Revised terms for Drax’s £702m acquisition of Scottish Power assets

Drax has today announced that it has reached agreement with Iberdrola on revised terms for the acquisition of Scottish Power’s portfolio of pumped storage, hydro and gas-fired generation at the previously agreed price of £702m in cash.

The listed Selby power station group said the revised contractual arrangements were designed to mitigate the risk to 2019 capacity payments arising from the recent suspension of the Capacity Market.It first announced its acquisition of Iberdrola – Scottish Power’s parent company – in October. The acquisition is a major step in taking the North Yorkshire power station coal-free.

Payments to generators by the UK Government which were scheduled under existing capacity agreements and the holding of future capacity auctions have been suspended because of an EU ruling into Capacity Markets. Drax and Iberdrola have now agreed a risk sharing mechanism for capacity payments for the period 1 January 2019 to 30 September 2019, worth £36m. If less than 100% of these payments are received from the Government and the gross profit of the Portfolio for the full year 2019 is lower than expected, Drax will receive a payment from Iberdrola of up to £26m. The mechanism also gives Iberdrola the opportunity to earn an upside of up to £26m if less than 100% of these payments are received but the Portfolio performs better than expected in 2019.

 Will Gardiner, Chief Executive Officer of Drax Group, said: “The strategic merits of this acquisition remain unchanged and the Board believes there is a compelling logic in our move to add further flexible sources of power to our offering, which will accelerate our ability to deliver our strategic vision of a lower-carbon, lower-cost energy future for the UK.

“The capacity market is a central pillar of the UK’s energy policy and ensures security of supply while minimising costs to consumers. The Government has stated it is working closely with the European Commission to aid their investigation and to reinstate the full capacity market regime, including existing agreements, as soon as possible.

“To mitigate the risk that capacity payments take time to be restored, we have agreed revised terms which provide protection in 2019. Beyond 2019, while reinstatement of the Capacity Market is the most likely outcome, we considered other outcomes, the more plausible of which would still deliver returns in excess of Drax’s weighted average cost of capital.

“The acquisition makes financial and strategic sense, delivering material value to our shareholders through long-term earnings and attractive returns.”

Today’s announcement comes after the General Court of the European Union issued a ruling in November which annulled the European Commission’s 2014 decision not to undertake a more detailed investigation of the UK Government’s scheme establishing the Capacity Market. The Ruling imposed a “standstill period” while the European Commission completes a further state aid investigation into the Capacity Market. 

Contracted capacity payments make up a significant proportion of the earnings of the Portfolio. For the period from 1 January 2019 to 30 September 2022, the Cruachan pumped storage hydro asset has contracted capacity payments of £29m, the Galloway run-of-river hydro assets have contracted capacity payments of £5m, and the Combined Cycle Gas Turbine assets have contracted capacity payments of £122m.

The company announcement this morning stated: “Drax recognises there is some uncertainty whether the contracted capacity payments for the 2018/19 Capacity Market year, which are currently suspended, will be paid by the UK Government. To mitigate the risk that these payments are not received for the 2018/19 Capacity Market year, Drax has agreed with Iberdrola certain amendments to the agreement signed on 16 October 2018.” 

Drax added that based on recent power and commodity prices and assuming that all contracted capacity payments are received, the Portfolio is expected to generate EBITDA in 2019 in a range of £90m to £110m, from gross profits of £155m to £175m, of which around two thirds is expected to come from non-commodity market sources, including system support services, capacity payments, and the Daldowie energy-from-waste plant.

If, in light of the Ruling, the contracted capacity payments payable in 2019 in respect of the Portfolio are not received or accrued in 2019, the expected EBITDA for the Portfolio in 2019 would be reduced by up to £47m down to a range of £43m to £63mbefore considering mitigating factors. Drax believes that the arrangements agreed with Iberdrola mitigate in economic terms the majority of the risk that those suspended capacity payments will not be paid.

Assuming performance in line with current expectations and if all capacity payments due in 2019 are received before the end of 2019, net debt to EBITDA is expected to fall to Drax’s long-term target of around 2x by the end of 2019. If capacity payments are not received in 2019, net debt to EBITDA is expected to fall to around 2x during 2020.

Following the EU Ruling, £7m of contracted capacity payments relating to 2018, principally in relation to Drax’s remaining two coal-fired units, will not be paid as and when expected. Drax said: “Taking this into account, and following Drax’s recent good trading performance and assuming continued good operational availability for the remainder of the year, Drax’s full year EBITDA outlook remains in line with previous expectations, with net debt to EBITDA expected to be around 1.5x for the full year, excluding the impact of the Acquisition.”