Originally published in Biomass Magazine, February 6, 2015
Biomass thermal projects are becoming increasingly popular and it is important to make sure that they are done correctly. Project financiers, be they equity partners or bankers, will require carefully thought-out contracts that will enable the project to get paid and address potential problems. One of the most important components of the contract is the offtake agreement. They establish how much the project will get paid, what factors could impact those payments and more.
Most offtake agreements are long-term contracts, often matching the length of any debt term, in order to ensure that there will be revenue available to pay the debt service and usually include renewals. They are binding upon signing, but often include early termination provisions to allow either party to get out of the deal, such as allowing the seller (project owner) to terminate if they cannot arrange financing for the project.
Along those same lines, the agreements usually include conditions precedent, or events that have to take place before either party is obligated to perform. Common conditions include final granting of permits, feedstock agreements, and financing for the seller and any regulatory approvals for the buyer.
Milestones are an important part of any project development and are often part of an offtake agreement, mostly because the buyer may be relying on the project to come online at a certain time in order to meet their own requirements. Often, there are penalties for missing milestones, though a seller should negotiate that penalties be waived if the project comes online by the commercial operation date.
The commercial operation date (COD) is the date when the plant is capable of delivering the thermal energy to the buyer. The COD is a critical piece of the agreement and the seller will face significant penalties if the project is not operational by the COD. Determining the right criteria for the COD is important to all parties to the project.
Before the plant is in commercial operation, issues of the delivery of the thermal energy, such as when and where does the ownership of the thermal energy transfer from the seller to the buyer must be answered. Much of that depends on how the thermal energy is delivered to the buyer, such as colocation, district energy or steam pipelines, but sellers will generally want the transfer, and thus the sale, to occur once the thermal energy leaves its plant.
Pricing is one of the most important aspects of a thermal energy project and pricing will generally be based on equivalent thermal energy costs, plus any premium for “green” thermal energy. Pricing is either fixed, with escalators, or based on market indexes. It is critical for the seller to have a complete understanding of their costs before agreeing to final pricing. Financing parties will be sure to run the numbers. It may help to think of it as a financial mass balance.
Curtailment is one of the issues the financiers dislike, but is usually a part of an offtake. Curtailment means that in certain circumstances the buyer has the right to refuse delivery of the thermal energy. In these cases, sellers want the buyer to continue to pay the regular price and count the curtailed thermal energy towards their requirement. Buyers understandably want to minimize paying for thermal energy they are not using and the parties usually reach a compromise, which could include capping the payments, having the energy count towards the requirement or other options.
Tax credits and renewable energy credits, where and when available, can be significant factors in the viability of a thermal energy project. Determining who gets the credits and how they can impact the bottom line pricing for the thermal energy is critical.
Performance guarantees are usually required by the buyer and normally amount to the seller guaranteeing that it will deliver a certain minimum amount of thermal energy to a buyer each year. Unexcused failures to deliver result in significant penalties or even rights to terminate. Sellers need to be sure that their construction and technology partners are able to build the plant to meet these guarantees. Financing partners will closely scrutinize performance guarantees and may require independent financial support such as credit enhancements in the form of standby letters of credit. Connected to performance guarantees, the parties will try to limit their liability to damages from a breach while at the same time maximizing the liability of the other party.
Thermal energy offtake agreements are complex legal documents that also need to be drafted in the context of the entire project. Take care, plan early and consult experienced advisors before getting started.