Mineral property owners should also be aware of the mining operator's rights in relation to recovery of all Advance Minimum Royalties, and the possibility that the mining operator may also be able to recover all, or a stipulated portion, of its capitalized expenses on, or related to, the mineral property. Mineral property owners and operators should also be aware of the difference between royalties which call for payment based on production contrasted with royalties that are based on sales. Individual mining lease requirements determine the royalty payment schedule, which may vary from monthly to quarterly to annually. Mining lease clauses may also specify the amount of production or sales information that the mining operator must supply to the mineral property owner to demonstrate that the proper royalty payments are being calculated and paid.

The Flat Rate Unit of Production Royalty is simply a fixed amount of money that the mineral property owner and mining operator have agreed upon will be paid for each ton, pound or ounce of mineral product that is produced or sold from the owner's property. This royalty is perhaps the simplest to understand and administer because it only requires an accurate count of the 'units of production' produced or sold during a royalty accounting period. This royalty does not take into account the selling price or any costs of production of the mineral product being mined from the property, and does not usually have any adjustment for inflation. This type of royalty appears to be most commonly used in construction materials properties, those that are mined for sand, gravel and crushed stone. This type of royalty has lost some of its popularity because mineral property owners realized that the payments did not keep pace with inflation, or were not providing them with a fair return for the use of their land.

The Gross, or Net Smelter Return (NSR) Royalty, is characterized by royalty payments that are a fixed or variable percentage of the sales price, or gross revenue, the mining operator receives from the sale of mineral product from the property. The mining operator's gross revenue, in metal mines, is often referred to as Net Smelter Return because it is common for the mining operator to sell the mineral product in a form that requires further processing by a smelter or refinery. The Net Smelter Return is the amount of money which the smelter or refinery pays the mining operator for the mineral product and is usually based on a spot, or current price of the mineral, with deductions for the costs associated with further processing. In non-metal mines the selling price is usually 'fob mine site' because of the transportation costs involved in delivering the mineral product to the buyer.

Gross, or NSR, royalty payments are also fairly simple to calculate and administer in that only the selling price and quantity of mineral product produced or sold are required for their determination. A mining lease clause usually specifies the selling price that is to be used because of the differences in price among the spot, contract and forward markets that exist for different mineral products. Because the mineral price and quantity of mineral produced or sold may vary considerably during a royalty accounting period, the mining lease must provide details regarding the amount of information that is supplied to the mineral property owner in order for the owner to verify, or audit, the royalty payment amounts. This type of royalty will usually have the highest market value of all the royalty types in the event the royalty owner should want to sell it to a royalty buying company.

A Net Revenue, or Net Proceeds Royalty is often interpreted to mean that some operating costs associated with the on-site mining and processing of the mineral are allowed to be deducted from the gross revenue before calculation of the royalty. Net revenue is defined as gross revenue less allowable production costs. Net Revenue royalties are usually a fixed or variable percentage of this net revenue. It is usual for these allowable production costs to be actual direct cash costs at the mine site and not 'accounting' or 'standard' costs that include indirect expenses such as exploration and corporate overhead. The costs of production which are allowed to be deducted must be accurately described in the mining lease to eliminate future disagreements about the amount of the royalty payment. Some mining leases will contain an exhibit, that describes by example, exactly which mining and processing costs are allowable deductions, how these allowable costs will be determined, and the calculations used to arrive at the net revenue and royalty amounts.

As in the Gross Royalty, a mining lease clause usually specifies the price that is to be used because of the differences in price among the spot, contract and forward markets that exist for different mineral products. Because the mineral price and quantity of mineral produced or sold may vary considerably during a royalty accounting period, the mining lease must also provide details about the amount of information that is supplied to the mineral property owner in order for the owner to verify, or audit, the royalty payment amounts. Depending upon the amount of the allowable deductions, a Net Revenue Royalty may be able to be sold to a royalty buying company for a lump sum cash payment.

A Net Profits Royalty is similar to a Net Revenue Royalty in that certain production costs are allowed to be deducted prior to determination of the royalty payment. But, the allowable cost deductions in a Net Profits royalty may include all of the costs that can be tied to a particular mining operation, including exploration, corporate overhead, depreciation, depletion, amortization and any and all taxes. There seem to be two basic types of net profits royalties, one that is based on direct cash production costs, and one that is based on all production costs, direct and indirect and cash and non-cash, and may or may not be based on after income tax profit. In periods of high mineral prices, a net profits royalty may provide the mineral property owner with an attractive payment level because mineral production costs are usually the same regardless of the mineral's selling price. In periods of average to low mineral prices, net profits royalty payments can become quite small or disappear altogether. There are virtually no buyers for this type of royalty because of the creative accounting that the mining operator can use to depress the royalty payment amount. The distinguishing feature of a net profits royalty is that, depending upon the exact definitions in the mining lease and the actual calculations, it will very often be zero.

Advance Minimum Royalties are payments made by the mining operator to the mineral property owner before the commencement of commercial production. Many mineral property owners are not aware of the difference in meaning between a lease, or ground rental payment, and advance minimum royalties. Advance minimum royalty payments, unlike ground rent, are usually allowed to be recovered by the mining operator from any actual future mineral production royalty payments. Many leases that require the payment of minimum royalties after the commencement of commercial production also allow the mining operator to recover these payments out of future actual production royalty payments.

Capitalized Expense Recovery: Some mining leases contain clauses that will allow the mining operator to recover its capital investment in the mining property before the mineral production royalty payments begin, or to pay a lower royalty rate until these costs are fully recovered. The definition of capital investment, or capitalized expense, contained in those mining leases with this provision, is usually very nebulous and may include all of the mining operator's expenses, direct and indirect and cash and non-cash, up to the point of commencement of commercial production.

Total Royalty Payment Amounts: Many mining leases contain clauses that limit the total royalty payments to a specified maximum amount, at which time no more payments are made to the mineral property owner whether or not the mine is still in production. A knowledgeable and willing mineral property owner may have agreed to sell his property to the mining operator at an agreed upon price and to accept this selling price as a series of royalty payments. Many less knowledgeable mineral property owners have accepted a cap on the total royalty payment amount without an actual sale of the property to the mining operator.

Discuss your mineral property appraisal, mining business valuation, or other mineral industry related concerns with Mineral Business Appraisal:
Michael R. Cartwright  michael@minval.com
Five Claret Court, Reno, NV  89512-4744
Tel/Fax: 775-322-9028

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