what is take or pay 
take or pay is a provision in a contract stating that a buyer has the obligation of either taking delivery of goods from a seller or paying a specified penalty amount to the seller for not taking them take or pay provisions benefit both parties by sharing risk and they benefit society by facilitating trade and reducing transaction costs understanding take or paya take or pay provision is generally included between a company and its supplier it requires the purchasing firm to take a stipulated amount of goods from the supplier by a certain date at the risk of paying a fine to the supplier if it doesn t 1this sort of agreement benefits the supplier by reducing the risk of losing money on any capital spent to produce whatever product it is trying to sell it benefits the buyer by allowing it to ask for a lower negotiated price elsewhere the provision can be an overall net gain to the economy because the sharing of risk by the buyer and supplier facilitates both a transaction that might otherwise not occur and the accompanying gains from trade for both parties take or pay provisions are very common in the energy sector 2 this is because of the substantial overhead costs for suppliers to provide energy units such as natural gas or crude oil and the volatility of energy prices the overhead costs of providing crude oil as compared with giving a haircut for example are very high take or pay contracts provide energy suppliers an incentive to invest capital upfront because they have a measure of assurance that they ll be able to sell their products without a take or pay provision the supplier bears all the risk that the buyer s ongoing need for the energy might dry up or that a price swing might induce the buyer to break the contract the supplier could also be subject to what is termed a holdup by the buyer if it has made overhead investments that will lose value if the buyer does not buy the output as agreed holdups are a type of transaction cost identified by economist oliver williamson that occurs with this kind of relationship specific assets 34examples of take or payfirm a contracts to purchase 200 million cubic feet of natural gas from firm b over 10 years at an agreed amount of 20 million per year firm a finds however that this year it will only need 18 million firm a does not purchase the full 20 million and is instead subjected to a fee that was agreed to in the original contract the fee is defined in the contract and is usually less than the full purchase price in this case a reasonable fee might be 50 of the contract price of those two million cubic feet alternatively with world gas prices having fallen significantly during the course of the contract firm a decides to decline the delivery entirely and instead purchase gas from another supplier firm c at a new lower price instead it pays the agreed penalty to firm b it is in firm a s interest to do this if the total cost of the gas from firm c plus 50 of the original negotiated price with firm b is still less than the originally negotiated price to take firm b s gas in both cases each party benefits from the take or pay provision firm a gets only the amount of gas it needs at a lower total cost than it would have paid firm b while firm b at least receives the penalty price from firm a rather than in the first instance losing the full cost of two million cubic feet of gas or in the latter case getting nothing at all when firm a switched suppliers 