August 12, 2010Blog

The Many Considerations of a Fuel Supply Agreement

A recent panel discussion on financing biomass projects drove home a fundamental point: you need to be able to tell your lender / investors a story. In the days of looser credit, maybe any story that made them laugh would have sufficed. But in these days of tight wallets, your story has to convince them your project is viable and able to give them their required return on investment.

That same panel described the gold standard story as being one that already had in place a fuel supply agreement and an off-take / power purchase agreement. My initial reaction was, “of course – who wouldn’t finance a project that had adequate, locked-in margins?” However, as every lawyer should know, a contract can look like a good deal on its face (e.g., a low fuel supply price) but actually constitute a raw deal – and lenders / investors know this, too.

So, before you go out there with the mindset that any supply agreement that locks in a low price gets you halfway home, you should take the time to consider aspects of the agreement I describe below. If you do, you’ll have a much better story.

  1. Force majeure – A force majeure clause excuses a party’s performance under the contract when something happens completely beyond the control of either party, also referred to as an Act of God. Standard language for the clause covers war, flood, lightning, drought, military action, terrorist act, etc. The clause is usually considered boilerplate language inserted at the end of any contract and given little thought.
  2. However, for a biomass supply agreement much of what is usually included in a force majeure definition consists of very realistic considerations for agricultural production. A drought or flood doesn’t usually factor too highly in the negotiations of supplying car parts, but would be a very significant factor in supplying corn stover. Events such as flood and drought should probably be carved out of a standard force majeure clause and specifically addressed with their own set of procedures and resolutions to ensure a drought doesn’t necessarily shut down the facility.
  3. Nonconforming goods – Specifics need to be spelled out as to the quality of the supply called for under the agreement. If not, the parties will immediately begin the relationship arguing and/or litigating what they understood the agreement to mean. Further, what happens when a level of quality is defined but the shipment of supply falls short of that standard? The procedures for dealing with nonconforming shipments should also be addressed so that, in the event the facility incurs losses in finding substitute goods or working with the low quality goods, it can be fully compensated.
  4. Facility’s performance – We’ve mentioned the need to carefully consider what excuses the supplier’s performance, but should also consider excusing the facility’s performance. The facility’s job is pretty simple: to buy the supply. Any argument to excuse it from doing so is difficult to make. Yet, what if the facility locates a substitute buyer for the supplier when the facility has no need to buy the current shipment? Forcing the supplier to sell to the alternative buyer would save the facility some administrative costs. Also, the agreement could automatically terminate if the facility closes, either indefinitely or for a known extended period of time, thereby saving the business from paying a termination fee or contract buyout.
  5. Cost of shipment – Transportation costs are one of the largest obstacles in the way of the biomass industry. A lot can change in this area over the course of performance. Gas prices could double, regulations could limit the preferred method of transport and what was once efficient logistically could become inefficient. The risk of any such changes need to be allocated between the parties, and the closer the facility can get to only worrying about paying for something that arrives at its door, the better.
  6. Measure of supply – The supply agreement can be structured as the delivery and purchase of a set amount of supply per interval, all of supplier’s product per interval, or dependent on the facility’s needs per interval. Obviously, the third option puts the facility in the best position because it controls how much it has to buy at each delivery. However, to use this option the supplier will usually ask the buyer to provide forecasts of its expected need that may bind the buyer within a certain timeframe of actual delivery. If the agreement is structured as either of the first two, the facility runs the risk that it will be stuck purchasing product for which it currently doesn’t have a use.

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