Consumers, Did You Take or Pay?

In 2020, COVID-19 hit businesses in different ways. Large industrials, retailers, hotel chains, and many mining companies were labeled as non-essential activities in Mexico and were forced to close down operations for certain periods of time. Others were impacted by their supply chain’s response to the pandemic and driven to decrease activity. These changes to operations have challenged their ability to comply with their supply commitments, for example in energy. Many of these companies have been enjoying economic benefits through bilateral electricity supply contracts which, in many cases, included Take-or-Pay obligations. Many of these commitments have turned into penalties due to the lower consumption in 2020 as a result of COVID-19 and are items that are yet to be resolved. 

Take-or-Pay clauses are commonly integrated into electricity supply contracts to define a commitment of energy and capacity, a block for example, to be taken and paid by a business consumer during a certain period. The block is typically calculated by historical and forecasted consumption profiles.  The Take-or-Pay can be structured in many ways.  In some cases, the supplier allows for a consumption band that mitigates the fluctuations in consumption. 

On the other hand, there is a “hard” Take-or-Pay obligation whereby the consumer pays the full price of the block regardless of whether the whole block has been consumed or not. This practice helps consumers ensure they are supplied a certain volume at an agreed upon price and enables generators to mitigate risk related to having to sell energy back into the market or to CFE; it gives them certainty around cash flow and supports project financing. 

Although supply contracts can be structured such that the block can be reviewed on an annual basis, many companies do not have this feature in their contracts and are facing a COVID-19 blow around energy supply contracts. Although this clause supports risk-balancing between the parties engaged in an electricity supply contract, it becomes an issue when a business moves drastically away from the projected profile that was considered when the negotiation took place. The forceful halt to operations across the country has put many high-energy consumers in this risky and disadvantageous position, making their estimated forward consumption projections for 2020 inaccurate.  

Another reason that consumers faced penalizations regarding their Take-or-Pay obligations is due to having added on-site generation, such as solar, without taking into consideration their supply contract. Distributed generation, especially through renewable sources, has become a popular way for companies to meet reliability and sustainability goals. Adding on-site generation reduces the energy consumed from the supplier who still enforces the Take-or-Pay obligations, partially or wholly eroding the economic benefits of the on-site generation. Ideally, consultants, like Acclaim Energy, are hired to analyze and optimize the integration of both supply schemes, considering physical, regulatory and economic impediments and benefits. In this sense, solving the puzzle can protect against financial penalties and generate interesting benefits all around.  

What’s next? From here on out, supply contracts will have a deeper focus on force majeure clauses around pandemics and government announcements that drive plant shutdowns. The language used in these clauses will be much less ambiguous and will induce fewer surprises when events like COVID-19 affect the parties in unpredictable ways. It is crucial to include both legal and commercial reviews in these transactions. On the commercial front, volumetric risk must be evaluated and mitigated through historic and forecasted projections around different scenarios in order to assume Take-or-Pay obligations in supply contracts and avoid penalties in 2021.

COVID-19 has led many companies to evaluate the terms and conditions in their energy supply contracts, especially those that are long-term. This is a healthy practice that should be performed periodically and that as consultants we always encourage. This evaluation provides an opportunity to assess and re-evaluate risks and opportunities within the same contract, which due to market, political and regulatory changes are always present and must be mitigated for business success.