What an offtake agreement does

An offtake agreement is a contract to buy output that does not exist yet, signed before the plant that will make it has been built. The buyer commits to take a stated quantity, over a stated term, at a stated price or at a formula that will generate one. The seller commits to deliver it.

That is a strange thing to sign, and it is signed for a specific reason. A project financed with debt has to service that debt out of revenue, and a plant under construction has no revenue at all. An offtake agreement converts an open question — will anyone buy this, and at what price — into a named counterparty with a dated obligation. Lenders size debt against contracted revenue, not against hoped-for revenue, which is why the agreement is usually negotiated before the loan rather than after it.

What the contract fixes

Four terms do most of the work, and a lender reads them before it reads anything else about the project.

1. Volume: how much of the plant's nameplate capacity is committed, as against left to be sold on the open market.
2. Price: a fixed figure, a floor beneath which the buyer still pays, a formula indexed to a published benchmark, or a cost-plus arrangement. Each of the four puts price risk on a different party.
3. Term: how many years the commitment runs, which matters chiefly in relation to how many years the debt runs.
4. Remedy: what happens when either side fails. Take-or-pay obliges the buyer to pay for volume it does not lift; liquidated damages oblige the seller to pay when it cannot deliver.

What it does not do

An offtake agreement does not remove construction risk. If the plant is late, the seller owes a delivery it cannot make, and the contract turns from an asset into a liability at exactly the moment the project can least afford one. It does not remove input risk unless the price formula is indexed to inputs: a seller locked into a fixed price with floating feedstock and power costs has signed away its margin rather than protected it. And it does not make the buyer creditworthy. A long-dated commitment from a counterparty that may not exist at the end of it is worth what that counterparty's balance sheet is worth.

Analysts disagree about what long-dated offtake does to an industry over time. One argument holds that it is the only instrument that will finance first-of-a-kind capacity, because no lender will fund a plant into a market that does not yet exist, and that the state should be willing to be the buyer when no private one will. The competing argument holds that guaranteed demand at an administered price removes the pressure that drives cost down, and that industries built this way stay dependent on the arrangement that started them. Both sides are describing the same mechanism, demand certainty, and disagreeing about what it does after the first plant is running.

The useful question, when a project is described as underpinned by offtake, is not whether an agreement exists. It is what share of capacity is contracted, how the contract term compares with the debt term, and who the buyer is. A project with a small share of its output committed, for a period shorter than its loan, to a counterparty rated below the project itself, has an offtake agreement and very little protection.