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Take-or-Pay Contract

Definition

Take-or-Pay Contract” is one of the three most used LNG contracts type, see comments below. Take-or-Pay Contract are written agreements between a buyer and seller that obligate the buyer to pay regardless of whether or not the seller delivers the good or service. Generally, this obligation to pay does not involve the full amount due for the product, and protects the seller in the event that the buyer refuses to accept the good or service when delivery is attempted. The clause of the Take-or-Pay Contract which stipulates this obligation for the buyer to pay a compensation in the case he does not take the good or service is commonly called the killing clause.

Comments

There are three major pricing systems in the current LNG contracts:

  • Oil indexed contract, the JCC Contracts, used primarily in Japan, Korea, Taiwan and China,
  • Take-or-Pay Contracts based on a combination of oil products and other energies used primarily in Continental Europe;
  • Market indexed contracts used in the USA and the UK.;

In most of the Northeast Asia LNG contracts, price formula is indexed on a crude oil basket imported to Japan called the Japan Crude Cocktail (JCC).

In the Continental Europe, the energy is produced out of multiple sources, so the LNG price formula indexation does not follow the same format as in Asia.
LNG price varies from contract to contract. Brent crude price (B), heavy fuel oil price (HFO), light fuel oil price (LFO), gas oil price (GO), coal price, electricity price and of course natural gas price indexes are the indexation elements of price formulas.

In addition to the different pricing reference in Europe from Asia or USA, the Take-or-Pay contracts used in Europe include the, so called, killing clause mostly due to the fact that the gas is distributed in Europe mainly through gas pipelines which do not give flexibility to re-route gas deliveries in case of buyer default.

Historically the Take-or-Pay contract was mostly used in the sale of food commodities. A farmer may contract with a buyer to purchase an entire harvested crop during a given season. If the buyer for any reason decides to not purchase the entire crop, he or she will still owe the farmer some type of reduced payment. This ensures that the farmer does receive some compensation on the transaction, while still allowing the farmer to seek other buyers for the crop.

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