How does the future look for Drax?

With technology controversy, state aid questions and courtroom wrangling disrupting its strategy to lead the charge on a low carbon economy, what’s the outlook for Drax? Jane Gray reports.

Through this transformation we will provide cost-effective, low carbon and reliable renewable power to the UK consumer.”

These words could easily have been spouted by energy secretary Ed Davey in one of his many attempts to sell Electricity Market Reform, the government’s proposed solution to the UK’s energy “trilemma”. In fact, the claim was made by Dorothy Thompson, chief executive of the UK’s largest power plant, Drax. The 4GW Drax has undeniable influence over the UK’s push for a low carbon economy, despite its distance from the Westminster bubble.

Drax provides around 7 per cent of the UK’s total electricity – roughly the amount required to meet London’s energy needs. It is also a leading light of low carbon evangelism as it transforms from coal-fired carbon guzzler to biomass believer.

In recent years this conversion has made Drax a poster child for the UK’s energy transformation ambitions, but this position of celebrity is not without its burdens. The company has found itself increasingly at the mercy of fluctuations in markets, and environmental backlash not to mention a high profile clash with government over obscure renewables subsidies decisions.

These trials are unsettling to shareholders, and Drax’s ability to overcome them will have a big impact on the UK’s future energy security.

An unhappy first half

Drax’s most recent financial results, released in July, revealed the extent of its sensitivity to the market.

The government-enforced carbon tax (the carbon floor price) has eroded earnings from the largely coal-fired power generator by 15 per cent year on year. At the same time, it took a hit due to low weather-linked power demand and depressed market prices.

These stresses and strains would be enough to make many energy executives blanche, but because Drax is also reliant on renewables subsidies to support its biomass conversion, the generator is under further pressure from the declining prices of Renewable Obligations Certificates due to record windfarm output.

Drax’s management effected a certain nonchalance about this challenging environment when it announced the company’s first half-year results – and about the fact that profits fell by 15 per cent rather than the 13 per cent analysts had anticipated.

A sharp rise in the carbon tax and increased depreciation – not a cash item – as well as additional finance costs were blamed for the weakened bottom line, which Thompson shrugged off as a “temporary” inconvenience. All will be well when Drax has completed its journey to being a predominantly biomass-fuelled power plant, she said – a milestone it expects to reach in 2016.

The best laid biomass plans

Biomass and carbon capture and storage (CCS) are the technologies Drax has backed to carry it in into a new era of low carbon generation. The company plans to convert four of its six coal burners to run on biomass. The first started full commercial operation in April 2013 and the second is set to follow in April 2015 (see timeline).

This plan represents a weighty investment commitment in UK energy infrastructure – which many commentators agree is in dire need of such big ticket attention.

In 2014 so far Drax has pumped £123 million into capital expenditure and expects to meet its full year capital investment guidance of around £200 million. More broadly, the company says it will spend £650-£700 million in total between 2011 and 2017.

In addition, its role as part of the Capture Power consortium helped clinch the €300 million funding offered by the European Commission to develop the White Rose Carbon Capture and Storage project. That award was made in July this year.

The White Rose project is the only CCS initiative to receive funding through the competition, and entails a new 426MW coal-fired power station on the Drax site fitted with equipment to capture around 90 per cent of its emissions.

However, Drax has found that its route to becoming a low carbon champion is full is complications.

The company was awarded an “early investment” subsidy contract for one of its conversion units through the government’s contracts for difference (CfD) scheme. However, when the government withdrew its promise of a similar subsidy for another unit, Drax launched legal proceedings.

The ensuing dispute in the High Court and then the Court of Appeal filled plenty of page space in the national press and, sadly for Drax, ultimately resulted in a government victory on 7 August.

This means the coal-fired unit Drax had planned for conversion later this year will have to rely on Renewables Obligation Certificates (Rocs) as a source of subsidy rather than the more lucrative CfDs.

Clearly this has implications for the economics of the conversion. Biomass output will get an estimated £10/MWh less with Rocs than under the CfD regime, which guarantees biomass output at £105/MWh. Under the Renewables Obligation, Drax’s second biomass conversion will get 0.9 Rocs, currently worth £41.50/MWh, plus the wholesale power price.

The news caused Drax’s share price to plummet 10 per cent before a slight recovery saw it finish a disappointing day down 8.2 per cent (see graph, opposite). Nonetheless, Drax has so far revealed no plans to abandon the beleaguered conversion project and in the aftermath of defeat in the Court of Appeal Thompson was philosophical.

“The regulatory landscape still presents uncertainties, but positive progress is being made and we hope that most of the key issues will be clarified in the coming months,” she said.

The uncertainties she refers to include a crucial pending decision from the European Union on the validity of the CfD for unit 3.

The terms offered by the Department of Energy and Climate Change (Decc) for this conversion are certainly generous and the European Commission may yet decide they contravene rules on state aid. All three biomass programmes allocated early CfDs by the government in July could be hit by a negative decision from the Commission. This includes two biomass conversion projects and a dedicated biomass combined heat and power plant.

Analysing Drax’s position, policy research analyst Nigel Hawkins, says: “Undoubtedly, Drax is undergoing radical transformation, especially on the fuelling front. It does benefit, though, from a reassuring balance sheet, with net debt of just £38 million.”

Hawkins says “outstanding biomass-related decisions are key” in the short term, and in the longer run “if earnings remain weak and forward power prices ease back, investor concerns will deepen”.

How sustainable is biomass?

Behind the high-profile legal wrangling over subsidies for Drax’s biomass conversions lies a broader debate on the suitability of biomass as a contributor to the UK’s carbon abatement programme. Opponents say wood farming is unsustainable and, ultimately, carbon intensive.

Drax chief executive Dorothy Thompson remains defiant in the face of such claims: “[Sustainable biomass] is the only renewable that can supply both baseload and flexible electricity at scale in the UK,” she says. “It is more cost effective than many renewables and it is lower carbon than other dispatchable technologies.”

Nevertheless, concerns over potentially negative impacts on the environment surfaced with new vigour in July when Decc released a controversial new carbon calculator, accompanied by a technical report that was seized upon by biomass opponents. Oliver Munnion – co-director of not-for-profit biomass awareness group Biofuelwatch – said: “[The government’s] own commissioned research now shows that the wood most likely to be burned in import-reliant, big biomass power stations, such as those proposed across the UK, will make climate change worse. Decc must end subsidies for these power stations now.”

Even more measured commentators admit that the Decc report is troublesome for biomass advocates in the UK. Matthew Aylott, policy engagement manager at the UK Energy Research Centre, observed that “Decc appears to be conflicted over the future role of biomass in the UK energy mix” and that continuing environmental concerns are generally seeing biomass become “marginalised”. He maintained, however, that biomass could still be an important technology for decarbonisation if paired with carbon capture storage.

Despite the crowing of some biomass opponents, Drax is adamant that the government has not changed its view of biomass as an important contributor to a low carbon economy. Indeed, the government’s own comment on the report was that it showed “in the short term, biomass can help us decarbonise our electricity supplies”.

The release also said “we are committed to supporting cost-effective, sustainably produced biomass”.

Drax is confident that its policy of using offcuts of wood as well as thinnings and residues that would otherwise be left to rot comes under the heading of what the government would term “biomass dwone well” in that it can return overall carbon savings.

James Court, a spokesperson for the Back Biomass campaign group, supports this view and adds: “Most forest land in the southern US, where Drax sources much of its biomass, is owned by landowners whose land has been in their families for generations.

“Decades of careful stewardship have seen growth in the region’s forests of around 97 per cent between 1953 and 2007. Biomass energy is key to supporting this growth and creating stability following the collapse of the paper mill industry.”

Countering claims that the shipping of biomass material from America adds an unacceptable carbon footprint to its biomass operations, Court also asserts that it is comparable to the footprint that would be created in trucking similar fuel from forests in Scotland.

Hammering home the economic arguments in favour of biomass, Court concludes: “Excluding biomass from the energy mix would significantly increase the cost of decarbonising our energy system – an increase estimated by recent government analysis at £44 billion.”