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Drax Is 4% Off Recent Peaks On Biomass Announcement, Is the Business Viable Long-Term?

Tim Worstall
Tim Worstall trader
Updated 2 Dec 2021

Drax (LON: DRX) is 4% off recent peaks overnight as it makes an announcement about its biomass business. That the former coal plant is falling at a time of record highs for energy prices is evidence of the different opinions about the company. Differences of opinion are of course trading opportunities.

The business itself was formerly a coal fired power station which was then converted to biomass. That in itself brings political risk – for only if the EU and UK continue to define biomass as a contribution to net-zero does the business have any future at all. 

Given that current law does regard burning American trees as being carbon zero then the plant, and company, benefit hugely from the current high energy prices – the Drax share price is up nearly 100% over the year. 

So far so good. But now to the controversy, the difference of opinion. Current trading results are great and that’s good. The new announcement is that they’re going to expand their biomass business. Double it in fact.

If they’re burning American wood pellets themselves, which they are, then clearly Drax has contacts with plantations and so on who grow and make wood pellets to be burnt. At first sight, a company like Drax should leverage the knowledge they’ve got. So, why not use those contacts and so on to increase the production and sale of wood pellets to third parties? To other biomass plants who don’t have the volume and thus the contacts? Which is what the announcement is, that Drax will be doubling production of biomass wood pellets to 8 million tonnes a year and doubling the amount sold to others to 4 million.

Exactly where the concern starts to arise. For this is indeed a reasonable and sensible leverage of the company’s contacts and structure. But it’s also an increase in political risk. For how long is biomass going to remain privileged under the varied climate change and net-zero regulation schemes? It’s not exactly obvious that using fossil fuels to cut, chip, compress and then ship wood pellets are in fact carbon-free nor a contribution to net zero. At least one calculation perhaps not a correct one –  suggests that the total emissions are higher than if Drax merely burnt the coal bed it is built upon.  

So, what’s the long-term viability for the business? The valuation of any asset – plant, building, company – is the net present value of the future income stream. So, the idea that the income stream might disappear in 5 or 50 years as the law changes will have an effect on current valuations. As also increases in profits right now, likely mean more income in the near future, also changes that asset price.

It’s possible to see, immediately, the gains from current high energy prices. Legal changes, political risk, are entirely uncertain – no one knows whether there will be any changes at all. The conflict between the two views over valuation could well cause that volatility which is a trading opportunity.

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Tim Worstall
Tim Worstall is a freelance writer specialising in economics and the financial markets.