Offtake agreements play a critical role in obtaining project financing for high capital expenditures, such as manufacturing plants or processing facilities.
From early-stage enterprises to more mature businesses, cash flow challenges can make it difficult to secure loans to finance infrastructure projects. This type of contract can go a long way to mitigate risk in the eyes of lending institutions.
Offtake agreements are often employed in a wide range of sectors, including mining, energy, agriculture, pharmaceuticals and foodservice manufacturing.
But what are offtake agreements, and how do they work? Here’s a brief overview of these deals and how they are typically structured.
What are offtake agreements in project financing?
An offtake agreement is a binding contract between a company that provides goods or services and a company that needs to procure those goods or services. It formalizes the buyer’s intention to purchase a certain amount of the producer’s future output.
Still confused? Here’s a simple breakdown of how offtake agreements work:
Let’s say a company has been working on a new coffee mug, but is looking for financing to develop this new project before it is actually produced.In order to secure financing from the bank, the company signs an offtake agreement with a coffee shop that is interested in selling the mugs once they are produced. Under the terms and conditions of this contract, the coffee shop agrees to buy all the mugs that the company intends to produce during the next year.The mug producer can assure investors and lenders that there is a market for its product before it begins production. It can also be confident that it has ensured a minimum return on its goods.The coffee shop can continue functioning as normal because it knows that it has secured a supply of mugs for a particular price and for delivery at a particular date.
What are the benefits of offtake agreements in mining?
The risks associated with extracting resources are high. One way exploration companies can reduce these risks is by securing offtake agreements.
Mining offtake agreements are important for many companies, but are particularly crucial for those focused on critical and industrial metals. Many of these metals are not sold on the open market, and that makes it harder for producers to offload them.
Generally, offtake agreements are negotiated after a feasibility study is completed and prior to mine construction; they help assure producers that there is a market for the material they plan to produce. That is beneficial for a number of reasons — most obviously, it means the mining company won’t have to worry about being able to sell its metal.
Additionally, having an offtake agreement tends to make it easier for producers to secure financing to move a project through mine construction. A lender or investor is more likely to finance a project if they are confident that companies are already lining up to buy the metal it will produce.
Buyers will also sometimes provide producers with money to advance their mining projects when an offtake agreement is created. However, that is not always the case.
Of course, this type of contract can also be beneficial for buyers. Offtake agreements allow buyers to purchase metal at a particular market price. This can function as a hedge against future price changes if demand outweighs supply. The terms and conditions of an offtake agreement also guarantee that buyers will receive the product they are purchasing at a specific date.
What risks are associated with offtake agreements?
While offtake agreements have many benefits for both producers and buyers, there are risks associated with them as well.
It’s possible for both parties to back out of an offtake agreement, though doing so usually requires negotiations and often the payment of a fee. Companies also face the risk of not having their offtake agreements renewed once they are in production, and they usually must make sure that their product continues to meet the buyer’s standards.
Offtake agreements can also be complicated and can take a long time to set up. For mining companies that want to move forward quickly with project development, spending that time can be a hindrance. These companies may choose to progress on their own and discover other routes to project financing.
Securities Disclosure: I, Melissa Pistilli, hold no direct investment interest in any company mentioned in this article.