Off-Take Agreement In Project Finance
Off-Take Agreement Most Critical Project Document
Although Project Financings always have extensive, precise project documents, none are as critical to loan approval as the Off-take Agreement
Off-Take Agreement in Project Finance Overview
Few project sponsors realize just how important an Off-take Agreement is for the project finance documentation in successfully arranging project financing. let Simply stated, the Off-take Agreement is arguably the most critical of project documents. Project Documents are vitally important for shielding the project sponsors, managers and investors from recourse liability. They are also vitally important for securing loans to finance their project. It is the project documentation that initially influences project lenders and how they view your proposed project.
All project lenders closely scrutinize the project documents for any deal that is seeking project financing. Because of the importance, we prepare the project documentation package for our project finance clients so we can be assured that lenders will view your deal favorably as we navigate the financing process, and also to protect your interests during development and operation of the project after we successfully procure financing.
Although only one in a package of critically important project documents, the Off-take Agreement is, perhaps, the lynchpin of any loan approval. Every lender in the world who provides project finance looks to the Off-take Agreement for the financial assurances lenders need to validate the cash flow forecasts that form the basis for loan repayment.
While the counterparty in this agreement has a funny name, the contract between you and the off-taker will have a substantial influence on the financing for your project. Below we have prepared a very brief overview of the structure and workings of the Off-Take Agreement.
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What Is An Off-Take Agreement?
An Off-take Agreement is an agreement between a producer of a resource, in the case of project financing the producer is the , and a buyer of the resource, who is known as the off-taker, to sell and purchase all or a substantial portion of future production. The Off-take Agreement is negotiated prior to the development of the project which will become the means of production of the resources being sold under the agreement. When the project is one that produces resources like electrical power or natural gas, Off-take Agreements are vitally important to the success of the project. They lock-in a significant amount of future revenue and allow the project company to account for recurring sales and profits for many years into the future.
Off-take Agreements are also just as important to getting the deal built and financed. In order to mitigate risk, most project lenders insist that Off-take Agreements are a condition of loan approval. Locking down future revenue is an inducement most project lenders require to approve the project financing. Because they are a critical component of the deal, the Off-take Agreement is an extremely important part of the project documents. The Off-take Agreement secures the sale of the future resources the project will produce and provides evidence that a market for the future resource output of the project actually exists. When project finance lenders can see that the project has a prearranged purchaser of a substantial portion of its future production, lenders are much more likely to approve the project financing loan.
Analyzing Off-take Agreements
Off-take Agreements are often used in projects for energy production and distribution projects which require a significant capital investment to produce and distribute the resource. The project sponsor, owner, and lender all want a guarantee that some of the production is already sold.
Off-take Agreements are carefully crafted, long-term agreements between buyers and sellers that are negotiated and entered into before the subject project is even developed, become effective when project development is completed and production comes online, and continue for a long period of time, at least several years. These agreements help the project owner secure financing for the project, in fact, they are most likely required, because Off-take Agreements provide a promise of future income as well as proof that a market exists for the product.
Benefits of Off-Take Agreements
Off-take Agreements are generally a win-win document, with the project company and the off-taker both deriving an equitable deal. While beneficial to both parties, an Off-take Agreement provides its most substantial benefit before the project is even built, in that it is a key – if not the key – project document that provides the project lender with assurances sufficient to secure loan approval for the project.
Before any product is delivered or any money changes hands under the agreement, the Off-take Agreement delivers the biggest benefit in that the deal got done, and likely would not have absent the agreement. We cannot stress its importance in strong enough terms. Although it is more likely than not that our deal team will prepare the project documents, if we do not prepare the rest of the project documents, we should be engaged to prepare the Off-take Agreement.
Benefits to the Project Company
» Project financing was approved due in very large part to the agreement;
» A substantial portion of future production is pre-sold for many years into the future;
» Guaranteed income under the agreement for a long period of time;
» The project company will earn a predictable profit for many years into the future.
Benefits to the Off-taker
» Off-take Agreement allows Off-taker to lock-in a long-term supply;
» In addition to guaranteed supply, the off-taker gets a guaranteed price;
» Contract provides a hedge against future price increases;
» Protected against market shortages because delivery is guaranteed.
Different Types of Off-take Agreements
Off-take Agreements establish a contractual agreement between the Project Company and the off-taker. The agreement establishes the contractual role of the parties as described above, which is memorialized in the project documents. These are fairly normal terms and conditions of Off-take Agreements. The Off-take Agreement also sets forth the nature of the off-take, establishing the volume that must be delivered and taken; the frequency of delivery; the pricing scale along with formulas; and, the type of off-take deal.
Take or Pay Contracts
Off-take Agreements are typically Take or Pay Contracts that require the off-taker to pay for the products on a regular basis whether or not the off-taker actually takes delivery of the products.
With Take-and-Pay Contracts, the off-taker only pays for the product taken on an agreed price basis.
Throughput Contracts apply when the user of a pipeline agrees to use the pipeline to carry not less than a specified volume of product at a contractually specified minimum price.
Power Purchase Agreements
Power Purchase Agreements are Off-take Agreements commonly used with electrical power projects in emerging markets. In this circumstance, the off-taker is usually a government entity that is required to buy the power or utilities.
Contract for Differences
With Contract for Differences the project company sells its product into the market and not to the off-taker or hedging counterpart. If however, market prices are below agreed-upon levels, the off-taker pays the difference to the project company, and vice versa, if prices are above agreed upon levels.
Hedging Contracts are used in commodity markets such as in an oilfield project.
Long-Term Sales Contracts
With long-term sales contracts, the off-taker agrees to take the contractually agreed-upon quantities of the resource or product from the project. Under this structure, prices are not established in advance.
Instead, prices are based on the market prices of those resources or products at the time of actual delivery or an agreed upon formula or market index, subject to certain contractual floor prices.
Notable Provisions of Offtake Agreements
Although the Off-take Agreement is a tightly drafted, legally binding contract, it does require both parties to the agreement to make some very big promises extending many years into the future. It is certainly within the realm of possibility that during the term of the agreement something will happen that materially affects the ability to perform under the contract that is beyond the control of either party.
To account for events that cannot be counted on, most Off-take Agreements contain a force majeure clause which allows either party to modify or cancel the Off-take Agreement if something happens that puts undue hardship on either party which is beyond anyone’s control. Force majeure protects against catastrophic harm from things such as acts of God, fires, floods or natural disasters.
Off-take Agreement Key Takeaways
An Off-take Agreement is a contract between the project company and an off-taker which provides for the purchase and sale of resources which will be produced as a result of developing the project. Few project sponsors fully realize the importance of the project finance documents or the Off-take Agreement, despite the fact that the Off-take Agreement may well be the most critical of the project documents. Project Documents go a long way towards successfully financing the project and provide a great deal of protection for the project sponsors and investors against liability.
Project lenders closely scrutinize project documents for any proposed project financing. Global Trade Funding prepares the project documentation, including the Off-take Agreement to best position the project to secure financing. Proper documentation also protects your interests during development and operation of the project. Although it is only one of the project documents, the Off-take Agreement is arguably the most important for successfully funding the project. The project company should take steps to ensure that the Off-take Agreement and the overall project documents are well-conceived and drafted.
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