Take-or-pay contract

A take-or-pay contract is a special type of supply agreement. It stipulates that a buyer must take a minimum quantity of a good. If they fail to do so, they must still pay — as if they had actually received the quantity. The name directly describes the logic: “take” or “pay”. Typical goods in such contracts are electricity, natural gas, liquefied gas, or raw materials such as ore. The terms are often long — ten, twenty years or more.

Why such contracts exist in the first place

Behind a take-or-pay contract there is almost always a problem: the supplier has to put up enormous amounts of money before earning even a single euro. A company building a gas pipeline or constructing a liquefied gas facility invests billions — often before a single buyer has even been secured. Without certainty that this investment will pay off, hardly any company would take on this risk.

Take-or-pay contracts solve this problem. They give the supplier a reliable revenue guarantee over many years. Banks and investors financing such projects often even demand these guarantees as a condition. Without such a contract, many infrastructure projects simply wouldn’t get funding.

How the payment obligation works in the contract

The contract sets a minimum quantity, often referred to in English as the “contract quantity”. If the buyer takes this full quantity within the agreed period — for example, one year — everything proceeds normally. If they take less, the penalty clause kicks in: they must still pay the agreed price for the quantity not taken. However, they do not receive the undelivered goods themselves.

Some contracts include a compensation arrangement, the so-called make-up clause. It allows the buyer to make up for the overpaid quantity in a later period. They then have the right to take more than they paid for — until the credit balance is used up. This softens the severity of the penalty payment but doesn’t change the fundamental obligation. A concrete example: an electricity supplier commits to taking at least five terawatt-hours of electricity annually. If they only purchase four, they still pay for five — but can make up the one terawatt-hour in the following year at a more favorable price, if the contract allows for it.

It is also important what happens if the supplier itself cannot deliver. In that case, the buyer’s payment obligation does not apply. Only if the buyer themselves is the cause of the non-acceptance must they pay. Natural disasters and similar events are generally excluded as so-called force majeure.

Take-or-pay contracts in practice and in the news

The term is most commonly encountered in the energy sector. European countries sourced Russian natural gas for decades on the basis of take-or-pay contracts. When Germany and other states wanted to sever these supply relationships after Russia’s attack on Ukraine, this was also complicated because ongoing contracts provided for penalty payments. This shows that take-or-pay clauses can become politically very sensitive.

Today, such contracts play a central role in building new liquefied gas terminals. Countries like Germany, which had to quickly overhaul their gas supply, signed new take-or-pay contracts with suppliers from the US, Qatar, or Norway starting in 2022 — often spanning 15 to 20 years. Critics warn that such long terms can slow down the transition to renewable energy, because buyers remain tied to fossil fuels for decades.

Outside the energy industry, similar structures also appear in the semiconductor and chip industry. When a chip manufacturer builds an expensive new factory, it sometimes secures contractually that buyers will order a minimum quantity — the principle is the same, even if the term is used less frequently in that context.