Drax discusses recent regulation changes in half-year results

By Katie Fletcher | July 28, 2015

On July 28, Drax Group plc released its half-year results for the six months ended June 30, delivering Europe’s largest decarbonization project, on time and on budget, while also producing 8 percent of the U.K.’s electricity.

Before the half-year (H1) results were presented, Dorothy Thompson, chief executive, addressed the change to the Climate Change Levy, which will be removed for renewable electricity generated after Aug. 1. The CCL was set up in 2001, and the exemption was provided for renewable generators through levy exemption certifications (LECs). The value of a LEC was set and increased by inflation every year for the subsequent 15 years. During that period, the U.K. government made a number of changes to both the medium and the level of support for new investments in renewable generation. Thompson listed the renewable obligation certificate (ROC) banding review, feed-in-tariff (FIT) reviews and the introduction of the contract for difference (CfD) program as some changes. Thompson stated in the earnings report that for every single one of those reviews the government considered that the LEC income was a material income stream to the new investor in renewable generators, and they used it to offset part of the support that would otherwise be required under ROC, FIT or CfD support. “It’s that constant and consistent treatment of the revenue stream from the LEC that actually gave the whole industry a very, very big shock when the budget is renounced that there will be no exemption from August this year,” Thompson said.

She added that there is no proposal to change the level of support under the ROC bands or under the CfD. “This, we consider a very significant U-turn in government policy and makes one question whether the government is indeed going to honor its promises with respect to important investment in large capital projects that are long-term,” Thompson said. “It’s a very serious development to the U.K.”

Another U.K. government-related announcement discussed during the H1 report was the ROC grandfather consultation conclusion the Department of Energy and Climate Change published last week. The DECC announced it cut the grandfathering provision under the renewables obligation (RO) for new biomass conversions and cofiring projects. Thompson said, as expected, units converted after December 2014 are not grandfathered in. One exemption includes projects granted an early CfD going through a state-aid process, so this covers Drax’s third converted unit. Thompson said that the first two units are protected by the grandfathering, as they were converted prior to December 2014, and the third unit is also protected if the company should have to or chooses to convert it under the RO. However, “if we do further units the strong signal from DECC is that they prefer further units to be supported by a CfD rather than by the RO, and whether we would have an opportunity to be converted under a CfD would depend on what happens to the CfD program going forward and we don’t expect further guidance on that until autumn,” Thompson said.

Drax is awaiting the outcome of the EU state-aid process on early CfD for the third unit conversion. Currently, it is operating on over 85 percent biomass and will be fully converted once the state-aid process concludes. The estimated carbon saved when three units are fully converted is a carbon reduction of 12 million metric tons per year.

After the third unit came along, the first biomass-converted unit was taken offline for its first major outage as a biomass unit, which is now underway. “For us, this was a very important point in our biomass journey because it’s the first time we’ve done a major overhaul and therefore can do a really detailed inspection,” Thompson said. “I’m pleased to say now that we’re a few weeks in that there are no concerns and no surprises.”

Key financial performance measures relayed in the H1 report include an increased earnings before interest, taxes, depreciation and amortization (EBITDA) of £120 million ($187 million), up 18 percent compared to £102 million in the comparable period in the year prior. Lower EBIDTA is expected in the second half of the year results, due to the adverse impact of LEC removal. Drax will reduce its EBIDTA by £30 million in H2 and £60 million in 2016.

Drax reported underlying earnings of £41 million for the six months ended June 30, an increase of £2 million from the prior year period. Total dividends reported by the company for the period was 5.1 pence per share, or £21 million, compared to 4.7 pence per share, or £19 million, in the prior year period. Drax reported basic earnings of 10 pence per share, compared to a loss of 2 pence per share in the prior year period.

Of the highlights reported for the period, biomass investments are protecting the business from the increasing cost of U.K. carbon tax. Drax has also increased its biomass generation, which now accounts for 37 percent of net power sales in H1 2015, compared to 23 percent in H1 2014. Capital investment is on track to complete the biomass transformation in line with original cost guidance between £650 million and £700 million, which includes three unit conversions, U.S. supply chain investments and industrial emissions directive (IED) compliance. For the first-half results a capital investment of £54 million was reported and fully-year guidance is unchanged at £150 million.

On the investor call, Thompson provided an update on market conditions. “We’ve seen very unusual market conditions in the near-term market for biomass,” she said. “We are very well contracted for 2015 and that reflects that there has been a very healthy spot market.”

Thompson attributes this to the warm winter experienced in continental Europe. However, she said, Drax is less well covered for forward purchases, which are all about fueling the third unit. She said new investment in pellet plants will be required. “We’re looking forward to the approval of the CfD to underpin the investor’s confidence,” Thompson said.

Drax Power’s net sales in electricity output include 14 terawatt hours (TWh) for H1 2015, an increase from 12.9 TWh in the prior year period. Within that amount, there was a significant increase in biomass generation reported, 5.2 TWh, up from 3 TWh in H1 2014.

Drax’s first-half report included an update on its biomass supply, reporting that the 3-million-metric-ton Baton Rouge port facility is now fully operational and exporting biomass pellets. The company’s 450,000-metric-ton Morehouse plant is now in commercial operations and the 450,000-metric-ton Amite plant is in final commissioning—expecting commercial operations in August. Thompson said the company is continuing to evaluate a third 500,000-metric-ton pellet plant to feed through Baton Rouge.

Sustainability and safety were also addressed during the results. Thompson said the certification process under the Sustainable Biomass Partnership is underway at the pellet plants in Louisiana and Mississippi. “We and the other members of SBP are now working with certification companies and our biomass suppliers to certify compliance with these standards for our biomass fuel,” Thompson said.

Drax Biomass’s immediate priorities listed in the report include completing the commissioning of the two U.S. pellet plants, working closely with the EU for a successful outcome to the state-aid process, and continuing to strengthen its biomass supply chain. “Drax has performed extremely well over the last six months and we are well advanced with our long-term strategy to become a predominantly biomass-fueled power provider,” Thompson said.