Take or Pay

What Is Take or Pay?

Take or pay is a provision, written into a contract, by which one party has the obligation of either taking delivery of goods or paying a predefined amount. Take or pay provisions benefit both the buyer and the seller by sharing risk, and can benefit society by facilitating trade and decreasing transactions costs.

Grasping Take or Pay

Take or pay provisions are generally included between companies with their providers, which expect that the purchasing firm take a stipulated supply of goods from the provider by a certain date, at the risk of paying a fine to the provider in the event that they don't. This kind of agreement benefits the provider by diminishing the risk of losing money on any capital spent to deliver whichever product they are attempting to sell. It benefits the buyer by permitting them to ask for a lower negotiated price since they are taking on a portion of the provider's risk. It very well may be an overall net gain to the economy in light of the fact that, by better sharing of the risk among buyers and providers, it works with transactions that could somehow not happen, alongside their going with gains from trade.

Take or pay provisions are exceptionally common in the energy sector, on account of the substantial overhead costs for providers to give energy units like natural gas or crude oil and the volatility of energy commodities prices. The overhead costs of giving crude oil as compared to a haircut, for instance, are extremely high. Take or pay contracts give energy providers an incentive to invest capital front and center since they have a measure of assurance that they'll have the option to sell their products. Without even a trace of take or pay provisions, providers bear all the risk that the buyer's continuous requirement for the energy could dry up or that a price swing could initiate the buyer to break the contract. Providers could likewise be subject to a hold-up by the buyers on the off chance that they have made overhead investments that will lose value on the off chance that the buyer doesn't buy the output as agreed, without the base guaranteed revenue of a take or buy agreement. Hold-ups are a type of transaction cost, recognized by economist Oliver Williamson, that happens with these sort of relationship-specific assets.

For instance, Firm A can contract to purchase 200 million cubic feet of natural gas from the provider, Firm B, more than 10 years at an agreed rate of 20 million every year. Firm A may find, notwithstanding, that in a given year they will just need 18 million. In the event that they don't purchase the arranged 20 million, they will be subjected to a fee, which is agreed to in the original contract. Normally these fees are more modest than the purchase price; having done without 2 million cubic feet in purchased natural gas, Firm A might be subject to a fee of half of the contract price of 2 million cubic feet.

On the other hand, is world gas prices fall throughout the contract, Firm A should decline to take delivery of the gas and on second thought purchase gas from another provider, Firm C, at the new, lower price and on second thought pay the agreed penalty to Firm B. It is in Firm An's interest to do this in the event that the total cost of the gas from Firm C plus the penalty is not exactly the originally arrange price to take Firm B's gas.

In this situation, the two players benefit from the take or pay provision. Firm A gets just the amount of gas they need from Firm C, at a lower total cost than they would have paid; Firm B gets the penalty price from Firm A, as opposed to gaining nothing if Firm A were to just switch providers without a trace of the take or pay provision.

Highlights

• Take or pay provisions can commonly be found in the energy sector, where overhead costs are high.
• Take or pay is a type of provision in a purchase contract that guarantees the seller a base portion of the agreed on payment on the off chance that the buyer doesn't follow through with really buying the full agreed amount of goods.
• Take of pay provisions benefit buyers, sellers, and the economy as a whole by sharing the risk of overhead investment and facilitating commerce that could somehow not happen.