out outside the balance of the project sponsors. The latter are not liable for the debts of the mining project or have limited liability.
Project finance carries a significantly higher initial risk for lenders compared to corporate finance.
This determines the need for a thorough approach of the participants to the analysis of the project and its planning.
Risk sharing is the strongest motive for using off-balance sheet financing schemes for mining projects.
Commercial banks are showing an interest in taking project risks in some industries, so sponsors are increasingly opting for this financing method.
The cost of building a medium-sized mining and processing plant is in the hundreds of millions of euros, but many large projects involve multi-billion dollar investment costs in the first years, including exploration, construction and installation of equipment.
How applicable is the project finance model for such facilities?
It is important to understand that the fixed costs of organizing project finance schemes are significantly higher compared to models based on traditional long-term lending. This is due to a more complex contractual structure, the establishment of a project company and the funding of numerous studies.
As capital intensive, technically complex and high-risk projects by their nature, mining facilities are considered ideal for PF. This is especially true for projects with a high initial investment, where the interests of many parties, including governments, converge.
Project finance for mining and processing plants can be more expensive than traditional debt financing.
The reasons for this are as follows:
• Time taken by lenders, their technical experts and lawyers to evaluate a project and submit documentation for review.
• Increased insurance coverage, high potential indirect losses, environmental and political risks of the project, which require expensive insurance contracts.
• Significant fixed costs of bank loan management throughout the life of the mining and processing plant project.
• Additional costs on the part of lenders and possibly other stakeholders due to the risk of the mining project.
The benefits of project finance to the borrower must be high in order to choose this type of financing for a mining and processing plant project.
Are you looking for funding for major projects in the mining industry?
If you need professional advice, please contact the EFG Project Management Services team at any time.