Closed Loop Offtake
Companies develop projects for their own internal supply chain to support their carbon neutrality targets and develop technological, business and operational lessons learned.
How it works:
A closed-loop offtake mechanism is a strategic contract arrangement that can significantly empower companies to achieve their net-zero emissions targets. By leveraging control over multiple stages of their value chain, companies can optimise resource use, manage risks and minimise their carbon footprint. This mechanism involves an agreement where a company commits to purchasing the future offtake from its own operations or those of its subsidiaries.
Companies can initiate projects across their subsidiaries to extend ownership and operations throughout the value chain, thereby supporting their carbon neutrality targets. By doing so, they effectively become both the supplier and the offtaker, eliminating the need to negotiate offtake agreements with external organisations.
For example, a green steel company is willing to pay a greater premium if the low-carbon feedstock is sourced from a subsidiary company, as costs and risks can be absorbed within the broader company group if the strategic investment supports a transition towards a net-zero emissions future. This expansion can be done through capital projects and upskilling to develop the capabilities in-house or through mergers, acquisitions and partnerships.
What sectors can leverage this mechanism?
Companies with a high degree of vertical integration can leverage this offtake mechanism.
It is deemed less relevant for aviation where the business case to produce their own zero- and low-carbon fuels is not feasible and companies use airport fuelling stations.
It is deemed less relevant for shipping where the business case to produce their own zero- and low-carbon fuels is not feasible and companies use shared port fuelling stations.
Companies with a high degree of vertical integration can leverage this offtake mechanism.
Companies with a high degree of vertical integration can leverage this offtake mechanism.
Decarbonised concrete and cement is more likely to leverage a book-and-claim model, as opposed to a vertical integration approach.
What challenges does it solve?
Duration
Closed-loop offtake agreements provide companies with reduced uncertainty by exercising direct control over the supply chain. This enhanced control facilitates the commitment to long-term contracts, particularly due to the added advantage of flexibility inherent in subsidiary relationships.
Volume
Integrating the supplier and offtaker in the same organisation enhances visibility and control over volume-related risks, thereby minimising disruptions caused by external factors or supplier insolvency. This subsidiary relationship transparency ensures certainty in commodity volumes and aligns both parties in mitigating uncertainties across market cycles and operational challenges. Furthermore, it facilitates rapid adjustments in production volumes to align with internal demand, thereby providing greater flexibility and reducing supply-demand mismatches. Despite being internal, there may still be a lengthy and complex negotiation of agreement terms to distribute the cost burden and risks between the buyer and supplier.
Price
Closed-loop offtake agreements equip companies to better manage price volatility through enhanced transparency across subsidiaries and an ability to hedge against the green premiums associated with low-carbon products. This collaborative approach to pricing structures bolsters the business viability of decarbonisation projects.
Delivery terms
Closed-loop agreements facilitate more precise planning and adherence to delivery schedules, thereby minimising the risk of contract termination. Regular feedback and collaboration between internal teams enhances control over material and pricing dependencies, while also enabling swift adaptation to regulatory changes.
Technical definition
Closed-loop offtake agreements are still exposed to risks stemming from changes in law and are contingent on regulators setting clear, credible, adopted definitions for low-carbon products. Transparency is enhanced between the supplier and offtaker, which could allow for greater flexibility, such as accepting a certain threshold of ‘non-green’ products or adaptability to comply with changing standards.
Enabling infrastructure
This mechanism indicates sustained investment and demand in the sector and geography for a predictable future, which could attract government attention and accelerate investment in supporting infrastructure. The supplier and offtaker may be co-located, meaning a reduced reliance on enabling infrastructure. The delivery of ports and pipeline networks could still be a bottleneck in project development.
Regulatory uncertainty
Subsidiaries engaged in a closed-loop agreement benefit from increased flexibility to respond to regulatory changes. Change-in-law risk remains and will undermine investor confidence across the value chain.
Trust
This mechanism eliminates the need for direct trust between a supplier and an offtaker, as both parties are part of the same organisation and often operate under the same leadership.
C-Suite and board buy-in
Securing buy-in from the C-suite and board is easier as subsidiaries share leadership and strategic goals.
Procurement capability
Not deemed relevant.
Mechanism challenges
This mechanism is limited to companies with a group model that can draw on synergies between different parts of the business, such as the energy production arm and the heavy industry arm of the group. In this sense, this approach is best suited to those with existing production capacity. Integrating different stages of production under common goals and targets also might increase organisational complexity compared to simply incorporating an external supplier.
Case Studies: Fortescue
One example of closed-loop offtake is Fortescue’s journey to build a green metal supply chain. The integrated green technology, mining and energy company set a target to achieve real zero terrestrial emissions (scopes 1 and 2) across its Australian iron ore operations by 2030 without the use of voluntary carbon offsets.
Fortescue focuses on zero emissions mobility as a part of its scope 1 decarbonisation pathway, with pilots underway to test its hydrogen-powered haul truck prototypes in a real-life mining environment. The most significant source of Fortescue’s scope 3 emissions is the steelmaking process. The company is employing a closed-loop offtake approach in its Green Metal Project in the Pilbara region of Western Australia by using Fortescue Energy’s green hydrogen production with an electric smelting furnace to produce high-purity green metal.
Case Studies: JSW
JSW Steel initiated a pilot project with 25MW electrolyser capacity at their Vijayanagar plant, which can generate 3,600 tonnes of hydrogen yearly. This green steel production demonstrates the strength of closed-loop offtake, as JSW Group is well-positioned to develop technological, business and operational lessons learned as both the producer (JSW Energy) and offtaker (JSW Steel).
JSW Steel has also adopted an internal carbon price to make operations future-ready as tighter climate regulations emerge globally. This tool also supports decision-making when evaluating the financial viability of new capital expenditure projects, while accounting for the cost of carbon emissions.