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Drax Group share price down as subsidies are called into question


Shares in sustainable power business Drax Group LON:DRX were slipping this week, down over 8% in the last five days following its latest set of results. While reported sales beat market expectations, investors were also surprised to see statutory EPS miss by a staggering 75%.

Drax Group also has big questions to answer around its sustainability record. The company received £893m in direct government subsidies in 2021 for burning forest biomass. While still considered carbon neutral under UK law, according to the European Academies Sciences Advisory Council, it “is not effective in mitigating climate change and may even increase the risk of dangerous climate change.”

Drax receives subsidies in the form of ROCs (Renewables Obligation Certificates) and CFDs (Contracts for Difference) dependent on the amount of woody biomass it burns. Ember calculates that from 2012 until 2027, when this support runs out, Drax will have collected more than £11 billion in subsidies. This figure is all the more extraordinary considering wind and solar generation, which guarantee real emissions reductions, are now effectively subsidy free.

Should investors be worried?

Drax Group CEO Will Gardiner said the company was doubling down on BECCS – bio-energy with carbon capture and storage. “”We believe that BECCS can become a world-leading solution for large-scale high-quality carbon removals and we are seeing increasing global policy support for its delivery,” he said last week. “Drax stands ready to invest billions of pounds in the development of this technology and, following the introduction of the US Inflation Reduction Act, we are increasingly excited about the opportunities to deploy BECCS in the US. In response, the UK government should accelerate its policy support for BECCS to make the UK a world leader in carbon removals, while attracting investment and delivering its net zero targets.”

Yet inside the European Union BECCS technology is dogged with controversy, especially as it produces significant emissions and contributes to higher food prices and consumes huge amounts of water.

Balance sheet-wise the company still looks in relatively good shape. Critical balance sheet metrics appear to signal strong support and a high likelihood of positive growth going forward, according to artificial intelligence analysis from Bridgewise in Israel. Drax has done an excellent job managing its liabilities, Bridgewise said in its latest analysis of the company.

Drax’s liabilities stood at £5.1bn in the current filing, which represents little change from the previous report. These liabilities changes appear balanced compared to Drax Group peers and project the message that management is capable and focused on balancing asset growth, resource allocation, and growing liabilities. But there remains the question of its reliance on government support.

“The government pays significant sums in renewable energy subsidies to bioenergy companies making sizeable profits, despite it releasing huge amounts of greenhouse gases and harming forests’ ability to absorb carbon,” said UK MP Pauline Latham. “This directly costs billpayers and families through their energy bills. In the context of the cost of living crisis, the government should be looking into these subsidies and ensuring they are used for proven renewable energy sources and energy efficiency measures, rather than harming nature.”

A survey from Cut Carbon Not Forests has also demonstrated that members of the British public finding it hard to understand how burning forest products is going to contribute to a carbon neutral solution.

Why should Drax Group shareholders be worried?

The heavy dependence of the company on UK government subsidies remains a significant risk factor when one is considering an investment in the business. Hence, it comes as no surprise that the management team is looking at possible further expansion in the US, which helps to diversify revenues away from a scenario currently dependent on subsidies from one country.

More importantly, fund managers are under enormous pressure to justify holding every stock in their portfolios on environmental grounds. Regardless of financial performance, controversy around environmental track records can cause fund managers to dump even profitable companies, with significant impact on the share price.

A considerable number of large scale fund managers remain invested in Drax Group: among them are the likes of Invesco, which reported a 9% holding in 2020, and BlackRock which held 7% last year according to Drax Group’s own data. We estimate around 30% of Drax Group stock is probably held by big brand asset managers at the moment.

The biomass pellet market

Drax Group is also facing some other pressures – as it reported to its investors, over the past 12 months, the cost of biomass in the European spot market has increased significantly, making it more challenging to procure and generate additional power with a margin. As a result of higher biomass prices, this created opportunities for the sale of biomass in addition to generation. Most of the biomass Drax Group uses is under long-term contracts. However, inflationary pressures in certain aspects of the company’s supply chain have led to some cost increases and management said they expect this to continue in 2023.

Drax actually remains fairly bullish on the whole biomass pellets market. The company says it believes the global market for sustainable biomass will grow significantly, creating international opportunities for sales to third-parties, BECCS, generation and other long-term uses of biomass.

To support this expected growth in demand for biomass products, Drax is targeting 8Mt of pellet production capacity by 2030. This will require the development of over 3Mt of new biomass pellet production capacity to supplement existing capacity and developments. “We are developing a pipeline of organic projects, principally focused on North America, which includes the recently announced Longview project. We will also look at other opportunities where appropriate,” the company told investors last week.

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This article does not constitute investment advice. Make sure you do your own research or consult a professional advisor.

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