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Carbon tax hits Drax

World Coal,

The rising cost of carbon tax has hit power group, Drax, hard – impacting H1 2014 earnings by 15%.

Half year earnings fell from £120 million to £102 million. Chief executive, Dorothy Thompson, said: “In the short term the increasing cost of the UK carbon tax drove EBITDA down year on year.”

In April 2014, the carbon tax almost doubled – to £9.55/t of carbon – and will rise again in a year’s time to £18. It will stay at this rate until the end of the decade.

The tax cost Drax £48.6 million in H1 2014, up from £13.7 million over H1 2013.

The company had warned in May that full year figures would come in below market expectations. Drax repeated this outlook alongside the half year figures, which means expected profits for the full year will be between £210 million – £220 million.

Even though European coal prices touched multiyear lows over Q2 2014, higher average fuel costs, which have arisen as Drax moves to convert its coal-fired units to biomass, weighed heavily on finances. These fuel costs, combined with the scrapping of the carbon emissions allowances saw Drax post a pre-tax loss of £11 million compared with a surplus of £206 million in H1 2013.

Drax has invested significant amounts to transform the company into a low carbon, renewable generator, thus reducing carbon tax levels. Thompson said in 2016 half of the power station would be fuelled by sustainable biomass, delivering 4% of the UK's electricity.

One of the power plant’s units was converted to biomass in 2013, and another two conversions are planned. The company recently won a legal battle against the UK Government over a subsidy for the conversion of one of its coal units to biomass. The case remains subject to appeal from the government.

A recently published report, “Why Government plans to subsidise burning trees are bad news for the planet” claimed that the “UK Government’s own analysis […] shows that the use of whole trees in [biomass conversion and wood pellets, etc.] would increase greenhouse gas emissions by at least 49% compared to using coal over 40 years”

In response to the report, Drax said its biomass is rigorously checked to ensure it meets the firm’s stringent green credentials.

Thompson said: “Our biomass produces 80% less carbon than coal. “This report concludes there are good ways to buy biomass and there are bad. If procured responsibly you can deliver a sustainable low carbon fuel.”

She added that the group is keen to set up a voluntary code with other European players to ensure that the biomass they all use is low carbon.

Thompson dismissed the notion that Drax could ever use biomass that pollutes as much as coal, saying: “It’s a risk not worth taking.”

Drax has constructed wood pellet manufacturing facilities in the southern US, which analysts said will strengthen the group’s supply chain – as these pellets can be used in the biomass units at the Yorkshire plant.

On the back of the plant’s biomass conversions, investors are cautiously optimistic.

Analyst, Angelos Anastasiou, at Whitman Howard issued a buy note with a 947p price target, saying: “Operationally, the 'biomass transformation' remains on track, and biomass is now providing 20% of Drax's output. Drax is not risk free, but it is moving forward sensibly with its biomass transformation. Our target price of 947p indicates a total return of around 43%, and we still believe that this value will crystallise as the unit conversions continue, leading to the consequent step increases in earnings, whatever the subsidy mechanism.”

Edited from various sources by Sam Dodson

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