Fashionable because, like all major energy producers, Drax is rapidly shifting its portfolio towards renewables — in fact the group stands far ahead of peers as it already completed its transition. This latter is no longer a coquetry but a strict imperative to meet the ESG criteria now required by institutional investors, which traditionally form big energy companies' shareholder bases.
Exit coal, then. Operated by Drax, the Selby site, once the largest in the UK, cased burning the loathed combustible last spring. Following the sale of its four gas-fired power plants to trading company Vitol, and the abandonment of the mega-conversion project at Selby, natural gas is a goner as well, at least for now.
In effect, Drax is prudently saving an option to build four smaller open cycle gas-fired plants, which are less profitable and less environmentally friendly than their combined cycle alternatives, but more flexible and therefore better able to respond to emergencies during demand peaks. Current distress in European energy markets certainly pleads in favor of such latitude.
In practice, Drax went all-in on solid biomass, and more precisely on the combustion of wood pellets. Betting the house on this distinctive positioning, the group has developed and partly integrated an entire value chain from forestry to logistics and distribution between North America and Europe.
Starting early enabled it to become the leading producer of renewables in the United Kingdom, accounting for roughly 12% of "clean" production nationwide, with a capacity of 7.4TWh at the end of last semester. 96% of Drax's renewable production is derived from biomass, with the remainder coming from hydro power.
Drax also supplies several of its peers — including Uniper, Mitsui, RWE or Sumitomo — with biomass. A key strategic focus over the next decade should be the establishment of PPAs (“Power Purchase Agreements”), i.e private contracts signed directly between energy producers and large companies, which themselves have to comply with stringent ESG standards.
Financially speaking the transition was well-conducted, thanks in particular to the subsidy-generous British legislator. Revenue has grown while operating cash-flows remained stable. It should be noted, however, that the billion pounds spent on acquisitions to develop the biomass supply chain since 2016 led to an equal increase of indebtedness.
That's for the fashionable part. As stated above, despite all its ESG appeal, Drax does come across as a fairly contrarian investment. The group has been the target of fierce criticism — and even subject of a formal complaint lodged by a powerful environmental lobby to the OECD — regarding the questionable ecological character of solid biomass.
Burning wood has long been suspected of causing more harm than good with respect to carbon emissions — maritime transport included — and deforestation. This debate entails another concern with Drax' actual earning power, which still remains highly dependent on subsidies, themselves conditioned by the "renewable" nature of solid biomass.
A reclassification would undoubtedly have damaging consequences, even though the board of directors brushed off what they claim are unfounded attacks. In effect, Drax explains that its strategy is entirely modeled after the IPCC's — the intergovernmental body of the United Nations responsible for advancing knowledge on human-induced climate change — recommendations.
Analysts — whose consensus is surveyed in real-time by MarketScreener — are sharing the same view. It is this combined set-up of ESG momentum and contrarianism that drove the investment decision earlier this year. Now that valuation — primarily based on dividends — has appreciated, the situation admittedly lost some of its appeal.
Nevertheless, like all other energy companies in Europe, Drax should deliver record earnings this year. As the cold season begins, that trend will continue if distress on electricity markets persists — so momentum has perhaps yet to run dry.