Financing projects typically involves securing offtake agreements with the buyer that lasts as long as the loan term. Project loans, especially from development finance banks such as IFC/World Bank, African/Asian Development Banks and the European Bilaterals such as FMO in the Netherlands or Proparco in France, are between 10 and 15 years.
10 to 15 years is a long time in politics, and lots can change in that time. The reason we mention politics is that, in developing economies at least, the offtaker will often be state owned, with its fortunes closely linked to those of the owner government.
The purpose of offtake agreements
The purpose of such agreements is straightforward: they provide the money to repay the project loans, and are a key element in making the project bankable. For instance, in a power station project, the offtaker buys electricity to sell to consumers. However, if the offtaker does not or cannot pay due to reasons like political upheaval, the underlying project loan will go into default, leading to both commercial and political consequences.
There are various strategies available to help kitigate the offtake risk of a developing economy offtaker. Solutions like debt service reserve accounts provide a short term cushion against non-payment. However, for long-term security, lenders should seek some kind of creditworthiness guarantee, often offered by development finance banks who, like the World Bank, can leverage their influence on governments to ensure offtaker performance.
The World Bank guarantees offtakers through the Multilateral Insurance Guarantee Agency – www.miga.org. Other multilaterals have similar products. These products are not cheap, nor do they come quickly, but they can make the difference between a project being bankable or not.
Direct agreements
Another approach to mitigate offtake risk is through direct agreements with the host government. Project documents offer no contractual connection between the lenders and a hoist government, so any default called by the lenders will only bite on the project company borrower. Direct agreements create contractual relations between the lenders and the host government. In principle, they allow lenders to bring claims against a host government for any actions that may have led to the offtake agreement’s failure.
Direct agreements need sensitive handling because their use implicitly suggests that a government might take action that compromises a project. And, governments do not normally take kindly to this sort of suggestion…
In summary, addressing credit issues in offtake agreements is vital for project financing, particularly in the long term and in politically volatile environments. By employing a comprehensive approach involving financial safeguards, political leverage, and careful negotiation, stakeholders can enhance project viability and sustainability, navigating the uncertainties inherent in such ventures effectively.