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Offtake Agreements2022-03-13T11:32:17-04:00

Offtake Agreements

Project Finance Document Critical For Loan Approval

Offtake Agreements significantly increase the likelihood of project loan approval by reducing long-term project risk and offering stable cash flow for years to come.

Overview of Offtake Agreements

Offtake Agreements may only be one document in a package of dozens of critically important project finance documents Offtake Agreements may be the most critical in terms of securing project loan approval. Overall, while well-written, well-presented project documents ensure that lenders will have a generally favorable impression of your project, Offtake Agreements are given a different level of scrutiny. Every project finance lender in the world scrutinizes Offtake Agreements because lenders rely on Offtake Agreements to provide the financial assurances they need to validate the cash flow forecasts that form the basis for loan repayment.

Because the project is not yet built or operating, there is no existing cash flow to pay debt service, there are only financial models which are far less certain. Offtake Agreements provide project lenders with documentary evidence which supports and validates the financial models and projections upon which the ability to repay is based. Quite simply, Offtake Agreements make many projects bankable.

An Offtake Agreement establishes the contractual framework for a long-term business arrangement between the project company and an offtaker for the purchase and sale of all or substantially all of the project output. Offtake Agreements provide fixed or contractually adjusted prices for as long as ten years or more into the future, so it is easy to understand why they have so much influence in the financing approval process.

Key Features of Offtake Agreements

Investopedia defines Offtake Agreements as contracts between the producers of a resource, in the case of project financing the producer is the project company, and a buyer of the resource, who is known as the offtaker, to sell and purchase all or substantially all of the future production from the project. The Offtake Agreements are negotiated prior to the development of the project which will become the means of production of the resources being sold under the agreement. When projects produce resources like electrical power or natural gas, Offtake Agreements are vitally important to their success. 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.

Offtake Agreements are also just as important to getting the deal built and financed. In order to mitigate risk, most project finance lenders insist that Offtake Agreements be a condition of loan approval. Contractually establishing future revenue is an inducement most project lenders require to approve the project financing. Because they are a critical component of the deal, Offtake Agreements are an extremely important part of the project documents. Offtake Agreement secure 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 Offtake Agreements

Offtake 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.

Offtake 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 Offtake Agreements provide a promise of future income as well as proof that a market exists for the product.

Advantages of Offtake Agreements

Offtake Agreements are generally a win-win document, with the project company and the offtaker both deriving an equitable deal. While beneficial to both parties, an Offtake 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 Offtake 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 Offtake Agreement.

Benefits to the Project Company

» Project financing was approved due in very large part to the agreement;
» A substantial part of future production is sold for many years into the future;
» Guaranteed income under the agreement for a long period of time;
» Project company earns a predictable profit for many years into the future.

Benefits to the Off-taker

» Offtake Agreement allows offtaker to lock-in a long-term supply;
» In addition to guaranteed supply, the offtaker gets a guaranteed price;
» Contract provides a hedge against future price increases;
» Protected against market shortages because delivery is guaranteed.

Types of Offtake Agreements

While all Offtake Agreements generally establish a long-term contractual framework defining a business arrangement between the project and an offtaker and establishing the terms under which the project will sell and the offtaker will buy, Offtake Agreements take many different forms.

Take or Pay Contracts

Offtake 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 offtaker actually takes delivery of the products.

Take-and-Pay Contracts

With Take-and-Pay Contracts, the offtaker only pays for the product taken on an agreed price basis.

Throughput Contract

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 Offtake Agreements commonly used with electrical power projects in developing countries. In this circumstance, the offtaker 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 offtaker 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

Hedging Contracts are used in commodity markets such as in an oilfield project.

Long-Term Sales Contracts

With long-term sales contracts, the offtaker 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.

Force Majeure Clause

Although the Offtake 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 Offtake Agreements contain a force majeure clause which allows either party to modify or cancel the Offtake 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.

Project Finance Learning Center

Project finance was first used in 1299 when an Italian merchant bank provided the project financing to finance the development of English silver mines. England repaid the Italian merchant bank who funded the project with the output from the mines. Project financing has been used to finance thousands of projects since those silver mines, including such notable projects as the Panama Canal and North Sea oil platforms. Our Project Finance Learning Center includes information we hope will improve understanding of this type of finance.

Offtake Agreement Key Takeaways

An Offtake 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 Offtake Agreement, despite the fact that the Offtake 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 Offtake Agreements 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 Offtake Agreement is arguably the most important for successfully funding the project. The project company should take steps to ensure that the Offtake Agreement and the overall project documents are well-conceived and drafted.

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