ESSENCE OF OFFTAKE AGREEMENTS, BANKABILITY IN AGRIC SECTOR:
Agriculture is the mainstay of the Zimbabwean economy and as such should be supported by all sectors to ensure its recovery. It is the biggest employer and its contribution to the manufacturing industry in Zimbabwe is very significant.
FARMING is however, a very volatile business, exposed to the vagaries of the weather, fluctuating commodity prices, and protectionist policies of worldwide markets. Whilst financiers of agriculture are overly keen to fund this sector, the risks attaching to agriculture are enormous as highlighted above. It is therefore imperative that the regulatory environment should ensure that financiers of agriculture have some protection, not only to ensure that funds pumped into agriculture are repaid, but also to allow financiers to continue supporting a performing sector.
One of the financing mechanism for the agriculture sector for certain crops such as horticultural products and animal production which can sold locally or for export markets is the offtake arrangements. This article tries to espouse on this method and its feasibility in our country context.
What is an offtake agreement?
An offtake agreement is essentially a deal between a company that produces a particular resource and a company that needs to buy that resource. It formalizes the buyer’s intention to purchase a certain amount of the producer’s future output.
As used in project financing, an agreement to purchase all or a substantial part of the output or product produced by a project. Depending on the nature of the project, this agreement can take the form of a purchase agreement or a service contract.
Offtake agreements take various forms depending mostly on the underlying commodity or product under consideration. For example, a power plant would have a power purchase agreement. By contrast, if the project is the construction of a pipeline, the output agreement would be a gas or oil transportation agreement. In other cases, the agreement may be a lease.
How does an offtake agreement work?
i. Let’s say a company is working on developing a new product or a crop hence looking for financing to develop this new product before it is actually produced.
ii. In order to ensure financing, the company signs an offtake agreement with a buyer that is interested in selling the product or crop once they are produced. In this agreement, the buyer agrees to buy all the crops produced during the next year. iii. The producer can assure investors and lenders that there is a market for its product before it begins production. It can also be confident knowing that it has ensured a minimum return on its goods. iv. The buyer can continue functioning as normal because it knows that it has secured a supply of product or crop for a particular price and for delivery at a particular date.
What are the advantages of offtake agreements?
Generally, offtake agreements are negotiated prior to implementation which is important to assure producers that there is indeed a market for the product they plan to produce. This brings in a number of advantages to the whole process:
The producer is not worried about being able to sell the produce ◆ An offtake agreement tends to make it easier for producers to secure the necessary financing to move forward. ◆ Lenders and investors are more likely to have confidence in a project if they know that companies are already lining up to buy the produce. ◆ Buyers sometimes provide producers with money to advance their projects when an offtake agreement is created. ◆ Offtake agreements allow buyers to purchase produce at a particular price. This can function as a hedge against future price changes if demand outweighs supply. ◆ Offtake agreements also guarantee that buyers will receive the product they are purchasing at a specific date.
Offtake agreement risks
Despite the advantages associated with the offtake agreements for both producers and buyers, there are a number of risks associated with them as well. These risks include: ◆ It’s possible for both parties to back out of an offtake agreement, though doing so requires negotiations and often the payment of a fee. ◆ Companies also face the risk of not having their offtake agreements renewed once they are in production Producers must make sure that their product continues to meet the buyer’s standards. Offtake agreements can also be complicated and can take a long time to set up. What are the prerequisites for the success of offtake agreements in agriculture? Zimbabwe being predominantly agricultural economy has scope to utilise the offtake agreement mechanisms to improve agricultural financing. The success of such mechanisms is hinged on a number of factors which currently are acting as the bottlenecks to financing. These include ◆ Institution of legal framework that afford the farmers/sellers adequate protection from exploitative buyers without taking away any incentives for financiers to lend sustainably. All local off takers should be well capitalized so that they are able to pay the financiers, service providers and farmers on delivery or within a few days of delivery. Capacitation of the Agricultural Marketing Authority and ZimTrade to seek markets for the farmers produce in the regional and international markets The Standard Associations of Zimbabwe should stamp authority advising the local farmers on how they can adhere and match international best practice. The institution of a stop order system to ensure that financiers are not prejudiced of their invested capital. An all stakeholder approach to the system e.g. all buyers of the agricultural products would be required to adhere to the stop order system laws.
Dr Sanderson Abel is an Economist. He writes in his capacity as Senior Economist for the Bankers Association of Zimbabwe. For your valuable feedback and comments related to this article, he can be contacted on abel@ baz.org.zw or on numbers 04-744686 and 0772463008