IS THE CONCEPT OF TAKE OR PAY CLAUSE IN A LONG TERM GAS CONTRACT,
INCLUDING MITIGATION THROUGH CARRY FORWARD AND MAKE UP
RIGHTS, COMPATIBLE WITH A COMPETITIVE MARKET?
Dominic K. Mwendwa
LLB, UoN, LLM, University of Dundee UK.
ABSTRACT:
Natural Gas development projects are capital intensive ventures. Overtime and especially in
the EU, gas development projects have relied on long term contracts to monetize gas and to
secure the requisite finances needed to sustain the investment.
A key provision in the traditional long-term gas sales contract is the Take or Pay clause. The
clause obligates the buyer to take delivery of a specified volume of gas within a contract year
or pay for it whether it takes it or not. The objective of the clause is to secure some fixed cash
flow for the producer to enable it to pay the fixed cost and sustain the investment.
However, the flip side of it is that the clause limits the purchaser’s right to choose its suppliers
where the take or pay volume is very high and almost equal to the demand of the purchaser.
This contradicts the goals of liberalization of the gas market spearheaded by Governments as
way of creating reforms in gas sector by introducing competition where prices will be set by
the rules of supply and demand.
This paper examines the role of the Take or pay in the long-term gas contracts and its
compatibility with the competitive gas market with a view to establishing the future of take or
contracts.
The author concludes that even though take or pay contract as they are popularly known, have
the potential to restrict the competition, they nevertheless play an important role in financing
gas development and market development as well. To reconcile them with the competitive
market an intervention is required to reduce the percentage of take or pay volume in relation
to the purchaser demand to allow the purchaser a leeway to play in the competitive markets.
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TABLE OF CONTENTS
ABBREVIATIONS ................................................................................................................... 3
1.INTRODUCTION .................................................................................................................. 4
2. CONCEPTUALISING TAKE OR PAY CONTRACTS ...................................................... 5
2.1 Brief overview. ................................................................................................................ 5
2.1.1 The Supply Contracts. ................................................................................................... 5
2.1.2 Depletion Contract .................................................................................................... 5
2.1.3 Hybrid Contracts ........................................................................................................... 6
2.1.3 Take or Pay ............................................................................................................... 6
2.2. Mitigating Take or Pay ................................................................................................... 7
2.3. The Purpose and the Implication of TOP on the parties. ................................................ 7
2.3.1 The purpose of Take or Pay ...................................................................................... 7
2.3.2 The Implication of the TOP the Buyer ..................................................................... 9
3. LIBERALISATION OF THE GAS MARKET .................................................................... 9
3.1. Brief Overview................................................................................................................ 9
3.2 Gas Spot Market ............................................................................................................ 10
3.3 LNG Trading Trivialising Take or Pay. ......................................................................... 11
3.3.1 LNG Spot and Short; The modern trading mechanism .............................................. 12
4.THE FUTURE OF TAKE OR PAY CONTRACT; RECONCILING TAKE OR PAY
CONTRACTS WITH THE COMPETITIVE GAS MARKET ............................................... 12
4.1. Long Term TOP Contract Versus Gas Spot Contracts ................................................. 12
4.2. Effects TOP Contracts on Competitive Gas Market and their Future ......................... 13
5.CONCLUSION ..................................................................................................................... 14
BIBLIOGRAPHY .................................................................................................................... 15
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ABBREVIATIONS
ACQ
ANNUAL CONTRACT QUANTITY
ATOPQ
ANNUAL TAKE OR PAY QUANTITY
DCQ
DAILY CONTRACT QUANTITY
EU
EUROPEAN UNION
GSA
GAS SALES AGREEMENT
LNG
LIQUIFIED NATURAL GAS
LTC
LONG TERM CONTRACT
TOP
TAKE OR PAY
UK
UNITED KINGDOM
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1.INTRODUCTION
Gas is different from oil. It is monetized through long term gas sales and purchase agreements.1
The contract is usually entered between the gas producer or the seller and the gas the purchaser
or the buyer. These long-term gas contracts are known as Gas Sales agreement (GSA)
The contracts define the relationship of the parties. It sets out their rights and obligations. The
importance of the long-term gas sales contract cannot be over emphasized, they arise from the
special features of gas. The fact that gas cannot be monetized like oil and needs a presence of
the market for the investment to take off.2
The long-term contract seeks to secure the market and provides the basis for packaging the
investment.3 The long term contract provide security of demand on the part of the seller and
enables it to obtain investment credit for the development of the gas project.4 Needless to say
that without such a contract it would be difficult for the seller to convince the financing
institution to provide investment credit.5
A typical GSA can either be a supply, depletion or hybrid as shall be outlined later but
irrespective of the type of the GSA, there will be common provisions that define the conduct
of the parties to the agreement.
One of the such provisions is Take or pay clause. The TOP obligation binds both the seller and
the buyer for a specified period usually 15 to 20 years under a bilateral monopoly.6 The contract
obligates the purchaser to commit to paying for a specified volume of gas whether the amount
is taken or not. Under this arrangement the supplier is also under obligation to supply the stated
amount.
Therefore, TOP contracts tend to limit the buyer’s choice to select its suppliers and this has
the effect of reducing competition which does not sit well with the liberalization process that
tends to vouch for a market structure which allows competitive market forces to thrive.7
1
Claude Duval, et al. International Petroleum Exploration and Exploitation Agreements: Legal, Economic and
Policy Aspects, (2nd ed.) (New York, Barrows Company Inc., 2009). 181
2
ibid
3
Karsten Neuhoff and Christian von Hirschhausen, Long term vs. short term contracts: a European Perspective
on National Gas (2005) available at< http\www.electricitypolicy.org/uk/wp/eprg505pdf.> Accessed 20
December 2019
4
Henning Matthiessen, ‘To What Extent do Take-or-Pay Contracts facilitate the Development of Infant Gas
Markets and What Challenges do they pose at a Time of Liberalisation?’ OGEL 4 (2003), available at:
www.ogel.org/article.asp?key=573 accessed 29 December 2019.
5
Robert Mabro, Oxford Energy Seminar, Natural Gas: An International Perspective. Proceedings of the Oxford
Energy Seminar 1982-1985 (Oxford University Press for the Oxford Institute for Energy Studies 1986) 36
6
Cameron PD, Competition in Energy Markets: Law and Regulation in the European Union (2nd ed, Oxford
University Press 2007)
7
ibid.33
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Liberalization presupposes opening of consumer choices and doing away with the monopoly
tendencies where consumers are forced to purchase from a monopoly. On the onset of the
liberalization the monopoly should cease to exist, and consumers be allowed to make a choice
for their source of gas. Presence of the long-term gas contract with take or pay obligation in
the gas industry seem to be in conflict with the objective of the liberalization and the resultant
competition.8
It is against this background that the author sets out critically study the role of TOP clause in
the long-term GSA and find out whether TOP is compatible with the competitive gas market
and its future thereof.
Towards this end, the paper is divided into four section. The first section seeks to understand
the concept of Take or pay and its application, mitigation and effects on the parties. The second
section deals with the analysis of the basics of liberalization in the gas industry and basically
on the EU model. The third section attempts to reconcile the concept TOP with the liberalized
market through a critical analysis of the two concepts. The paper concludes that take or pay
clauses are still relevant in providing a steady cashflow to finance gas investment but there is
need for the government to intervene and have the percentage of take pay or volume reduced
in the current and future contract in relation to the purchaser overall demand to give room for
purchaser to play in the competitive market.
2. CONCEPTUALISING TAKE OR PAY CONTRACTS
2.1 Brief overview.
The GSA has essentially two types of contracts, the supply contract and the depletion contract.
2.1.1 The Supply Contracts.
Under this contract, the supplier commits to supply a specific quantity of gas within the contract
period. The source of the gas is not fixed in the contract and the supplier is at liberty to source
the gas from wherever places it deems fit to.9
2.1.2 Depletion Contract
In this type of GSA, the contracts dedicate a certain field such that all the production from that
field is sold under the contract.10 The quantity is tied to the performance the reservoir and the
term of contract is usually based on the economic lifespan of the dedicated field.11
8
ibid
Martyn, R. David, Natural Gas Agreements, (London: Sweet & Maxwell, 2002).
10
ibid (n 4)4
11
ibid (n 9)149
9
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2.1.3 Hybrid Contracts
Authors have argued on the possibility of a hybrid GSAs, these would be normal supply
contracts, but the source of gas is disclosed. 12 The purpose of stating the source is allow the
producer to claim force majeure relief from liability based the enforceable events that effect
the source.13
2.1.3 Take or Pay Provision
The high cost required to put up a complete infrastructure for monetization of gas justifies the
reluctance by the gas producers to develop gas fields without the long-term contracts with the
buyers.14
The long-term contract however is not enough as the seller needs further assurance of a steady
cash flow. The long-term gas contract based on commercial terms would only provide for
payment of the amount of the gas taken and determined by the demand on the buyer’s side.
This scenario would put the seller at a precarious position especially when there little or no
alternative market to turn to.15
The genesis of TOP was therefore to cushion the seller from the fluctuating demand by assuring
them of some steady cash flow which was not tied to the demand at all.16 According to Trimble,
long term contracts are still relevant;
“Despite recent changes in some parts of the Europeans gas market, especially in Britain, the
popularity of take or pay remains unchanged.”17
The TOP clause can be couched in various ways but will have the effects of having the parties
agree on the minimum annual quantity as the TOP amount. The arrangement being that if the
buyer takes less than that the set amount he pays as if he took the whole amount. 18 The ACQ
is an aggregate of the DCQ while the take or pay amount will be a percentage of the ACQ
usually set between 70 % to 100 %. However, there are various reduction to this amount based
12
Ibid (n 9)150
ibid
14
ibid.
15
Ibid (n 4)4
16
Efe U. Azaino, ‘Natural Gas Contracts: Do Take or Pay Clauses Fall Foul of The Rule Against Penalties?’
(2012) available at
<https://www.academia.edu/10666060/Natural_Gas_Contracts_Do_Take_Or_Pay_Clauses_Fall_Foul_of_The_
Rule_Against_Penalties >accessed 20 December 2019
13
Niall Trimble, ‘Gas Sales Agreements’ in Upstream Oil and Gas Agreements (eds) Martyn R. David
(London: Sweet & Maxwell, 1996).168
18
ibid
17
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on the under deliveries by seller, application of the force majeure and carry forwards credits.19
Thus, in a year where the buyer takes gas which is less than ATOPQ it will pay for the amount
not taken20. The payment price is calculated by multiplying the amount of gas not taken with
the average price of the gas for the year that has just ended.
2.2. Mitigating Take or Pay; The Components Involved.
The harshness of TOP is mitigated by makeup and carry forward rights. As it is quite unfair
on the part of the buyer to continue making payments year in year out without a mechanism of
recouping the gas it has paid for.
Makeup and carry forward rights in the contracts facilitate the buyer to recover the volume it
has paid for under TOP. 21
The makeup right applies when the buyer has made some payment under TOP. The amount of
gas paid for but not taken gets into the makeup account. Sometime in the future after the buyer
has taken its TOP amount, it can take gas for free until it exhausts the amount in the makeup
account. 22
The carry forward right is like makeup rights, safe for that it allows the buyer upon taking more
than its TOP in a certain year, to apply the extra gas taken above the TOP in the future as
credit23. The credit amount carried forward is used to relieve the buyer from the future TOP
obligation to that extend. This is to say, it is used to offset the liability when the buyer takes
less than TOP amount in the future.24
2.3. The Purpose and the Implication of TOP on the Parties.
2.3.1 The purpose of Take or Pay
“Necessity is the mother of invention”25
As earlier discussed, the lack of an alternative market for gas in the early days (1930s)26 caused
a serious financial crisis for gas producers. They had to sell their gas to a certain monopoly. 27
19
ibid
J Michael Medina, 'The Take-or-Pay Wars: A Cautionary Analysis for the Future' (1991) 27 Tulsa LJ 283
21
ibid (n17) 169
22
ibid
23
ibid (n 4)4
24
ibid
25
English proverb associated with Plato. Simply means that a need is great motivation for invention.
26
Bitrus J. Bulama, ‘Take or Pay’ Obligation in Natural Gas Contracts: Any Respite for the Buyer? Available
at<Https://Www.Academia.Edu/11036248/_Take_Or_Pay_Obligation_In_Natural_Gas_Contracts_Any_Respit
e_For_The_Buyer> accessed 26 December 2019
27
Harold Alexander Lewis, Allocating Risks in Take or Pay Contracts: Are Force Majeure and Commercial
Impracticability the same Defense? 42 SW. LJ., (1988-89), Pg.1049 1050
20
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Where this monopoly buyer did not take enough volume to pay an amount that could sustain
the high fixed and operational cost of the investment, it would mean that the producer maybe
be forced go out of business and the purchaser on its part may not have the constant stream of
gas supply28.
The special nature of the natural gas industry and the problem it created, called for a specially
designed mechanism to address the effects of demand fluctuations on the part of seller as they
threatened to send it out of business. Take or Pay clause emerged as a result.29
It is a device that guarantees a continuous revenue stream on the part of seller independent of
the demand pattern.30 The producers and its financiers secure a steady stream of cashflow
across the contract term which improves the bankability of the project and enables the producer
to meet fixed and operational cost enabling it to sustain the investment.31 As noted by Martyn;
“Take or pay only offers protects “volume risk” for the seller. It ensures that a volume is
paid for but does not protect the buyer against “price risk” that volume. The later can be
reduced in several other ways e.g. Price indexation floor prices and caps re-openers, and
market outs.32
The buyer is not left without benefits, it is assured of security of supply of the minimum
quantity which assurance is critical for its planning on the down steam marketing strategies
and contracts.33
More specifically the purpose of take or pay according Martyn can summed as; -34
i.
To guarantee steady revenue for the seller across the contract period. Making it possible
for the seller to cover its fixed operating costs.
ii.
To make the project bankable and to able the producer to obtain third party financing
iii.
It forms the basis upon which the investment decision is made. The investor is able
predicts its return on investment based on this TOP assurance.
iv.
Allocates risk by moving volume risk to the buyer which protects the seller against
demand fluctuations.
v.
It gives the seller a voice in the GSA which would have otherwise been controlled by
the buyer by taking what it wants and leaving the rest of the gas with the seller, who
28
Ibid (n-20)
ibid
30
ibid (n 20)288
31
Martyn, R. David, Natural Gas Agreements, (London: Sweet & Maxwell, 2002) p.183
32
ibid
33
ibid (n- 20).
34
ibid(n-31) 183
29
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would be great financial burden and at the mercy of the buyer for lack of another
alternative.
2.3.2 The Implication of the TOP the Buyer
The TOP forces the buyer to accept delivery of the minimum agreed volume of gas
continuously or pay for the volume if it does not take it.35 The clause therefore majorly as
alluded above, protects the seller against variation in demand. In so doing, it puts the buyer in
situation where it must keep paying for gas it has not taken especially when its demand is low
and the take or pay volumes are too high in relation to its total demand.
The obvious implication is that during the term of the contract, the buyer’s hands are tied with
take or pay obligation and even when the prices of gas in the market drops the buyer must still
pay the contract price. The TOP obligations can only be varied through a price negotiations
dialogue based on the price reopener clauses. The discussion takes a long time and all this time
the buyer is under the obligation to make the minimum payment under TOP.
Authors have argued that TOP obligation pose a real risk to the buyer.36 It has really affected
the UK companies. British Gas is one companies that suffered a major hit. It had to pay heavily
in the 1990s to secure their freedom from chains of TOP contracts as liberalization of gas
market lowered the prices in spot market and they needed get out of contracts and play in spot
market to enjoy the fruits of liberalization37.
3. LIBERALISATION OF THE GAS MARKET
3.1. Brief Overview.
Liberalization is a process that opens the market by reducing or entirely doing away with all
barriers to entry.38 The EU system particularly tends to introduce a market structure which
allows competition to thrive. Liberalization therefore opens consumer choice and does away
with the monopoly tendencies in any sector. 39 On the onset of full market liberalization, the
monopolies cease to exist, and the consumers can make a choice for their source of gas.
In the recent past there has been serious efforts by governments to promote liberalization
through their policies40 more specifically energy policies, to increase market efficiency and
35
ibid (n 19)
ibid (n 31) 183
37
ibid
38
Peter D. Cameron, Competition in Energy Markets: Law and Regulation in the European Union (2nd ed,
Oxford University Press 2007) 33
39
ibid
40
House of Lords, European Union Committee Report Gas: Liberalised Markets and Security of Supply Report
with Evidence 2003-2004 available at
36
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lower the price paid by the consumers of commodities. Multilateral treaties have captured the
agenda of opening the market through liberalization. For instance, article 3, and 8 of the Energy
Charter Treaty seeks to promote liberalization and prohibits long term agreement which limit
competition.41
Liberalization would be characterized by
 Consumers having freedom of choice as to the source of their gas.42 This creation of
competition on the demand side.
 Entry of several producers and whole sale purchasers or suppliers alongside the
existing monopolies. They set their own market rules and strategies which led to
introduction of competition on the supply side43
 Presence of third-party access to the transportation network free from the
discriminatory tendencies.44
Liberalization generally promotes liquidity and leads to mushrooming of short-term spot
market transactions through Beach trades or trading hubs and NBP trades like it is the case in
the UK45
3.2 Gas Spot Market
Upon liberalization of market, competition emerges. In a competitive gas market spot market
have been used as an alternative to long term take or pay contract in trading gas. Gas spot
market refers to a physical market where gas is traded on single transaction for delivery within
a short period.46 Gas is traded in real time at the prevailing spot price. The one-off transaction
in a spot market offers a lot of flexibility to the buyer to choose where to buy from and which
supplier to trade with next time.47 The parties can sell their excess gas when the demand
<https://publications.parliament.uk/pa/ld200304/ldselect/ldeucom/105/105.pdf> accessed 30 December 30,
2019
41
Energy Charter Treaty 1994 available at <https://www.energycharter.org/process/energy-charter-treaty1994/energy-charter-treaty/> accessed 26 December 2019 see also Johnston A, Kavali A and Neuhoff K, ‘Takeor-Pay Contracts for Renewables Deployment’ (2008) 36 Energy Policy 2481 available at
<https://www.sciencedirect.com/science/article/pii/S0301421508000736> accessed 30 December 2019
42
Stephen Dow., Lecture notes for the Downstream Energy Law and Policy module at the Centre for Energy,
Petroleum and Mineral Law and Policy, University of Dundee 2019.
43
ibid
44
ibid see also Peter D Cameron, 'Reforming Energy Markets: A Review Article' (2000) 18 J Energy & Nat
Resources L 353.
45
Ibid (n 4)8
46
Georgia Panebianco, Gas Spot Market: How Does it Work and Who are the Players? CEPMLP Annual
Review No. 35, 2017
47
ibid
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changes and buy more gas to balance their nomination on the day of performance. One good
example of spot market for gas is the European Gas Spot market48.
A prominent feature of a spot market is that gas is traded as normal commodity.49 The price is
determined by market forces of demand and supply and it is usually volatile but often lower
compared to prices in a long-term contract. Competition in the gas market helps to keep the
prices of gas down and consumers exercise their right of choice of supplier.
Gas spot market is daily spot market which is available every day hence parties can trade daily.
However, most of the gas is traded during the last week of every month to enable consumers
purchase suppliers for the next month50.
3.3 LNG Trading; Trivializing Take or Pay.
The introduction of new entrants through competition lead to expansion of regasification plants
which results in increased LNG trading.
The trade involves buying and selling LNG. It is based on long value chains that link the
various parties through contractual agreement.51 The process includes production of the gas,
transportation of it to the liquefaction plants, shipping through cargoes and then there is
regasification plant on the importing country backed by transportation infrastructure for the
downstream transportation.52
Despite the cost involved in the value chain the LNG is being traded on spot and short-term
contract as opposed the traditional long-term high value take or pay contracts.53 The onset of
liberalization in the gas market saw the entry of aggregators in the LNG market. They have
invested heavily in the liquefaction plants, regasification plants and shipping cargoes.54
With that investment in place aggregators have created flexibility in the LNG trade and have
contributed significantly in dealing with the problem of fluctuating demand. They own the
portfolios and hence they have the ability to divert cargoes to more profitable markets and still
be able to make up for the diverted cargo in the original intended market by purchasing gas
from elsewhere through cargo replacement.55 The effects of TOP contracts are trivialized by
this mode trading.
48
ibid
ibid
50
ibid
51
Paul Griffin, Carolyne Boyle and Books Dawson, Liquefied Natural Gas: The Law and Business of LNG (2nd
ed, Globe Law and Business 2012) 53
49
52
ibid
ibid
54
Ibid (n 51)54
55
ibid
53
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3.3.1 LNG Spot and Short Market Contract; The Modern Trading Mechanism
Authors opine that in the recent past, Global LNG, has blossomed and it has now attracted
many entrants. 56The trade has adopted spot and short-term contract market model. The growth
is said to have begun in the 1990s and it had reached 18.9% by 2010.57
Even though short-term LNG contracts may contain TOP clauses the very fact that they are
short term is a reprieve from the traditional long term take or pay contracts as they dilute the
harshness and rigidity of the long-term ones.58
Further LNG trading industry has introduced the ‘unwind’ mechanism which allows the seller
to cancel un intended delivery after payment of an agreed some of money to enable the buyer
to obtain the gas from the sport market while the seller directs its cargo to more profitable
market.59 These short term contracts allows the buyer to fix its demands through forecast. It
is easier to determine demand over a short period than a long period hence this reduces the
volume risk on behalf of the seller.60
Further presence of short LNG contracts helps to fix defaults by the buyer under a long-term
contract it allows the seller to dispose of the extra cargoes in the spot market.
Finally, Peter Roberts et al argues that it is now possible to have LNG development financed
based on the spot market unlike in the past when gas investments were based on long term
contract61.
4. THE FUTURE FOR TAKE OR PAY CLAUSE CONTRACT; RECONCILING TAKE
OR PAY CONTRACTS WITH THE COMPETITIVE GAS MARKET
4.1. Long Term TOP Contracts Versus Gas Spot Contracts
Competitive gas market despises long term take or pay contracts in favor of spot transaction
which allows the consumers to choose their next source of gas and enjoy the competitive prices
in the market. However, these two contracts can coexist together with the role of the spot
contract being supplementary.
In the UK where spot market development is attributed to liberalization of the gas market, long
term contracts are still in place. Spot contracts are used to help the parties to purchase or sell
56
ibid
ibid (n 51)56
58
ibid
59
ibid
60
ibid
61
See ibid.55
57
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extra gas to balance the party’s nomination on the day of performance.62 Therefore whether or
not Long term take or pay contract are compatible with is competitive market one thing is clear
that the spot contract though having originated from different business model can be utilized
in the long term framework for the stated purpose.
4.2. Effects of TOP Contracts on Competitive Gas Market and the Future of TOP
Contracts
As it has been illustrated in the discussions in chapter two, TOP Contracts usually limit the
right of the buyers to choose the source of their gas. The author opines that that long-term TOP
contracts are inflexible and cannot adjust to competition. This aspect denies the consumers the
right to take advantage of the cheap gas sources in a competitive market.
The long-term TOP Contracts ties all the gas produced to single buyer. They tend to create
barriers to entry for new potential gas suppliers as there is usually no gas for the new entrants
to trade in. They can be said to a classical example of monopolistic tendencies which the
import of article 3 and 8 of the ECT prohibits.63Creating the need for the government to take
some actions in future as far as the take or pay contracts are concerned.
However, the above not withstanding and based on the studies made herein the role of longterm TOP Contracts in gas industry cannot be underestimated. Gas development projects are
financed based on this contract. In fact, very few lenders if at all would be willing to project
finance a gas project based on the availability of the sport market and in absence the long term
take or pay contracts.64
Considering the cost involved in the gas development project and the need to secure the
requisite finances, and the pivotal role played by long term Take or Pay contracts in
guaranteeing investments in the natural gas industry, the author is of the view that there is
need to strike a balance between the effects the of the monopolistic aspect of TOP contracts
and the need to sustain gas production 65.
Niall Trimble, ‘Gas Sales Agreements’ in Upstream Oil and Gas Agreements (eds) Martyn R. David (London:
Sweet & Maxwell, 1996)
63
ibid (n 40)
64
Jeffrey M Petrash, 'Long-Term Natural Gas Contracts: Dead, Dying, or Merely Resting' (2006) 27 Energy LJ
545
65
ibid.566
62
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The mitigation and the government intervention in countries that are promoting liberalization
in should to be create licensing requirement that would either reduce the term of the TOP
contracts to short term contracts66 like the those currently being used in the LNG trading
alluded earlier. The effect of this would be to reduce the time a consumer is bound in TOP
obligation. Giving them a reprieve to make another choice within a short time would promote
competition in the long ran as the new entrants can always play games with timing of the shortterm contracts to come in once those contracts expires and compete with the existing suppliers
and producers for new contracts.67
The government can also intervene by requiring reduction of the TOP percentage in the future
contracts. This would release the buyers to play in the competitive market for the remaining
percentage of their gas demand. A percentage of 40- 50%
ATOPQ based on the supplier
annual demand would reduce the harshness of Take or Pay the buyer and allow the seller a
steady cash flow for the term of the contract as well allowing both parties to turn to the
competitive spot market to purchase and dispose of their volume differences respectively. This
arrangement perfectly reconciles the long-term TOP with the competitive gas market to the
extend that parties in the long-term TOP Contract will be able to take advantage of the
competitive market.
5. CONCLUSION
Long term TOP Contracts have traditionally been used in the gas industry to allocate risk
between the parties so as to ensure a steady stream of cash flow on the part the seller to enable
it to sustain the investment and to guarantee a steady supply of gas to the buyer which would
enable them to strategize on their downstream markets. The contracts tend to limit the rights
mostly those of buyer to choose their source of gas for the contract term. The buyer has either
to take the gas under TOP or pay for it.
Governments in the recent past have formulated polices that call for liberalization of the gas
market. The objective is to allow entry of more participants to create competition which would
eventually lead to reduced prices for gas.
Liberalization proponents have criticized and frowned upon long term TOP for being anticompetitive. The criticism is because TOP obligation tend to bind both the parties into long
term contracts usually 15-25 years without the option of the parties to play in the competitive
market.
66
67
ibid .568
ibid (n 4) 5
Page | 14
As way of reconciling the long-term TOP contract with the objects of liberalization, there is
need to balance the conflicting implication between the need for competition in the gas market
and the role of long-term TOP contract in securing investment in the capital-intensive industry
with fixed cost upfront cost to be met. Banning TOP contract is economically unviable option.
Governments should therefore intervene not ban the contracts but either to obligate the term of
the long-term contract to be reduced to a shorter period of 5-6 years68. This is what is happening
in the LNG trading markets.
Alternatively, the government should dictate reduction of the Take or Pay percentages in the
future and the current long-term contracts to levels of 40-50 %. This will promote competition
because it will open up and give some alternatives for parties. For instance, the buyer will have
a choice of source for the reminder of their gas demand while the seller can sell its excess gas
in the spot market.
BIBLIOGRAPHY
A. Primary Sources
Energy Charter Treaty 1994 available at <https://www.energycharter.org/process/energycharter-treaty-1994/energy-charter-treaty/> accessed 26 December 2019
B. Secondary Sources
Books
1. Cameron PD, Competition in Energy Markets: Law and Regulation in the European
Union (2nd ed, Oxford University Press 2007)
2. David, M. R., Natural Gas Agreements, (London: Sweet & Maxwell, 2002).
3. Duval, C., Leuch, H. C., Pertuzio, A., and Weaver, J., L., International Petroleum
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