Offtake Agreement
From CEOpedia | Management online
Offtake Agreement are long-term contracts in which one counterparty commits to delivering certain volumes/quantities of a good or service. The other, called the offtaker, agrees to pay predefined sums of money or a set fee for a certain period of time in exchange for a good/service. The price the offtaker pays in indexed to parameters that trends in the rate of inflation for production prices and consumer prices[1].
Three main types of offtake agreements
Offtake agreements can take various forms[2][3]:
- take-or-pay contract - the purchaser is obliged to pay for the output of the project whether or not the purchaser takes delivery. If the purchaser does not take delivery, payment is still required. These payments are credited to future delivery. If te project is unable to deliver the service or produce the product, the purchaser does not have to pay.
- take-and-pay - offtaker only pays for the product taken, on an agreed price basis. Clearly this has limited relevance for an offtake agreement in a project financing, as it provides no long-term certainty that the product will be purchase.
- long-term sales contract - offtaker agrees to take agreedupon quantities of product from the project, but the price paid is based on market prices at the time of purchase or an agreed market index. This type of contract is common only used in, for example, mining, oil and gas and petrochemical projects.
What may include offtake agreement ?
An off-take agreement may consist of provisions relating to matters such as[4]:
- quantity and quality of the output to be delivered, purchase price and delivery timetable
- escalation or adjustment formulas for the purchase price in accordance with certain appropriate indices for local and foreign costs
- pass-through purchase price adjustment formulas intended to compensate the project company for certain increased costs, including taxes, costs of complying with changes in law, and interest rate fluctuations
- incentive payments and low performance penalties in order to encourage a project to operate efficiently
- a term of at least equal to, and preferably two to three years longer than, the term of the debt financing
- conditions of effectiveness establishing that the obligation of the project company to deliver the output shall commence at a date certain, which date must be consistent with the completion date established in the construction contract with a reasonable cushion time for contingencies
- a well-established mechanism for notice of a contract breach and a reasonable cure period
- scheduled outages and overhauls of the plant
- liquidated damages provisions
- dispute resolution mechanisms
Examples of Offtake Agreement
- Crude oil: In this type of agreement, an oil producer agrees to supply a certain amount of crude oil to the offtaker in exchange for a set price per unit. The offtaker may be a refiner or an energy company.
- Power purchase agreement: In this type of agreement, an electricity producer agrees to supply a certain amount of electricity to the offtaker in exchange for a set price per unit. The offtaker may be a distribution company or a large industrial user of electricity.
- Gas supply agreement: In this type of agreement, a gas producer agrees to supply a certain amount of natural gas to the offtaker in exchange for a set price per unit. The offtaker may be an energy company, a gas utility, or a large industrial user of natural gas.
- Mineral supply agreement: In this type of agreement, a mineral producer agrees to supply a certain amount of minerals to the offtaker in exchange for a set price per unit. The offtaker may be a manufacturing company that uses the minerals in its production process.
Advantages of Offtake Agreement
Offtake Agreements offer a number of advantages to both parties involved in the agreement. These advantages include:
- Price Security: An Offtake Agreement provides both parties with price security for a predetermined period of time. The offtaker is assured that the price of the good/service will not increase during the agreed-upon period, while the supplier is assured of a fixed return on their goods/services.
- Long-term Planning: Both parties are able to more accurately plan for the future, as the Offtake Agreement provides a long-term commitment that both parties will adhere to. This helps to reduce uncertainty and create more efficient and cost-effective long-term strategies.
- Improved Investment Opportunities: The fixed price and long-term commitment provided by an Offtake Agreement makes it easier for the supplier to secure financing and attract investment. This can lead to improved opportunities for growth and expansion.
- Flexibility: The terms of an Offtake Agreement can be tailored to the specific needs of both parties, allowing them to negotiate and agree upon the terms of the agreement that best suit their interests.
Limitations of Offtake Agreement
- Offtake agreements are subject to both legal and economic risks. For example, the seller may not be able to deliver the agreed-upon quantity or quality of goods or services, or the buyer may not be able to make payment on time.
- Offtake agreements may be difficult to enforce if either party fails to comply with the terms of the agreement.
- Offtake agreements may be subject to changing market conditions, making them difficult to accurately price.
- They can be restricted to a specific geographical area, limiting their potential for expansion.
- Offtake agreements may be subject to government regulations, taxes, and tariffs, resulting in unforeseen costs.
- Offtake agreements can be difficult to negotiate and can take a long time to complete, resulting in delays and higher costs.
- Secured Financing: Secured financing involves providing the offtaker with a loan secured by the underlying assets of the project. This form of financing gives the offtaker access to capital while providing the lender with security against default.
- Forward Contracting: Forward contracting is an agreement between two parties to buy or sell a good or service at a certain time in the future. This type of contract allows the offtaker to secure future supplies at predetermined prices, while also allowing the offtaker to hedge against market price fluctuations.
- Prepayment Agreements: Prepayment agreements are arrangements in which the offtaker agrees to pay an upfront amount for future supplies of a good or service. This allows the offtaker to purchase goods or services at a discounted price, while also providing the supplier with a secure income stream.
- Output-Based Pricing: Output-based pricing is a type of contract in which the offtaker pays for the delivery of a good or service based on the output of the supplier. This allows the offtaker to pay for the delivery of a good or service on a per-unit basis, rather than having to pay a fixed price that might not be reflective of the actual cost of production.
In summary, Offtake Agreements are long-term contracts between two parties in which one commits to delivering a certain volume of a good or service, while the other agrees to pay a predefined sum of money. Other approaches related to Offtake Agreements include secured financing, forward contracting, prepayment agreements, and output-based pricing.
Footnotes
| Offtake Agreement — recommended articles |
| Take-or-pay contract — Lombard loan — Revolving letter of credit — Countertrade — Staged payments — Outright Forward — Trade counter — Sole distributor — Flexible pricing |
References
- Buljevich E.C., Park Y.S. (2011), Project Financing and the International Financial Markets, Springer Science & Business Media, Boston.
- Crundwell F. (2010), Finance for Engineers: Evaluation and Funding of Capital Projects, Springer Science & Business Media, London.
- Gatti S. (2007), Project Finance in Theory and Practice, Academic Press, New York.
- Yescombe E.R. (2002), Principles of Project Finance, Elsevier, California.
Author: Ewa Szczyrbak
