take-or-pay agreement

Case Study Take-or-pay agreements linking sellers and buyers through long-term contracts are common in the energy business, where producers are required to make huge initial expenditures, and consumers often need a steady long-term supply of energy. The agreements require a purchaser to pay for a prespecified minimum quantity of coal, gas, or electricity, regardless of whether the purchaser actually takes delivery. In certain instances, a purchaser who must pay but cannot use product in one year may be permitted to take extra product the following year. Likewise, the producer guarantees to deliver a minimum quantity. PetroChina financed a 2,400-mile natural gas pipeline on the basis of signing long-term take-or-pay contracts with 40 customers. A little less than half the sales were to residential customers and another quarter of sales were to industrial customers. These were generally considered low-risk agreements. The remaining gas was contracted mostly to power plants owned by municipal governments or companies owned by municipal governments. There was some concern that municipal governments would be unable to sell enough electricity to make use of all the gas specified in the take-or-pay agreements. It was unclear how the contracts would be enforced in the event of a dispute. In addition, coal was less expensive than gas at the time the pipeline was completed, thereby making it less likely the municipal governments would want all the gas they had agreed to take.