King Coal in royalty dispute

Canada’s junior coal-mining sector is officially back: we have our first bitter legal battle over some small coal assets in western Canada.

Rookie coal-producer Western Canadian Coal (WCC) has filed a petition in the Supreme Court of British Columbia to set aside a royalty agreement struck in March 2000 between WCC and three British Columbia residents: David Fawcett, Kevin James and Mark Gibson.

All three had connections with WCC: Fawcett was a director from September 1999 to June 2003, president from November 1997 until June 2003, and CEO from mid-2001 to June 2003; James was a director from November 1997 to June 2001, secretary from October 2000 to June 2001, and vice-president of exploration from June 2001 to October 2004; and Gibson was a shareholder when the royalty agreement was forged, though he has never been a WCC director or officer.

Founded in 1997 and based in Vancouver, WCC owns three neighbouring, multi-deposit metallurgical-coal property groups — Wolverine, Brazion and Belcourt — near the town of Tumbler Ridge in northeastern British Columbia. WCC’s most-developed asset is the newly opened Dillon open-pit mine, which exploits part of the Burnt River coal deposit in the Brazion group. Other advanced assets are the Perry Creek open-pit and underground deposits, and the E.B. Trend open-pit deposit, both of which are in the Wolverine group.

In its petition, WCC states it had entered into the royalty agreement to compensate the trio for lending the company $80,000, divided between Fawcett ($32,500, or 40.6%), James ($17,500, or 21.9%) and Gibson ($30,000, or 37.5%). As compensation for making the loan (for which the principal was repaid a month later in shares priced at 30 apiece), the three received a combined 1% royalty on the free-on-board price for all product tonnes produced from WCC’s West Brazion, Brazion, Mount Speiker, Perry Creek and Hermann deposits, to be paid quarterly. (The last three deposits are all part of the Wolverine group.)

While Perry Creek has tentatively been scheduled to come on-stream by mid-2006, there has so far been no production from the deposits under the royalty agreement, and no royalty payments have been made. Furthermore, WCC says the agreement stipulated that the royalty could not be assigned without the written consent of all parties.

When WCC’s board gave its blessing to the royalty agreement in March 2000, Fawcett and James were the company’s only two officers, and the directors were Fawcett, James and David Austin, who was terminal-agent manager for B.C. Ferry Corp.

WCC alleges in its petition that neither Fawcett nor James disclosed his interest in the royalty agreement when the board met to discuss to the offer.

WCC further states that the agreement was not approved by a special resolution of WCC’s shareholders, and the company did not file the royalty agreement with the Canadian Venture Exchange at the time, despite the agreement’s being a material change.

WCC says that in July 2001, a year after the loan was repaid, its audit committee examined the deal and “expressed concerns regarding the legal standing and enforceability [of] the royalty agreement.”

However, the issue was put on the back-burner in the subsequent years, as WCC underwent a large turnover of directors and personnel. None of WCC’s current directors or officers was in place when the royalty deal was agreed to.

The royalty issue flared back to life in early February 2005, when Fawcett requested WCC’s written consent to assign half his royalty interest to Denver-based International Royalty Corp. (IRC), which recently closed a $150-million initial public offering in connection with its acquisition of a 2.7% net smelter return royalty on Inco’s Voisey’s Bay nickel deposit in Labrador.

IRC had offered Fawcett C$312,500 in cash and 218,023 IRC shares valued at C$4.30 apiece — or a combined C$1.25 million — for a 0.203% royalty on the WCC assets, giving the entire 1% royalty a market value of C$6.2 million. A week later, IRC also requested WCC’s written consent for the IRC-Fawcett proposal. IRC, meanwhile, is holding Fawcett’s cash and share payment in escrow until WCC consents to the deal.

By mid-March, WCC’s board had met and unanimously resolved to petition the court to set aside the royalty agreement. WCC says its directors concluded the transaction was “not in the best interests of WCC and had not received appropriate approvals.”

International Royalty isn’t giving up, saying it believes WCC’s position “is without merit,” and that it will “vigorously pursue all legal avenues available to protect its interests.”

While the courts decide whether or not the deal was approved appropriately, this case shows just how quickly and unexpectedly the fortunes of British Columbia’s metallurgical coal producers have improved in recent years. After all, could a controversial deal like WCC’s 1% royalty be struck today, now that real money is at stake? No way.

After languishing for a decade, metallurgical coal prices have soared to above US$125 per tonne from US$42 two years ago.

The tipping point for metallurgical coal came when China, with its explosion in steel production, began to cut back on its coking coal exports, which fell to no more than 4.2 million tonnes in 2004 from 13 million tonnes in 2002.

Other metallurgical coal users in the region, most notably Japan and South Korea, had to seek out new sources in places such as Canada, and they were willing to pay premium prices to secure supply.

The coal industry in British Columbia and Alberta had consolidated earlier in the decade broadly into two massive blocks: the Elk Valley metallurgical coal mines in southeastern British Columbia, which are geared toward export markets, and Luscar’s dominantly thermal coal mines in southern Alberta, which feed power plants in Alberta and Saskatchewan.

Farther east, Saskatchewan’s less-valuable, Luscar-operated lignite mines plodded along and Nova Scotia virtually vacated the coal-mining sector and began importing Colombian coal for its power plants.

However, today in Canada we are seeing the established giants expanding and a new crop of dynamic coal juniors sprouting up, including WCC, NEMI Northern Energy & Mining, Pine Valley Mining, Grande Cache Coal, Fortune Minerals, Cline Mining and Pioneer Coal.

Allen Wright, executive director of the Coal Association of Canada, told an audience at the recent convention of the Prospectors & Developers Association of Canada that the estimated 65.9 million tonnes of coal the country produced in 2004 could be ratcheted up to 75-80 million tonnes annually within the next ten years.

There’s a phrase we haven’t used in The Northern Miner in a long, long while, and it’s true once again: it’s a great time to be in the coal business.