A throughput contract is a type of contract used primarily in the oil and gas industry. Although a number of large oil and gas producers and service providers dominate the oil and gas industry, a number started as small businesses. Throughput contracts provide a portion of the “collateral” or guarantees required to obtain project financing. With throughput contracts, small companies in the oil and gas industry can make big moves.
A throughput contract is a type of take-or-pay contract. This means that the buyer is fully obligated to pay regardless of whether the buyer takes delivery of the goods or services. For example, a regional power company in India or Nicaragua may agree to pay a set low fee for power from a power plant built by a U.S. company even if a hurricane or tornado interrupts power delivery. Take-or-pay contracts are generally used to facilitate project financing since these contracts have guaranteed payments and both protect the buyers from commodity price increases while protecting the sellers from price decreases.
Throughput Contract Defined
A throughput contract gets its name because one party to the contract agrees to pass through a minimum amount of liquid or gas through a pipeline or processing plant during a specified period of time. More specifically, using the oil and gas industry as an example, a group of oil or gas producers enter into a contractual agreement with a processor to pass a base minimum of crude oil, refined oil or natural gas through a refinery, pipeline or processing plant. The parties agree to do this for a month, quarter or year.
How It Works
A throughput contract provides for the producer to pay a set price for the processing and to supply a guaranteed minimum amount of material to be processed. Many small oil refineries in the Gulf Coast region of the United States were built using project financing secured by throughput contracts.
A start-up refinery founded by former oil industry managers in Mississippi wants to tap government-backed project financing funds to build a refinery. The founders tap their contacts to meet with several midsized-to-large oil producers regarding their plans. After discussions with a number of producers, the refinery founders enter into a preliminary throughput agreement to process a base minimum number of gallons of oil for a set price once the refinery is built. The refinery’s founders use this preliminary throughput contract to begin arranging the financing they need for the refinery project.
Tiffany C. Wright has been writing since 2007. She is a business owner, interim CEO and author of "Solving the Capital Equation: Financing Solutions for Small Businesses." Wright has helped companies obtain more than $31 million in financing. She holds a master's degree in finance and entrepreneurial management from the Wharton School of the University of Pennsylvania.