January 08, 2019

Production Off Take Agreements

Jess Hewitt

Jess Hewitt
Investor and Executive Management/Lereno, LLC; Gulf Hydrocarbon, HYPERFUELS, LLC

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December 2018, Originally appearing in Biofuels Digest 

 

No matter how ubiquitous your product is it always seems that banks and investors fear that you will not be able to sell your product – to anyone.  Now, this may seem preposterous if you are intending to make what we call a commodity product (a product whose price is easily established by numerous market participants and privately or publically published).  But, believe me, once you start planning your project you will get questions about who will buy your output.

The Production Off-Take Agreement (POTA) is the answer to these questions and concerns.  These agreements are non-binding letters of intent that document the buyer’s intent in buying your production, should you be able to actually produce a product.  For best results, the off-taker should be recognized as a reliable buyer of the product you are producing, or if yours is the first product of its kind, then the buyer should be involved in a market for a competing product.  An example would be an off-taker for biodiesel who is in the diesel market.

Once you have a signed POTA then you can use the agreement to prove that you have buyers who have indicated a willingness to buy your product.  You can show it to investors and lenders to answer their questions about who will buy the output from your facility.

I can’t tell you how many off-take agreements that I have written over the years.   Most people who approach me do not have a well thought out plan but I offer encouragement by showing that their plan has credibility and the product has a market.  For these entrepreneurs, this is their first contact with an industry participant and many times I can shed light on their plans or answer their concerns for their project.

 

How to make an Off-Take Agreement

 

The Basics

 

The POTA is a letter agreement that is legally known as a non-binding letter of intent.  Now many would rather have a binding agreement for the counterparty to buy their output but let me explain why this is not possible. 

As a real buyer of the product you are going to produce, I can write a binding agreement to purchase your product.  However, you have no product; you may not even have a facility to produce a product.  So, my first question is how are you going to supply me with a product if you do not have a facility?  In other words, you can’t sell what you don’t own.  I will address this issue again in the Pitfalls of Off-Take Agreements.

You can, however, make a non-binding letter of intent to sell your product and reference your facility and make it your intent to sell the output to your off-taker under mutually agreeable terms.  Essentially, you can agree to later agree to a binding contract to sell your output.

 

POTA Terms

 

The POTA has basic terms of construction and you can write your own, have someone write it for you but mostly I recommend you allow the Off-Taker to write the letter.  These are the basic terms that will be in your agreement:

  1. Identification of the Parties: If you have formed a company then it will be identified in the opening paragraph as the seller of the product.  If you have not set up an entity then you can identify yourself as a party with these words following your name, “and or assigns” to indicate that there may be another entity that will be the actual seller of the product.
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  3. Facility: You will have to describe your facility whether an existing or a future facility.  The description can be as easy as an address or if no address is available just identify the nearest town or landmark, the parish or county and the state of the location. If you have multiple locations then you can list all locations on a separate page called an addendum.
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  5. Product: This is an important section.  You and the Off-Taker must agree on the “product” to be offered for sale.  I recommend that you allow the Off-Taker to help you define the key terms of the product definition and include any specifications as an addendum. 
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  7. Volume Offered: This paragraph is very important and it is missing in many agreements.  Even though an off-take agreement is non-binding, many disagreements can erupt when the off-taker is not aware that the seller has other off-takers or intends to sell their own product to others.  This section should make it clear if there is an exclusive for the off-taker to take all production or just a portion.  I always recommend that the seller retain the right to sell a portion of the output.  This puts the Off-Taker on notice that they are not an exclusive buyer.  If you are going to have two or more Off-Takers then you should disclose that fact in this letter.
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  9. Price: I see many poorly constructed POTA’s that have no price definition.  See one of the Pitfalls of not including a pricing section.  Now it may be premature to discuss an actual price but it is very important to document the type of pricing that will be used.  For example, if you are selling an alternative to diesel fuel then you can reference the nearest market price for diesel fuel and document how your price will relate to that market price.  See the box below for a sample of the price language.
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Sample Pricing Language

Price:  Price for the Product will be the Ultra-Low Sulfur Diesel daily index price published by XYZ newsletter for the date of delivery less a deduction for location differential that will be mutually determined by the Parties, plus a premium for a portion of the Renewable Credit that will be mutually determined by the Parties.  The final price for the actual sales agreement shall be based on a formula using these parameters and actual deductions and premiums will be mutually agreeable.

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  1. Payment: Don’t forget to have a discussion about when you will be paid as this question will be asked by investors and lenders.  Your pro forma financial statements should reflect the same payment terms as your POTA.
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  3. Non-Disclosure Agreement: This part of the letter agreement will be binding as you may not want your Off-Taker to disclose your plans or even the existence of a POTA.  Therefore make sure you include a section that requires each party to obtain the agreement of the other party for any disclosures of the terms of the letter – or even the existence of the letter.
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  5. Term: Every agreement should have a term.  The term should be the time you need to establish your production plus a few months.  If you need more time then you can always request an extension.  This clause is mainly for the producer to show the buyer that you mean business. 
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  7. Signatures: Be sure to get all parties to sign the agreement.  Many years ago I discovered that my future producers were using my POTA’s drafts without my signature – of course when the investors or lenders called me for a due diligence check I had to tell them that no agreement was in place as the producer never returned a signed document. 
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How to Select an Off-Taker

 

Finding a good off-taker is vital to the credibility of your plan.  The more prominent the buyer then the more credible is your plan.  Your off-taker selection is very important.  Having gone to the trouble to identify and sign a letter of intent with off-taker shows you are serious about your project.

Depending on what you product you produce, you will either have many, or a few buyers.  I am not sure which case will be best.  In the case that there are many buyers then you will have a large selection of potential off-takers but this also is a negative as it is more difficult to find an off-taker.  It is actually easier when the field is smaller, as the sole, or few off-takers are probably going to be very interested in doing business with you.  Whereas the larger market participants may have little time for a new entrant asking for a letter agreement.

Your best bet is to ask others for advice.  If you are a member of a business group then look to their leadership to identify potential buyers.  If there are just a few then start making calls.  If you’re not sure what to do then you can always engage an expert or consultant like Lee Enterprises to find you an off-taker.

How you approach your potential buyer is also critical.  The best approach is a business or personal referral.  If someone you know is acquainted with an influential leader at the target off-taker then ask them to make a written introduction.  What is in the written referral is important, too.

Let’s go over what should be in any introduction (whether you are making your own or asking for a referral) should have these basic points:

  • Your name, company name and title of your current company or your future project
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  • Your background that is related to your project. For example are you an experienced executive or engineer, or did you work for a similar company?
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  • Do you have others on your team that have any experience related to your project? I am not referring to name dropping.  I want you to list real people with operating roles in your project.
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  • Do you or your team members have any association with industry groups? If so, then list the groups ad nauseam.
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  • Identify the product you will be producing and reference the specification if one does exist – be careful here. If you call your product by an unknown or improper name then you are sunk.  Whenever I get a call about D6 then I know the called does not know what they are doing as the term D6 has no meaning as it is a refining term that indicates the distillation level but not the actual product.
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  • Identify the market you are looking at – is it a local community, a state, the continental United States or the world – make it a credible goal.
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  • Brief explanation of your project. Make it very brief, such as “we are planning the restart of a unit that previously produced renewable product.”  Or, “we are an investment and operating group planning the construction and operation of a renewable fuel facility that will produce a product of interest to you.”
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  • Outline your timeline, where you are now, where you have been and where you have to go.

Once you have opened the conversation then you can develop a rapport with the off-taker.  Ask them about their affiliations with any business groups.  Do your research and hopefully, your excellent research will provide you with answers to the questions you will pose.  For example, you know the person is the current chairman of an industry group representing companies involved in the product you will be producing so ask, “I heard the State XYZ Association works on matters involving our product.”  His answer will be to let you know that he or she is a member with a prominent role.

After your conversation develops then you or your target will ask the question about your call.  If you ask then you might say, “Over the last few months we have been working on a project to produce a renewable product that could be of interest to you as we are planning to produce it in your market area.  We are at the point where we need to confirm commercial interest in our product.  Would you have an interest in the output?”

Your counterparty will take it from there and will let you know if they have or do not have an interest.  Do not try to talk them into buying your product but if they are negative then ask them what would it take for them to have an interest.  Maybe you are in too early a stage or maybe they have an agreement that would prohibit them from contracting with your project.

In any event, log your call responses and follow up to provide any requested materials.

Once you have satisfied their requests then you can move to document the intent of the parties to have an off-take agreement.  Use the tips we are giving you to put together an agreement or ask the off-taker to draft the non-binding letter of intent.

 

Pitfalls to Avoid

 

Up to now I have covered some very detailed instructions and provided some education.  So to this point, I have taught you everything you know but not everything that I know.  So now I move to some of the finer points that were not discussed but could get you in real trouble if you allow them to occur.

Let’s start with the letter of intent.  It is non-binding and that is important as neither you nor your counterparty can predict what will happen that may change your intent.  That is key – if your intent changes then you can terminate the letter agreement.  Some counterparties may try to have you sign a binding agreement and this can be a mistake for many reasons.

First of all, at this stage, you don’t even have a product to sell but some clever companies may try to get you to commit to selling them “a” product – not necessarily your product.  Here’s the way this plays out. You sign a committed supply contract that has a start date for supply one year from today.  That day comes and your facility is not capable of producing the product.  You contact your off-taker and inform them you are not able to produce.  What is your off-takers response?  They go out and buy the product at any price and then charge back to you any price difference to buy a replacement product.  You object but they just keep buying replacement product and sending you due bills. 

Turns out that you are in a very bad position because you sold what you did not have and you defaulted on a committed supply agreement.  All you created was a liability and most likely a lawsuit.  So believe me when I say, no committed contacts – only non-binding agreements.

Next, you have to be aware that you will come across unscrupulous lenders or brokers who will ask you to do things that are not in your best interest and could cost you a relationship with your off-taker.  Here’s the way the lenders or brokers approach you. 

They will say, “Do you need money for a project?”  You of course answer, “Yes we have a need for financing for our equipment.”  Their response is, “Well you have a very creditworthy buyer for your product so we can get you financing based on the buyer’s credit.”

Stop right there.  Here is what they are going to ask you to do.  They will ask you to call your buyer and request their financial statements to evidence their creditworthiness.  This is the red flag. 

They don’t stop there as they ask you to call the buyer to ask them if they will consent to paying your prospective lender who will finance your project.  Their answer will be of course and you report back to the lender.

And this is the point where it goes off the rails.  The lender asks you to conclude a new agreement with the buyer to provide the following terms, Buyer will pay $x/month to the seller and take the product or if not taken will pay the amount to buyer’s lender.

Now, let’s think this through.  Your lender is asking for the buyer to pay a minimum amount of money each month to satisfy the monthly payment for the loan.  That makes sense, doesn’t it?  Well, it doesn’t make any sense to the buyer.  Whether you know it or not the lender has just traded your credit for your buyer’s credit.  This means if your project has any troubles then your off-taker will be responsible for making monthly payments even if you are not making any products.  This seems ridiculous and you may be saying no one would do this but I see this scenario in about 20% of the offtake agreements that I sign.

The off-taker is not investing in the project so why should they be responsible for making your payments?   He will not and once you ask him to do this then you may lose him and your credibility will suffer.

Therefore if any potential lender asks you for your buyer’s financial statements then kindly reject that request and find another lender.  This will save you much time and you will find a lender who is interested in you, not your off-taker.

Here is the last pitfall to avoid.  The price you sell at will determine your revenue stream th, therefore, is very important to define the price as well as you can.  I always recommend a formula approach as you can document the base price and premiums and discounts for any other terms.

The pitfall if you don’t define your price and the time comes to execute a formal sales agreement and your off-taker rejects your price then you will lose valuable time to find another off-taker or you will lose revenue by accepting a price lower than you pro forma value.

Take time to construct your price from these basic principles.

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Basic Price Formula for Off-Take Agreements

 

Base Price – can be a published price for the exact commodity or a proxy.

                                For example, if you are selling a new commodity without a market but it will replace gasoline then you can use a published gasoline price index or even the commodity futures contract closing price.

Plus Premiums such as

                Quality Premium – if your product has a better quality than the proxy commodity

                Location Premium – if your product is nearer to the buyer than the proxy commodity

                Credits – if your products include renewable fuel or carbon credits or tax credits

 

Less Deductions such as

                Quality or Location Discounts – the opposite of above

Prepay or Fast Pay Discounts – if your buyer is paying you faster than the payment terms for the proxy commodity then you may have to offer a discount

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Your Production Off-Take Agreement will enhance your probability of success.  Just remember that if you have any issues obtaining an off-take agreement then there are always experts in the field that can assist you.  As a last point, I am often asked, “Should I pay for an Off-take Agreement?”  Of course, if a credible party is offering a documented POTA then ask for references and if the references check out then make that deal.  I actually use a small payment to make sure the project managers are serious – if you’re not willing to pay a token fee then you may not be serious about your project but then again I can produce substantial references that are positive.

One way or another you need a Production Off-Take Agreement to make your project a success.

Comments? You can contact me directly via my ExecRanks profile.

LINK:  http://www.biofuelsdigest.com/bdigest/2018/12/27/production-off-take-agreements/

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