What Is an Offtake Agreement?

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Offtake agreements are often made before production facilities are built.
Offtake agreements are often made before production facilities are built. (Image: Axel Ellerhorst/iStock/Getty Images)

Offtake agreements are legal contracts between two companies regarding specific amounts of goods to be delivered from one company to another. These contracts are quite common and are primarily used with energy producers like coal mines or power plants. Many times these agreements contain several protective clauses and may take months or years to complete.

Overview of Offtake Agreements

Offtake agreements are contracts between suppliers and buyers based on the future production of resources and not on existing supplies. Typically, the resource does not exist in a saleable form at the time of the agreement -- the supplier commits to sell to the buyer, and the buyer to buy from the supplier, when production starts. Prices are usually agreed when the offtake contract is drawn up.

Benefits of Offtake Agreements

Offtake agreements have benefits for both the sellers and buyers of resources and services. They give sellers the guarantee that they can sell their resources in the future and can earn a profit on their investment. This often helps them obtain financing to build plants and production facilities as it shows lenders that they have future purchasers in place. Buyers fix a price in advance and can use the agreement as a hedge against price changes in case of a future supply shortage. Additionally, their offtake agreements give them a guaranteed supply if there are any future shortages in the market, which may raise their profits.

Buy/Sell Options in Offtake Agreements

Offtake agreements should include three important statements. The first statement is whether the contract is a firm buy/sell agreement or an option contract. The buy/sell clause is important because it ensures that a future economic is guaranteed to take place unless one party breaches the contract. An option contract gives the buyer an option to exercise the agreement if the market provides a favorable environment for the buyer to execute the purchase.

Force Majeure Clauses in Offtake Agreements

A force majeure clause allows the offtake agreement to be canceled with no penalty assessed to the buyer or seller listed in the contract. In order for the force majeure clause to take effect, something outside of the buyer’s or seller’s control must take place. This clause eliminates or mitigates the risk from the contract parties for items such as major weather disasters, government regulation or failure of a third party assisting with production.

Default Clauses in Offtake Agreements

The third most important clause of an offtake agreement is the ability of one party to cancel the contract through a default by the other party. Because offtake agreements are legal contracts, cancellation of the contract is usually not permitted. Default agreements will state what constitutes a default, such as the violation of one clause or multiple clauses that will result in penalties. Because legal agreements are difficult to cancel, companies usually build stiff financial penalties into the contract to ensure the agreement is strictly followed.

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