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Stephens Valuation & Consultancy Pty Ltd

 

Roderick Stephens BSc (Hons) MC AAPI (CPV)   

Hard Rock Quarry Royalties in New South Wales                  

Introduction

In very simplistic terms the valuation of an extractive industry quarry is based upon the projected output multiplied by the quarry royalty to derive a rental, which is then capitalised over the life of the quarry. Consequently whilst the outputs may be based on estimates, both the quarry royalty and capitalisation rate adopted are usually based on market evidence of quarry sales and leases and then adjusted to the subject quarry.

 

Extractive industry quarry royalties can be identified from a number of transactions, but it is usual to group the royalties into the different types of minerals involved, which for quarrying tends to involve hard rock, sand, sand and gravel, sandstone, conglomerate, limestone, clay and several other categories. For the purpose of this paper we are only going to consider hard rock royalties, as the market evidence of each category is very different often due to the differing operating costs involved together with the location and other factors, and so we do not wish to mix a range of royalties together as this becomes meaningless for comparison purposes.

Sources of Quarry Royalties

The main sources of determining quarry royalties are derived from either sales evidence of market transactions, or from lease evidence. In New South Wales there are literally hundreds of market transactions of either quarry sales, lease agreements, or sales of mineral bearing land that can all be used to determine a market royalty for market evidence. We have an extensive database of well over 100 market transactions throughout NSW that we can consider for carrying out valuations of quarries, within particular markets and for specific categories of aggregates. We are also aware of a number of other sales and lease evidence that we currently have not got, and so we continue to search for such transactions to add to our database to expand our existing knowledge.

 

Perhaps the most common comments that our clients tell us about previous quarry advisors are:

 
The sales information is commercially sensitive = We dont know
 
There are very few sales in the market = We dont know the market
 
You cannot analyse a quarry sale = We dont know how to do it

 

Our comment is : The majority of sales and lease information is not commercially sensitive, there are hundreds of sales and lease transactions in New South Wales, and you can analyse a quarry sale if you know what your doing.

Hard Rock Royalties

Hard rock quarries are easily distinguished from other extractive industry quarries as they invariably involve blasting. If the rock is more friable and can be ripped, then it is more likely to be categorised as a sandstone, or conglomerate or something similar. Hard rock quarries are often derived from igneous or metamorphic rocks, but can be worked from sedimentary rocks such as limestone.

 

One of the factors that determines the royalty for hard rock quarries is the quality of the rock, and it needs to be borne in mind, that a rock can be too good, and involve a penalty. For instance there are several granites that can be very hard, and have a high blasting cost, but also highly abrasive which can have a high wear and tear factor on plant, machinery and equipment. So there often needs to be a balance and the ideal material may involve a hard rock, which passes all the specifications for concrete aggregates and other specifications, but is not too hard, so as to cause additional blasting and crushing, screening and handling costs.

 

Conversely poorer quality hard rock resources may not pass the specifications for high end uses, and may only be suitable for road bases and for fill material, and again this is reflected in the royalty.

Location   The Type and Nature of the Market

Our analyses of the New South Wales quarry market involves splitting the State into 22 different operating areas, which we consider all operate as separate markets, although many are interlinked involving both imports and exports to and from adjoining localities. There are some markets, where there is a distinct lack of hard rock quarries and premium prices can be obtained by the operators and potentially high royalties, whilst in adjacent areas there may be an abundance of hard rock quarries subject to very high competition and low margins for all of the operators, where perhaps royalties would be much lower. Certainly in a competitive market, then the operator who pays the highest royalties would be less likely to survive, so every quarry investment needs to be made taking into account the local circumstances of the operation, and the operator who perhaps has the best knowledge of their competitors can often be the most successful operator as many contracts are won by minor margins.

 

For explanation, where a quarry is purchased, then the purchase can be equated to a royalty per tonne, and this then forms the basis for comparison with other quarries in the area. In effect if two quarry operators own identical quarries, next door to each other and both sell to the same markets, but one operator paid a lot more to acquire the quarry compared to the other operator, then the operator with the lower capital invested, can afford to charge a lower selling price, and in effect win more contracts and benefit from economies of scale and potentially put the rival out of business. However if the failed quarry were put up for sale, then any purchaser would have regard to the pricing structure of the adjoining operator in making any bid, and this bid would have to be below the original purchase price to have any chance of making a success, but ideally below the current asset value of the competitor to have an equal chance of being competitive. So quarry purchases are very price sensitive, and any purchaser who pays too much to acquire a quarry, compared to the asset values of the competing quarries in the area, is doomed to failure. We have come across many such examples of this, and often the vendor wishes to receive a price of in excess of what they paid, to recover their initial investment, and the quarry can remain unsold for a number of years, so these quarries are often easily identified and best avoided, unless a price reduction can be negotiated.

NSW Hard Rock Quarry Royalty Chart

The chart below shows the broad variety of hard rock royalties derived from both sales and lease evidence found throughout a range of locations in NSW. For the record we have not included some of the more extreme royalties within the chart, as they could either mislead or distort the chart, as they involve significantly higher royalties, and we believe involve the highest royalties ever paid for quarries in Australia. We do not believe that these royalties are even close to other market royalties within the local area, and highlight the dangers of overpaying for assets. 
 
  

 

 

We identified earlier our view that there are 22 different markets to be considered for the majority of quarry transactions, and even within a single market, there are location differences that need to be taken into account, differences in quality of the quarry products, access to the major markets, types of processing involved, and impacts of economies of scale and subsequent pricing structure.

 

Quite often the reasons why lower royalties are often paid, is more to do with the quality of the hard rock rather than the location of the quarry, although location to major markets does play a strong role for the higher end royalties. In essence each quarry subject to an assessment needs to be judged on its merits, and the available quarry sales and lease evidence used as a guide to compare values achieved elsewhere to the subject quarry and suitably adjusted.

 

The chart also identifies that some royalties below the blue line, which may be leased, may need to be reviewed, and the royalties increased more in line with more recent transactions at a higher level. The converse argument is that royalties above the blue line, again where they are leased, may benefit from additional tonnages to the operator if the royalty is reduced following a rent review.

 

So to concentrate purely on the royalty, whereby the landlord always wishes to receive a higher royalty, the output also needs to be taken into account, as the tenant could often sell more tonnes, if their royalty were reduced and allowed them to become more competitive. So it is a balancing act to maximise the income of the landlord, by maximising the output for the tenant.

Minimum Rents for Quarry Leases

The vast majority of hard rock quarry leases contain a minimum rent, whereby a fixed rental for the quarry is paid, oblivious of whether tonnages achieve certain limits or not. Fixing the minimum rent can also be price sensitive for the quarry operator. If the minimum rent is too high, then the tenant may not benefit from economies of scale for the operation and cause the business to fail, but if too low, then the landlord may not be maximising their income potential and this can be eroded over time. We have identified that where low minimum rents are involved, then the quarry operators do not concentrate their outputs from that operation, where they may have other quarries which are providing better returns. Worse still, there are leases that contain no provision for minimum rents, and it is quite common for quarry operators to not work these resources until a much later future date. This often renders the lease as having little value, and the tenant is then in a strong position to negotiate a purchase at a significantly reduced value. So any drafters of leases need to ensure that they incorporate minimum rents within the lease, as they could find themselves liable for any losses, unless they obtain an agreement not to do so from their client.

Lease Renewals and Rent Reviews

When considering lease renewals or rent reviews of existing quarry leases, then provision of comparable market evidence is essential to be able to prove whether a royalty should be increased, decreased or remain the same. Many tenants would not object to marginal increases to royalties being made throughout the term of a lease, as they can often pass these on through their pricing structure. However where conflicts arise, is when a landlord has neglected to review the royalties over a longer period, and then wishes to significantly increase the royalties, which can cause much damage to a tenants pricing structure and is often met with strong opposition. Therefore it is advisable to look at reviewing the royalties at every available opportunity as this tends to minimise future conflicts.

Conclusion

Royalties play an important role within quarry leases and sales and for other purposes. It is an essential tool for every quarry advisor to determine applicable royalties for other quarries they may be comparing to, and to understand how to carry out the analyses to derive the royalties from all market transactions, which involves a complex optimiser which many quarry advisors have little knowledge of.

 

The opinions expressed in the above paper are the personal views of the author gained from experience and research within the extractive industries. No responsibilities can be held for any person or company who relies on information within this paper or who attempts to take any extracts from this paper. This paper is not to be used or quoted in part or as a whole for commercial use without the express written consent of the author.

 
Stephens Valuation and Consultancy Pty Ltd

 

By Roderick Stephens BSc (Hons) MC AAPI (CPV)

Certified Practising Valuer

Registered Valuer QLD & WA

PO Box 404

Emu Plains

NSW 2750

Tel No:  02 *4704 *8483         

E mail: rodstephens@optusnet.com.au

Mobile 0423 *383 *343

Website: www.quarryvaluations.com which is a Registered Trade Mark   
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