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Iberdrola wraps up £702M sale of UK generation assets to Drax

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The 440-MW Cruachan pumped-storage station in Argylle and Bute, Scotland, part of the portfolio Drax is acquiring from Iberdrola.
Source: Scottish Power

Iberdrola SA has closed the sale of its gas and hydro power plants in the U.K. to Drax Group PLC, after a court-ordered suspension of the British capacity market sparked a revision of the £702 million transaction to reduce the risk of Drax losing out on millions in government payments.

The companies announced on Jan. 2 that the deal closed on Dec. 31, 2018, following approval from Drax shareholders 10 days earlier. Under the transaction, first announced in October of last year, Drax is acquiring almost 2.6 GW of pumped storage, run-of-river hydro and gas-fired generation in England and Scotland from Iberdrola subsidiary Scottish Power.

The new power stations will increase Drax's electricity generation capacity by 60% and boost the company's transition from operating Britain's largest coal-fired power plant to becoming a cleaner and more flexible generator, it said. The portfolio consists of the 440-MW Cruachan pumped storage plant, 126 MW of run-of-river hydro assets in Galloway and Lanark, a biomass-from-waste facility and four combined-cycle gas power stations: the 805-MW Damhead Creek, 715-MW Rye House, 420-MW Shoreham and 60-MW Blackburn Mill plants.

After a European Union court ruling led to the suspension of the U.K.'s power capacity market, Drax and Iberdrola announced on Dec. 3, 2018, that they had agreed on a risk-sharing arrangement for the period of January through September 2019 that provides a potential buffer of up to £26 million to mitigate any impact from the standstill. The court ruling, caused by concern over the European Commission's original approval of the capacity market, put a halt to hundreds of millions in contracted payments for power generators, including some of the assets sold by Scottish Power.

The U.K. government has since said that it plans to retroactively pay out capacity contracts to power generators if the scheme is reapproved. It expects the European Commission to open an investigation of the capacity market in early 2019 and will hold a replacement auction, contingent on the mechanism being reapproved, this summer. Under the scheme, coal and gas power plants, demand-side response services and battery storage operators receive subsidies to provide or save power during high-demand periods.

Drax had expected the portfolio to generate EBITDA between £90 million and £110 million and later said that the standstill puts at risk a "significant proportion" of the 2019 earnings of the Scottish Power assets. The £26 million risk buffer amounts to just under three-quarters of the earnings that Drax could lose out on, since contracted capacity payments for the Scottish Power assets amount to £36 million over that period.

Analysts at investment bank Jefferies argued that the revised deal still poses a potential downside for Drax because capacity payments from the Scottish Power assets were expected to contribute £47 million for the full year 2019.

Drax has been converting its 3,900-MW power plant in North Yorkshire from burning coal to using wood pellets in recent years and is intent on exploiting the need for dispatchable power assets in the future energy system. In a press release, the company said that adding 35% of Britain’s power storage capacity and 2 GW of gas-fired power stations will position Drax to balance the intermittent generation from the U.K.'s growing solar photovoltaic and wind power plants.

To decarbonize the electricity system, "You need a power system with 85% solar and wind, but you also need a dispatchable system," Drax Group CEO Will Gardiner told an industry conference in London last October. "Solving that problem of how do you support that system is what Drax is all about."