Efficient Adaptation in Long-term Contracts: Take-or-Pay Provisions for Natural Gas.

Abstract

To mitigate the inflexibility of long-term contracting for natural gas, parties will look for terms that minimize the need for costly adjudication while maintaining incentives for appropriate adaptation. The authors examine the incident of take-or-pay provisions in contracts between natural gas producers and pipelines from this perspective. They argue that take obligations can be viewed as a mechanism for effecting appropriate incentives for contractual performance, and show that efficient breach considerations define an optimal take percentage as a function of characteristics of the transaction. These incentives are distorted by regulated price ceilings, which cause the adoption of take obligations in excess of optimal levels. The findings refute the common perception that take-or-pay provisions are just an artifact of wellhead price regulation and serve no useful purpose in the absence of regulation. 20 references, 1 figure, 1 table.

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