UK Consumers Needed Energy Relief — a Loophole Lost Them Millions
As UK electricity prices skyrocketed last year, Drax Group Plc was in a position to blunt Britain’s pain.
Since December 2016, a generator at the firm’s giant power plant had received £1.4 billion ($1.8 billion) in green-energy subsidies from consumers — payments above the market rate for electricity. The goal of this public aid was to make it profitable for Drax to fuel the unit with “biomass,” pellets made from wood that are considered a renewable energy source.
This expensive method for weaning Britain’s power grid off fossil fuels contained a consumer safeguard: If electricity prices ever increased enough that Drax’s “Unit 1” generator could comfortably make money without subsidies, its earnings would be capped, and the company would have to send any extra cash back to bill payers.
But when that moment came, Drax changed course. As household energy bills began more than doubling, the company slashed production at Unit 1. Idling the generator for weeks at a time — and instead using others that weren’t required to cap their earnings — has let Drax avoid sending consumers an estimated £639 million as of July, according to a Bloomberg News analysis of thousands of power market records.
Meanwhile, the company sold some of its biomass pellets at high prices on the open market, according to its public statements and to five people with direct knowledge of the biomass market. Drax posted a record £731 million in earnings last year, almost double its 2021 income.
The company didn’t break any rules. But “it looks like they are acting in bad faith,” said Ed Davey, who was the UK government’s energy secretary when it negotiated the firm’s subsidy deal, and is now leader of the opposition Liberal Democrats. “It’s against the national interest.”
Drax said in a statement that soaring biomass prices last year made it “uneconomical” to operate Unit 1 much of the time. The company said it acted responsibly to avoid the risk of biomass shortages posed by Russia’s invasion of Ukraine, and had to make “careful decisions” about how best to deploy limited supplies. “No serious observer of the energy system would advocate that we ought to have exposed our business and Britain’s power grid to those risks,” the firm said.
Yet three former UK energy secretaries who oversaw subsidy policy told Bloomberg that Drax appeared to have violated the spirit of its 2014 agreement. Davey didn’t mince words: “This is gaming the contract, which is supposed to protect consumers in these circumstances,” he said.
With Britain mired in an energy crisis last year, some power companies found ways to generate additional revenue while saddling consumers with extra costs. A handful engaged in what traders described as supply-gaming — announcing plans to turn off their plants ahead of peak demand periods, only to keep them running in exchange for higher prices.
Drax’s gaming, as Davey described it, shows how a loophole in the UK’s energy subsidy program exposed the bill-paying public when prices jumped. The company was able to avoid returning hundreds of millions of pounds to consumers for a simple reason: Nothing in the agreement prevented Drax executives from shutting down their generator if they could make more money doing something else. After Russia invaded Ukraine, causing massive price spikes for both biomass and electricity, that’s precisely the situation Drax encountered.
“This is another example of a failure where policy wasn’t ready for extreme circumstances,” said Michael Grubb, professor of energy and climate change at University College London. “Where there are opportunities for profiteering, companies will seize them.”
This particular opportunity stemmed from a type of subsidy agreement called “contracts for difference,” or “CfDs” for short. The CfD for Drax’s Unit 1 follows a straightforward logic.
First, negotiators agree on how much it will cost Drax to produce electricity from biomass. They add some extra to ensure a reasonable profit. This total is called the “strike price.”
Then they figure out how much the firm can sell its electricity for on the wholesale market. If that “market reference price” is lower than the strike price, consumers have to send Drax the rest of the money — the “difference” — via charges added to their energy bills.
But if the market reference price rises above the strike price, the arrangement flips. The contract holds that Drax, now assured of turning a profit, must send the difference back to energy suppliers, who by law then reduce what they charge consumers.
The market reached that crucial juncture for the first time in April 2022. But at the very same time, the price of biomass pellets also soared. And that meant Drax could make more money by simply closing up shop at Unit 1.
Biomass pellets — unlike wind, the other main renewable energy source awarded CfDs — can be sold easily in a global market. For years, Drax had imported pellets from the US using its own production facilities and long-term contracts with other suppliers, locking in a cost of about $181 per ton for much of its fuel. In April 2022, the company could sell such pellets for an almost 70% markup, according to data provided by the market research firm Argus Media Ltd. Profits from those sales would not be capped.
So Drax had a choice. It could produce power with Unit 1 in return for earnings that would be capped. Or it could cut output and make more money by deploying the pellets in other ways: selling them, using them for electricity in other generators that had no such cap, or delaying delivery for times when they could produce power more profitably.
Soon, Unit 1 had cut back to less than half its usual output. By January 2023, it went completely dormant, and it has been mostly switched off since then — though Drax pointed out that it has remained available if needed. As of July, the company has sent consumers, via suppliers, as much as £81 million for the times since April 2022 when the generator did run. That’s about 11% of what it might have sent if it generated as usual, according to Bloomberg’s analysis.
Drax said that its decision-making about how to use its pellets is complicated — by burning fewer, the firm was playing it safe in a risky environment. Overall, the company was a net buyer of pellets and could have lost money in situations where suppliers couldn’t deliver pellets it had already purchased, a risk aggravated by the market disruptions created by Russia’s war, the company said.
Drax’s chief financial officer, Andy Skelton, cited different considerations when laying out the company’s strategy earlier this year. “Look at the relative attractiveness of the CfD versus what you could get selling the pellets,” he said on a February call with analysts. “And that should give you some idea of what the opportunity is.”
The three former energy secretaries who spoke to Bloomberg questioned whether a company that has received billions of pounds for operations across its power plant should behave in this fashion. One, Andrea Leadsom, said she despaired that some firms prioritized making a profit over doing the right thing, especially with inflation approaching double digits and after years of receiving public money.
“Some businesses will always take advantage of a scheme and say ‘yes, but it’s within the rules,’” said Leadsom, who held the job from 2019 to 2020, and remains a lawmaker. “To many it looks like unacceptable behavior.”
An energy department spokesperson declined to answer specific questions about its oversight of Drax or the subsidy program, and said that generation decisions are a matter for private companies.
It’s unclear precisely how much consumers lost out on because Drax cut back Unit 1’s generation. To arrive at its £639 million estimate, Bloomberg used the daily notices that Drax sent to grid operators that specified how much electricity Unit 1 would be able to supply if called upon. Some of that money might have ultimately gone to the UK Treasury, because the government spent all of last winter subsidizing consumers’ bills.
Even though the company has sent comparatively little to consumers under its CfD, Drax executives have publicly touted the program’s payback provision. This June, Chief Executive Officer Will Gardiner wrote in an op-ed in The Times of London newspaper that it helps “guard customers from energy price spikes.” The Harvard-educated former JPMorgan Chase & Co banker didn’t mention that Drax has delivered little of that protection.
In its statement, Drax said it was “misleading to compare Will Gardiner’s comments on the concept of how CfDs operate in general to the extraordinary situation faced by Drax’s CfD unit following the Russian invasion of Ukraine and the subsequent rise in biomass fuel cost.”
The dozen gray concrete cooling towers that make up Drax Power Station dominate a horizon otherwise mostly composed of green fields in Yorkshire, northern England. At 374 feet, each is large enough to house an entire Statue of Liberty.
The plant, one of Britain’s largest, began generating in 1974, and for most of its existence, it burned coal. Global warming changed that. In 2003, after British policymakers began offering subsidies to encourage energy suppliers to adopt cleaner fuels, Drax began experimenting with biomass.
Biomass producers glean the discarded branches and other “offcuts” left behind after commercial forests are harvested for paper or construction products. They chip and shred the wood down to a fine powder, then compress it into pellets that are a couple of centimeters long and resemble large-grain cat litter.
The result is billed as a renewable energy source because trees can be planted to offset the carbon dioxide released when it’s burned. But environmentalists have long been skeptical, and some academic studies have found that burning biomass releases carbon into the air much faster than the next generation of trees can absorb it.
Nonetheless, UK officials included biomass alongside wind and solar in their green-energy subsidy programs. Drax signed up for one in which consumers end up paying about £50 per megawatt-hour on top of the wholesale market price.
By 2012, the firm was receiving over £60 million from consumers each year through existing programs. But only 5% of the plant’s fuel was biomass, and most of that was for research purposes.
Dorothy Thompson, who was Drax’s CEO at the time, declared that the subsidy just wasn’t enough. Drax wanted protection from turbulent wholesale prices that could imperil profitability and make it difficult to attract investors for an expensive biomass conversion project.
At the same time, Davey, who was the energy secretary then, wanted to move to a new program that would offer some form of consumer protection. He said he implemented CfDs to try to ensure that when market prices went up, bill payers would get some money back.
The government took a limited approach to using CfDs for biomass; it approved only one of Drax’s available generators, Unit 1, for a deal to begin in December 2016. Drax also converted three other units, which continued collecting subsidies from the earlier initiative, which is limited to about £650 million per year. Last year, Drax increased output at those three generators, which aren’t required to send money to consumers.
As the CfD program got under way, Drax wasn’t the only biomass-fired power plant to win one. Lynemouth Power Station, owned by Czech energy giant EPH, did as well. Like Drax, once electricity prices rose in April 2022, Lynemouth began reducing its output.
EPH said in a statement that it did so partly because of “exceptional planned and unplanned” outages at its plant, which required extensive maintenance work. When the station was fully operational again, the market was too volatile for Lynemouth to appropriately hedge its exposure, the company said. The plant has remained mostly dormant since. It’s unclear how much Lynemouth would have returned to consumers under its CfD if it had operated when it was able to.
When the biomass plants were seeking their CfDs, those involved in the negotiations had expected the price of power to remain fairly stable for many years to come. For the first five years, they were right: The price of electricity hovered between £40 and £60 per megawatt-hour.
Then the market went haywire.
First came Covid shocks. Then in February 2022, Russia invaded Ukraine, and the British public began receiving dark warnings that household energy bills were about to double, or worse.
After halving the normal output of Unit 1 that spring, Drax said in public filings that July that it was “reprofiling” its output — shifting it from summer to winter — to ensure it could produce electricity when “security of supply” was most likely to be threatened. Cutting back its summer generation would enable the company to “provide high levels of reliable electricity generation” just when the UK would need it most, Drax said. In the month following the announcement, Drax’s shares rose 22%, compared with a 4.5% gain for SSE Plc, a rival UK power company, and a 7.8% increase in the wider FTSE 250 stock index.
While the announcement went largely unnoticed at the time, two analysts at Citigroup Inc., Jenny Ping and Rory Graham-Watson, did spot the consequences for consumers. In a note to clients they wrote that they were “surprised that Drax is doing this in the face of political focus on cost of living, energy bills and scrutiny around excess profits.” Ping and Graham-Watson declined to be interviewed for this story.
When winter came, Drax didn’t ramp production back up like it said it would. Instead, in October, it slowed Unit 1 even further. In mid-December 2022, the generator stopped completely. According to Drax, it changed its position because spot biomass prices stayed high into the winter, making Unit 1 “generally uneconomical to run.”
The company added that the soaring prices in the biomass pellet market created new dangers. Drax sells a lot of its power months or even years in advance. Much of its pellet supply also comes from long-term contracts that lock in low prices — and therefore profits. But not all of it does, and Drax had chosen to use much of that cheaper biomass to fuel units not covered by a profit cap. If any future pellet deliveries fell through, Drax could lose money on some of its contracted power sales.
Because Drax generated less electricity from biomass than usual, Britain needed more fossil fuels last winter than it would have otherwise. In March, electricity supply became so tight that National Grid Plc paid coal generators to stand ready to produce, including two owned by Drax. The company said Unit 1 had remained available to run if the grid operator asked it to.
The mood on Drax’s earnings call was festive on Feb. 23 when the company announced its record earnings. Gardiner, a rangy, sandy-haired American-British dual citizen, held court. The company had benefited from higher power prices, he said, but also from its ability to “optimize how and when we generate.”
“We can either sell pellets or we can sell power, whichever is most beneficial, and having this ability has significantly driven our results,” he said. This spring, Drax increased its dividend payments by almost 12%, and started buying back as much as £150 million worth of its shares, delivering a windfall to investors.
Drax’s Amite BioEnergy plant, in Gloster, Mississippi. Photograph: The People’s Justice Council
In recent years, Drax has sought more from the British public. Even as it was shutting down production at Unit 1 last year, the company was lobbying the government — successfully — for a partial exemption from a windfall tax on energy company profits.
As the UK has amped up its drive to cut greenhouse gas emissions to net zero by 2050, one new plan has earmarked tens of billions of pounds of public money for projects that would capture and bury carbon dioxide emitted by factories and power plants.
Drax pitched a £2 billion capture upgrade for its power station that it said would create 10,000 jobs and remove 8 million tons of carbon dioxide every year. The company is asking for CfDs to fund the work.
The government’s climate watchdog, the Climate Change Committee, expects Drax’s proposal to become a key component of the UK’s path to cutting emissions. Yet the company’s use of the CfD it won years ago may raise difficult questions.
“Drax is making a lot of money from something that with hindsight probably should never have been agreed,” said Jacob Rees-Mogg, a former energy secretary. “I would encourage the government in any renegotiations to be pretty tough on Drax.”
If the company decided to stop operating its generators under a carbon-capture CfD — as it did under the existing one — “then there’s a real risk the UK might not hit its net-zero targets,” said Adam Bell, director of policy at consultancy Stonehaven. He was formerly a senior civil servant working on energy policy.
This spring Gardiner warned that if the government doesn’t accept his company’s proposal, Drax might invest more in US-based ventures. Its power plant, which last year provided 4% of Britain’s power, might no longer be viable, Gardiner said. The firm also released a report saying the UK faced a critical shortage of energy capacity by decade’s end, a supply crunch that would be significantly worse if Drax Power Station stopped operating.
In March, the government declined to include Drax in its first round of funding. Two months later, the firm announced it had selected two sites for new biomass-fired power plants in the southern US, each costing around $2 billion. Drax said it was evaluating nine other sites in the US for similar projects.
The company has paused all further UK investment in carbon capture until it gets clarity on when it would receive more public money. British lawmakers have left the door open to further negotiations. “With the right engagement from government and swift decision making,” Gardiner said in a recent statement, “Drax stands ready to progress.”
