What Is an Offtake Agreement in Project Financing?

What Is an Offtake Agreement?

An offtake agreement is an arrangement between a producer and a buyer to purchase or sell portions of the producer's upcoming goods. It is normally negotiated before the construction of a factory or facility to secure a market and revenue stream for its future output.

Offtake agreements are typically used to help the selling company acquire project financing for future construction, expansion projects, or new equipment through the promise of future income and proof of existing demand for the goods.

Key Takeaways

  • An offtake agreement is an agreement to buy or sell, in advance, some of a producer's goods that haven't yet been made, making it easier for producers to obtain financing.
  • This type of agreement may be negotiated far in advance, often prior to construction of manufacturing facilities and before actual production has begun.
  • Offtake agreements can help buyers lock in a price and guarantee supply of a product in anticipation of future demand.

Offtake Agreement

Understanding Offtake Agreements

Offtake agreements are legally binding contracts related to transactions between buyers and sellers. The provisions usually specify the purchase price for the goods and the delivery date, even though the agreement is reached before any goods are produced and any ground is broken on a facility. However, companies can usually back out of an offtake agreement through negotiations with the other party and with the payment of a fee.

Offtake agreements are frequently used in natural resource development, where the capital costs to extract resources are significant, and the company wants a guarantee that some of its products will be sold.

The offtake agreement serves an important role for the producer. If lenders can see the company has clients and customers lined up before production begins, they are more likely to approve the extension of a loan or credit. So offtake agreements make it easier to obtain financing to construct a facility.

Benefits of Offtake Agreements

In addition to providing a guaranteed market and source of revenue for a company's product, an offtake agreement allows the producer/seller to guarantee a minimum level of profit for its investment. Since offtake agreements often help secure funds for the creation or expansion of a facility, the seller can negotiate a price that secures a minimum level of return on the associated goods, thereby lowering the risk associated with the investment.

Offtake agreements may provide a benefit to buyers as well, functioning as a way to secure goods at a particular price. That means prices are fixed for the buyer before the manufacture of them begins. Doing this may act as a hedge against future price changes, especially if a product becomes popular or a resource becomes scarce, causing demand to outweigh supply. It also provides a guarantee that the requested assets will be delivered: fulfillment of the order is considered the seller's obligation under the terms of the offtake agreement.

Offtake agreements also include default clauses that outline the recourse—including penalties—either party has in case there is a violation of one or multiple clauses.

Special Considerations for Offtake Agreements

Most offtake agreements include force majeure clauses. These clauses allow the buyer or seller to cancel the contract if certain events occur deemed outside the control of either party and if one puts unnecessary hardship on the other. Force majeure clauses often provide protection against the negative impact of certain acts of nature, such as flooding or wildfires.

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