Absolutely Nothing Wrong With “Take-Or-Pay” (Article)

By: Paa Kwasi Anamua Sakyi

In recent times, there has been a strong debate on factors necessitating Ghana’s rising energy sector debt. One of such factors as mentioned, is the “take-or-Pay” (ToP) clause in the Power Purchase Agreements (PPAs) between the Government of Ghana (GoG) and Independent Power Producers (IPPs). GoG as the buyer of the power produced by the IPPs (sellers) have consistently blamed the challenges within the power sector on “take-or-pay” clause, otherwise referred to as “take-or-pay contracts”.

During the presentation of the 2019 mid-year budget review speech, and the 2020 Budget statement to the Parliament of Ghana in 2019, Ghana’s Finance Minister Mr. Ken Ofori Atta explained that Ghana pays the independent power producers (IPPs) for power they generate for the country including those not consumed under a “take-or-pay” agreement. He has on numerous occasions indicated that government will from August 1, 2019 only pay IPPs for power the country actually consumes, and suggesting that all “take-or-pay” contracts will be re-negotiated to convert to “take-and-pay” (TaP) for both Power Purchase Agreements (PPAs) and Gas Supply Agreements (GSAs).

In his estimation, on average less than 40 percent of the contracted “take-or-pay” capacity is actually used, with the country paying over half a billion U.S. dollars annually for excess power generation capacity. His concern was that “paying close to US$500 million per annum for excess power not utilize may contribute to the challenges in the energy sector that pose financial risks to the economy as a whole. More so, Government holds the view that it is as a result of obnoxious take-or-pay contracts signed by the past government, which obligate the country to pay for capacity it does not need.

These assertions are contestable, in that, it is rather the country that failed to plan to absorb or consume the power produced by the IPPs; thus creating the excess capacity we hear today. Government’s computation to arrive at the excess power is flawed as it figure suggest that it based calculation on installed capacity and peak demand. This is quite simplistic and very misleading, if not based on Dependable capacity (4613MW at end 2019), less the 20 percent Reserve margin (922MW at end 2019), and less end 2019 Peak demand (2881MW); to produce excess power figure of less than 850MW at end 2019.

Whatever the excess power is, there are many sectors of the Ghanaian economy that require power for production and service purposes; such as in agriculture, manufacturing, mining, and commerce. Another of such areas to deploy the so-called “excess power” is in rural electrification, a program which government has failed to grow over the past few years, with the country unable to inch close to the 100 percent Electricity Access rate target it set for itself to achieve by 2020.

Again, one cannot conclude that the energy sector challenges are related to obnoxious “take-or-pay” contracts signed in the past, because other very factors such as non-reflective tariff, distribution inefficiencies, and government interference, have also contributed greatly to the rising energy sector debt, which stood at a little over US$2 billion in January 2017 to over US$4 billion by mid-2019. And though Bulk Distribution Companies have recently been paid close to $1 billion, Ghana’s energy sector debt is still over US$3 billion, and the figure keeps rising.

Even the measures proposed in the 2019 Supplementary Budget to confront the issues in the energy sector, clearly shows that the challenges in the sector goes beyond “take-or-pay” issues.

One reality the Government of Ghana must admit is that a “take-or-pay” clause in power purchase agreements as a guarantee instrument is legally accepted by parties to power contract, and as a result, there is absolutely nothing wrong with the arrangement as it exist in Ghana and other parts of the world. Government must accept that this type of clause/agreement amongst others are necessary to achieve final investment decision (FID) for many power supply agreements.

However, it is not out of place for government to consider negotiating or re-calibrating the existing PPAs, as it explores all relevant avenues to deal with the rising energy sector debt. What is most important is how well government explores the PPAs option without an undesirable costs to the country, and not be overly fixated on “take-or-pay” issues.

Take-or-Pay Contract/Clause

Diverse guarantee instruments have been cultivated to deal with various types of risk embedded in projects. Among the contractual arrangements that is able to allocate risks during the operating period; take-or-pay, throughput, and take-and-pay contracts are perhaps the most commonly applied (Razavi, 1996).

In a large scale energy project, the most familiar type of off-take contract is the “take-or-pay” contract. Kaiser and Tumma (2004) explains take-or-pay contract as an agreement between a purchaser and a seller that require the purchaser to either pay for or take delivery of a pre-specified quantity of a commodity or service at a price at specific time intervals (“take”) or pay for the same quantity without taking delivery (“pay”).

In contrast with “take-or-pay”, a “take-and-pay” contract obligates the buyer to both take and pay the contract price for a minimum quantity of commodity each year. This type of contract is often generally described as a “firm off-take” contract. That is, if the buyer fails to take the minimum contract quantity in any period it will be in breach or default of the contract each time such failure occur, and it will become liable to the seller for damages upon the occurrence of each such breach or default (King and Spalding, 2013).

According to Rogers and White (2013), “take-or-pay” contract is widely recognized by lenders, and it is often the most important method by which a seller secures the large external debt financing on limited recourse terms that energy projects typically require. A well-structured “take-or-pay” contract offers the seller with an assured revenue flow that provides sufficient return on the significant project capital investment and risks to which it is exposed. Vinter (1994) asserts that the predictability of revenue flows from the project minimizes the lender’s worry over potential risk of non-payment of the project debt.

Typically, a seller is concerned with two fundamental risks: market demand risk and price risk. A “take-or-pay” contract places the risk of deteriorating market conditions on the buyer by requiring it to always be responsible for the payment for a minimum purchase commitment (sometimes referred to as volume risk shifting), leaving the seller with only the market price risks to manage, which in some cases may be hedged (Rogers and White, 2013). It literally mean that, in the absence of the “take-or-pay” obligation a supplier bears all the risk that the off-taker’s ongoing need for the energy might dry up, or that a price swing might induce the buyer to break the contract.

“Take-or-Pay” contracts have been used by petroleum coke producers, aluminum company calination facilities, municipalities and waste incineration facilities (Kaiser and Tumma, 2004). The arrangement is also common in the energy sector, because of the substantial costs for suppliers to provide energy units such as electric utility, crude oil or natural gas; and the volatility of energy commodities prices.

“Take-or-pay” clauses are accepted the world over, as the arrangement exist in lots of places including Africa; in South Africa, Zambia, Nigeria, Tanzania, and Cote d’Ivoire. In Japan for instance, almost all liquefied natural gas (LNG) is imported under long-term contracts with a take-or-pay clause, although buyers assume considerable risk under such a clause. On the one hand, the government has accepted take-or-pay because it secures a stable supply of LNG (Namikawa, 2003).

Proceeding Cautiously

Reviewing and re-negotiating contracts could assist in achieving significant financial savings both in the short and long-term especially when market forces changes. However, one must to be careful not attract unnecessary costs because the service supplier is under no obligation to concede to you the buyer. In an attempt to re-negotiate, the buyer is essentially asking the seller for a favor. As a result, the buyer’s approach must be more calculated, as he seeks to restructure the contract to bring rates more in-line with current market conditions.

There could be financial or reputational damages if the process is poorly handled. In the instance where government would attempt to unilaterally re-calibrate the PPAs, it would be tantamount to a breach and/or repudiation of those agreements; and cost awaits the state in the form of judgement debt, reputational damage, and sabotages et cetera.

An approach for a collaborative consultation process to address the challenges in the energy sector will be less costly, compared to a unilateral re-calibration of the PPAs. Also an attempt to also blame the “take-or-pay” arrangement or blame the private sector who are the other side to those contracts, will result in government losing the goodwill to re-negotiate.

To this point, it is clear that “take-or-pay” clause as mostly capture in power purchase agreements is not wrong in all respect, and that it is an undeniable fact that risk associated with such capital-intensive projects must be well allocated to protect both the seller and the buyer. Government must therefore focus on areas to deploy effectively whatever “excess power” that may exist, and to correct the inefficiencies in especially the country’s power distribution segment.

Written by Paa Kwasi Anamua Sakyi, Institute for Energy Security (IES) ©2019

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The writer has over 23 years of experience in the technical and management areas of Oil and Gas Management, Banking and Finance, and Mechanical Engineering; working in both the Gold Mining and Oil sector. He is currently working as an Oil Trader, Consultant, and Policy Analyst in the global energy sector. He serves as a resource to many global energy research firms, including Argus Media and CNBC Africa