Clock ticks for Drax to find a new financial model
Subsidies that make up fifth of energy company’s revenues run out in 2027
When Will Gardiner took charge of UK energy company Drax last January, he knew it had only “10 years of life” left in its current form.
Mr Gardiner, who was finance director before taking the top job, is now in a battle to extend the prospects of a company whose main asset, the UK’s biggest power plant, provides 5 per cent of the country’s electricity from Selby, North Yorkshire.
Four of the plant’s six generating units produce power by burning wood pellets, which the UK government counts as renewable, attracting subsidies that added up to 19 per cent of Drax’s £4.2bn revenues last year.
But in 2027 these subsidies will expire, so Mr Gardiner must find an alternative financial model.
Although biomass — electricity generated from organic material — is classified in the UK as a renewable energy source, it is strongly opposed by some environmentalists, who argue it can in some cases be more damaging than burning fossil fuels.
Last year, the UK’s Committee on Climate Change said “sustainably harvested” biomass — which does not contribute to deforestation for instance — can help decarbonise the economy but subsidies should be shifted away from biomass for electricity generation, unless plants are fitted with carbon capture and storage technology. This involves burying carbon emissions in depleted oil and gasfields and is still in the early stages of development.
Earlier this year, Drax became the first wood-burning plant in the world to capture carbon dioxide produced in energy generation but had to release it back into the atmosphere because it lacked storage capability.
It is part of a coalition of companies, including Norway’s Equinor and National Grid, that wants to create a large CCS scheme in the north-east of England, but the plans depend on government support.
At the same time, Mr Gardiner is on a drive to cut the cost of generating electricity from biomass from £75-£80 per megawatt hour to £50 by 2027. This he believes, would put Drax in a position to survive without subsidy.
This target still looks high compared to other renewables, such as offshore wind; some wind developers this year pledged to build schemes in UK waters for a guaranteed electricity price of £39.65/MWh. At the moment, the guaranteed price for one of the Drax biomass subsidy agreements is £114/MWh.
Mr Gardiner said Drax would compete to provide power at peak times, when market prices are around £58/MWh.
He is betting on large power stations finding a profitable place in the market to meet demand and help keep the system stable when renewables such as wind and solar are not producing.
“We think . . . the peaks will become higher and it’ll become more volatile, the power system, over time as there’s more intermittent renewables and there’s less traditional generation,” said Mr Gardiner.
He also believes Drax’s biomass generating units could qualify for the government-run process where energy companies compete to provide standby power during winter.
To cut costs, Drax also intends to change its biomass sourcing.
It currently produces 1.5m tonnes of wood pellets itself at plants in US Gulf states such as Louisiana. These are then shipped across the Atlantic.
It forecasts it will need to increase this to 5m tonnes by 2027. Plans are already under way to increase capacity at its current plants to 1.85m tonnes by next year but it will also have to find alternatives to sustainable wood pellets, which are in limited supply. Options include bagasse — sugar cane residue — but the company has not yet fixed on a solution.
Mr Gardiner acknowledges the pressure to change — and Drax shares have had a tough year, down 22 per cent year to date — but he says the group has already made progress.
Its Yorkshire plant previously ran exclusively on coal but the first unit was converted to biomass in 2013.
Two units still produce electricity from coal but those could be switched to gas. Last year, it spent £700m buying “traditional” generating assets, including gas and hydro-powered plants, from ScottishPower.
But after the European Investment Bank last month said it would phase out lending for new gas-fired power plants by 2021, there has been speculation in the energy industry that gas projects could become “stranded assets”.
Mr Gardiner says he has not yet seen any evidence of other lenders following suit, but he acknowledges the company needs to be ready for that possibility. He says the gas units could ultimately be converted to run on hydrogen, which is talked up by some scientists as a cleaner alternative to gas.
He also insisted Drax would not push ahead with any conversion to gas unless it could secure favourable contracts to provide back-up power over winter.
“I’m not going to be in any hurry to take a contract I don’t like,” he said.
Mr Gardiner also pointed out that Drax had long outlived other large power plants built in northern England during the late 1960s and early 1970s, with the most recent example being Eggborough in North Yorkshire which closed only two years ago.
Analysts at JPMorgan said in a recent note that the company had “borne the brunt of UK decarbonisation policies in recent years”, referring to the phase-out of coal-fired power plants by 2025.
They estimate that its plan to increase its own biomass production would cost around £600m but said the strategy, plus recent acquisitions such as the ScottishPower plants, would put it on “a path to a more sustainable, predictable and profitable future”.