Enabling a zero carbon, lower cost energy future

Welcome to Drax Group

Our purpose is to enable a zero carbon, lower cost energy future.

Our ambition is to become carbon negative by 2030. Being carbon negative means that we will be removing more carbon dioxide from the atmosphere than we produce throughout our operations – creating a negative carbon footprint for the company.

Our strategic aims are:

2019 Highlights

1) We calculate Adjusted financial performance measures, which are specific to Drax and exclude income statement volatility arising from derivative financial instruments and the impact of exceptional items, to provide additional information about the Group’s performance. Adjusted financial performance measures are described more fully on page 131 of the full PDF report, with a reconciliation to their statutory equivalents in note 2.7 to the consolidated financial statements on page 149 of the full PDF report. Throughout this document we distinguish between Adjusted financial performance measures and Total financial performance measures, which are calculated in accordance with International Financial Reporting Standards (IFRS).

Our core activities at a glance

We operate an integrated value chain across three principal areas of activity: sustainable wood pellet production; flexible, low carbon and renewable energy generation; and energy sales and services to business customers.

PELLET PRODUCTION

A leading producer of wood pellets from sustainable low-value commercial forestry residues

Our pellets provide a sustainable, low carbon fuel source. This can be safely and efficiently delivered through our global supply chain and used by Drax’s Generation business to make flexible, renewable electricity for the UK. Our manufacturing operations also promote forest health by incentivising local landowners to actively manage and reinvest in their forests.

Our assets:

• 2 x 525 kt pellet plants
• 1 x 450 kt pellet plant
• 350 kt planned expansion of existing facilities, under construction
• 2.4 Mt export facility at Baton Rouge port

Pellets produced

1,407kt

Sales of pellets

£229m

GENERATION

A portfolio of flexible, low carbon and renewable UK power generation

Our multi-site, multi-technology generation portfolio provides power and system support services to the electricity grid. This portfolio provides long-term earnings stability and opportunities to optimise returns from the transition to a low carbon economy.

Our assets:

• Renewable biomass – 2.6GW
• Hydro – 0.6GW
• Thermal:
  • Gas – 2.0GW
  • Coal – 1.3GW

Generation

17.3TWh

Renewables

79%

CUSTOMERS

A leading supplier of renewable energy solutions to industrial and business customers

Our B2B Energy Supply business – comprised of Opus Energy and Haven Power – is the third largest B2B power supplier in the UK and the largest supplier of renewable energy to British businesses.

We are giving our customers control of their energy, which in turn supports the stability of the energy system.

Our assets:

• Opus Energy
• Haven Power

Customer meters

419k

Electricity and gas sales

18.9 TW

Group Financial Review

2019 Highlights

• 64% Adjusted EBITDA growth to £410 million

• Delivered net debt to Adjusted EBITDA ratio ahead of target of 2x, after adjusting for deferred cash receipt of Capacity Market payments of £72 million, received in January 2020

• Strong performance of acquired generation assets with Adjusted EBITDA of £114 million

• Significant increase in Adjusted profit after tax to £118 million resulting in improved Adjusted earnings per share of 30 pence

• Total operating profit of £62 million, increased from £60 million

• Net cash flow from operating activities of £413 million, compared to £311 million in 2018

• 13% increase in dividend to £63 million or 9 pence per share

Introduction

The Group has delivered significant growth during 2019, with Adjusted EBITDA increasing by 64% from £250 million in 2018, to £410 million.

Total operating profit, which includes the effect of remeasurement losses of £133 million (2018: remeasurement gains of £38 million) on derivative contracts, also increased from £60 million in 2018 to £62 million.

Our new portfolio of pumped storage, hydro and gas generation assets (hereafter referred to as the “new generation assets”), acquired on 31 December 2018, delivered Adjusted EBITDA of £114 million. Growth was further supported by an increased contribution from renewable power generation from sustainable biomass at Drax Power Station and our Pellet Production business.

This performance is particularly pleasing when considering the challenges we faced in the first half of the year where both our pellet production operations and biomass generation were impacted by lower levels of biomass supply as a result of historically bad weather conditions in the US Gulf.

Following the reinstatement of the UK Capacity Market in October 2019, the results for the year include £78 million of capacity market income, including £7 million for the period in 2018 after its suspension.

The associated cash was subsequently received after the year end and does not form part of our reported net debt at 31 December 2019.

The Group improved its access to capital during 2019. We refinanced the acquisition bridge facility, used to part-fund the acquisition in December 2018 of the new generation assets from ScottishPower, in three stages.

In May, we issued an additional US$200 million of the existing 2025 6.625% loan notes. In July, we entered into two new senior debt facility agreements, a £375 million private placement and a £125 million environmental, social and governance (ESG) facility. The average rate of the two new facilities is below 3%, reducing the Group’s overall cost of debt to below 4%, reflecting a reduced business risk profile.

Driven by strong cash generation in the period, supported by active management of working capital, net debt at 31 December 2019 was £841 million (2018: £319 million), delivering a net debt to Adjusted EBITDA ratio of 1.9x, ahead of our target of 2.0x for the year end after adjusting for the deferred receipt of £72 million cash in respect of Capacity Market payments received in January 2020.

We remain committed to a sustainable and growing dividend. The Board will recommend at the forthcoming Annual General Meeting a final dividend that takes total dividends for the financial year to £63 million, or 15.9 pence per share, an increase of £7 million or 1.8 pence per share when compared to 2018.

Financial Performance

Adjusted EBITDA

Group consolidated Adjusted EBITDA of £410 million includes a contribution of £114 million from our new generation assets, acquired at the end of 2018.

This is an excellent result and exceeds our forecast range of £90-£110 million, reflecting strong operational performance across the portfolio, better than expected performance in ancillary and balancing services and excellent progress with the integration of the assets into our existing generation business, which is now complete.

In total, the Generation business contributed Adjusted EBITDA of £408 million (2018: £232 million), an increase of £176 million or 76%. This performance comes despite industry- wide challenges with wood pellet production and associated supply constraints in the first half of the year, and includes the contribution of £114 million from our new generation assets, described above.

Following the reinstatement of the Capacity Market in October 2019, we have recognised related income totalling £78 million across the Generation portfolio. Our financial results for 2018 excluded £7 million of capacity market income following its suspension in October 2018, and this amount has now been recognised in 2019.

Total output at Drax Power Station reduced, as we continue our transition away from coal; however, our biomass units delivered output broadly in line with 2018, of 13.4TWh (2018: 13.7 TWh).

The small reduction in part reflected an outage over the summer period on Unit 1, which is supported by the Contract for Difference (CfD) regime.

Despite lower CfD generation, overall renewable support under the CfD and ROC regimes remained broadly in line with the prior period, due to higher ROC generation and indexation of support payments.

Overall captured spreads improved following efficiency gains as a result of our programme of investment in the performance of generating units at Drax Power Station and benefits from our trading position and portfolio.

We continue to derive value from flexibility (balancing mechanism, ancillary services and advantaged fuels), which improved from £79 million in the prior year to £129 million in 2019, an increase of 63%. Our new hydro and pumped storage assets performed particularly strongly in this area, a demonstration of the contribution of the acquisition to our strategy to become the leading provider of system stability in the UK.

The Generation business acquires biomass pellets predominantly in US dollars, which we actively hedge over a rolling five-year period, to manage our foreign currency exposure to a weaker pound. The renewable support (CfD and ROCs) received in respect of biomass generation are subject to UK inflation indices. This exposure is managed as part of our active long-term financial derivatives hedging programme.

We hold a large portfolio of forward and option contracts for various commodities and financial products, the nature, value and purpose of which is described in note 7.2 to the consolidated financial statements. These contracts are held to de-risk the business, by protecting the sterling value of future cash flows in relation to the sale of power or purchase of key commodities. We manage our exposures in accordance with our trading and risk management policies.

From time to time, for example where market conditions or our trading expectations change, action may be needed in accordance with these policies to rebalance our portfolio. This year such activity included restructuring in-the- money foreign currency exchange contracts, to balance short and long periods across the duration of the hedge. During 2019 we also realised value from closing out positions as expectations for coal generation reduced, the benefit of which is included in value from flexibility, above. The financial impact of these activities – which is driven by market prices at the point of execution – is recognised in the cost of sales of our Generation business and therefore is reflected in our Adjusted Gross profit and Adjusted EBITDA.

Our Customers business contributed Adjusted EBITDA of £17 million in 2019, an £11 million reduction when compared to 2018.

The 2019 result for Customers includes £8 million of investment cost in the restructuring of the business, to more closely integrate our two brands and bring them under one management team (In 2018, £3 million of restructuring and integration costs were treated as exceptional and excluded from Adjusted results in the first year post-acquisition of Opus Energy), and a further £7 million for the development of next-generation IT systems (2018: £6 million).

We delivered the new ERP system at Opus Energy during the second half of 2019 but have stopped the implementation of a new billing system and are in ongoing discussions with the supplier. We have incurred approximately £19 million of costs to date, held on the balance sheet, which we believe have value and will be recovered.

Overall volumes sold were down by 9% compared to 2018, which largely reflects a mild 2018/19 winter that led to a challenging first half of the year.

As a result, overall gross profit fell from £143 million in 2018 to £134 million in 2019.

During the year, significant attention was focused on improving cash collections, where we have seen a positive performance. As a result of this, in addition to a £6 million benefit in respect of resolution of legacy credit balances, bad debt charges reduced from £31 million in 2018 to £18 million in 2019. The higher charge in the prior year reflected an increased level of provisioning required due to reduced collection performance, plus a £3 million one-off expense in respect of SME business. The closing provision at 31 December 2019 of £41 million is slightly lower than the prior year (2018: £44 million), reflecting the improved performance during the year.

Pellet Production Adjusted EBITDA of £32 million increased 52% from £21 million in 2018.

Production in the year increased slightly to 1,406kt (2018: 1,351kt), reflecting a full year of operations at the LaSalle pellet plant. This would have been higher but for challenging weather conditions in the first quarter, resulting from unseasonably high rainfall and associated high river levels, which materially restricted output at all three of our pellet plants and caused difficulties in loading ships at the port.

We have made good progress with biomass cost reduction projects in the year, with the average cost per gigajoule of our self-supplied pellets falling to US$161/tonne in 2019 compared to US$166/tonne in the prior year.

Key contributions to this saving came from the benefit of a full year of lower operational costs as a result of the headquarters relocation from Atlanta to Monroe during 2018 and the rail spur project at our LaSalle plant, commissioned in early May 2019, saving transport costs across the rest of 2019 with a positive impact on supply chain emissions. Furthermore, the sawmill co-location project at the same plant has delivered further savings.

The total savings from these projects delivered in 2019 was £14 million, which more than offset the weather impact described above.

Central and other costs of £46 million have increased by £18 million in 2019.

This increase includes incremental research and innovation costs associated with key strategic initiatives – including those relating to Bio-Energy Carbon Capture and Storage (BECCS).

As we described at the half year, and in connection with the integration of the acquired generation assets; we incurred one-off costs implementing a new organisational structure that we believe will enable us to execute our strategy more effectively. Costs associated with delivering working capital initiatives have also increased.

Total Operating Profit

Total operating profit of £62 million has increased 3% from £60 million in 2018. This includes the effect of acquisition and restructuring costs and remeasurement gains and losses on derivative contracts that are excluded from Adjusted results. Our policy and approach to calculating Adjusted results is set out on page 131 of the full PDF report.

Acquisition and restructuring related costs of £9 million (2018: £28 million) reflect the first-year costs of integrating the new generation assets into our existing Generation business, following transaction costs associated with the acquisition last year. The integration is now complete, and in line with our policy no further acquisition and restructuring costs in relation to the acquired assets will be excluded from Adjusted EBITDA in 2020.

Net fair value remeasurement losses on derivative contracts included in operating profit were £131 million (2018: gains of £38 million) reflecting movements in the mark-to-market position on our portfolio of commodity and financial derivative contracts, to the extent they do not qualify for hedge accounting.

The losses in 2019 are predominantly the result of the strengthening of sterling in the period and the resulting impact on the value of our extensive portfolio of foreign currency exchange contracts, which provide a rolling five-year hedge against changes in exchange rates for fuel purchases denominated in foreign currencies.

Profit After Tax and Earnings per Share Adjusted profit after tax of £118 million compares to £42 million for the prior year, resulting in Adjusted earnings per share (EPS) of 30 pence (2018: 10 pence) which represents a 200% increase.

Improvements in Adjusted profit after tax and EPS largely reflect the growth in Adjusted EBITDA described above, although this has been partially offset by higher depreciation charges resulting from the new generation assets, and an increase in interest charges as a result of the new debt issued to part-fund the acquisition, as described in further detail below.

Total profit after tax of £1 million is lower than £20 million for last year, with a corresponding reduction in Total EPS from 5 pence in 2018 to nil pence in 2019.

Total profit after tax reflects exceptional items and certain remeasurements, including the derivative remeasurements and acquisition and restructuring costs described above. In addition, it includes a further £5 million of interest charges relating to the acquisition bridge facility. These costs have been treated as exceptional given the direct link to the acquisition and their one-off nature (2018: £7 million).

The total tax credit of £3 million (2018: £6 million) reflects an effective tax rate that is lower than the standard rate of tax in the UK. This principally reflects the benefit of patent box tax credits in respect of biomass research and development expenditure. Total patent box credits included in the overall tax credit for 2019 are £8 million (2018: £8 million).

Cash taxes paid during the year were £9 million (2018: £1 million).

Capital Expenditure

We maintain a disciplined approach to capital expenditure, with all significant projects subject to appraisal and prioritisation by a Capital Committee prior to approval, overall ensuring adherence to our capital allocation policy and maintenance of an appropriate net leverage profile.

Total capital expenditure of £172 million in 2019 was higher than £114 million in the prior year.

The increase principally reflects additional expenditure in respect of the new generation assets, strategic projects and investments to progress our objective of increasing self-supply of pellets to 5 million tonnes and reduce the cost of pellets.

We have made an initial investment in biomass expansion projects in the Pellet Production business, ahead of full delivery in 2020, in line with our strategy to expand self-supply. We have also continued investment in our gas development projects – our four OCGT sites, a new CCGT at Drax Power Station and the expansion option at Damhead Creek.

Cash and Net Debt

At 31 December 2019, total borrowings were £1,245 million (2018: £608 million) and net debt was £841 million (2018: £319 million).

Following the reinstatement of the Capacity Market in October, we accrued the £78 million of associated income in full; however, the cash payments were not received until after the year end.

After adjusting for the receipt of £72 million of cash in January 2020 in respect of Capacity Market payments, covering the standstill period, this reflects a net debt to EBITDA ratio for 2019 of 1.9x (2018: 1.3x), within our target of less than 2x. Without adjusting year end net debt for this payment our closing net debt to EBITDA ratio was 2.1x.

The increase in borrowings and net debt in 2019 reflects the additional debt drawn to part-fund the acquisition of the new generation assets, for which the cash consideration was settled in January 2019.

Taking this into account, and allowing for a full year of EBITDA from the new generation assets in 2018, this represents a significant deleveraging on a like-for- like basis from a net debt to EBITDA ratio of 3.1x.

On 2 January 2019, the Group drew down £550 million from the £725 million acquisition bridge facility to partially fund the acquisition, with the remainder of the consideration funded from the Group’s cash resources. At inception, the acquisition bridge facility was due to mature in the second half of 2020.

During 2019, we refinanced the acquisition bridge facility in three stages, including two new long-term debt facilities.

On 16 May 2019, we issued an additional US $200 million of the existing 2025 6.625% US dollar loan notes. The proceeds from the issuance were used to repay £150 million of the drawn down acquisition bridge facility. Reflecting the strong investor appetite, the notes were issued at 101.5% of their face value which, when swapped back into sterling, achieved an interest rate of 4.74%.

On 24 July 2019, we entered into two new senior debt facilities agreements, a £375 million private placement with infrastructure lenders with maturities between 2024 and 2029, and a £125 million ESG facility agreement that matures in 2022. The ESG facility includes a mechanism that adjusts the margin based on carbon emissions against an annual benchmark.

Together these new facilities extend the Group’s debt maturity profile beyond 2027 and reduce the Group’s overall cost of debt to below 4%.

A full reconciliation of the Group’s borrowings in the period is provided in note 4.3 to the consolidated financial statements.

The Group continued to generate strong cash from operating activities in 2019, with a total inflow of £413 million in 2019 (2018: £311 million). The increase principally reflects improved profitability, the contribution from newly acquired generation assets and a disciplined approach to working capital, partially offset by increased interest payments on the expanded debt portfolio.

In addition to the improvements in operating performance described above, the Group has a strong focus on cash flow discipline. We also use various methods to manage liquidity through the business’ cash generation cycle.

The Group has access to a £315 million revolving credit facility, which can be used to manage low points in the cash cycle, which expires in 2021. No cash was drawn under this facility at 31 December 2019 (2018: £nil). We actively optimise our working capital position by managing payables, receivables and inventories to ensure that the working capital committed is closely aligned with operational requirements.

The key working capital benefits in 2019, in terms of cash flow, arise from making sales and purchases of ROC assets and rebasing foreign currency exchange contracts.

Historically, cash from ROCs has typically been realised several months after the ROC was earned at the end of the ROC compliance period; however, the Group is able to limit the overall impact of ROCs on working capital by making separate sales and purchases in the compliance period.

For 2019, such transactions generated a net cash inflow of £131 million and supported an overall working capital inflow from ROCs of £54 million. The Group also has access to facilities enabling it to sell ROC trade receivables arising on a non-recourse basis. These facilities were not utilised at 31 December 2019 (2018: £nil).

During 2019 the Group rebased several foreign currency contracts, which resulted in a working capital benefit. The total cash released from related trades still outstanding at the end of the year was £84 million (2018: £3 million) reflected in cash generated from operations. By undertaking a similar exercise on cross-currency swaps, we released a further cash benefit of £23 million (2018: £nil). This has no impact on Adjusted EBITDA, the gains are held on the Group’s balance sheet, until the rebased trades expire.

In addition, the Group has access to a £200 million receivables monetisation facility (extended from £150 million in 2018), which accelerates associated cash flows and mitigates exposure to credit risk, and a number of payment facilities to leverage scale and efficiencies in transaction processing. We also facilitate a supply chain financing scheme, which enables certain suppliers to access payment earlier than contractually agreed payment terms and supports the wider working capital efficiency of the Group. The balances outstanding at 31 December 2019 and change in utilisation in respect of each of these facilities is set out in note 4.4 to the consolidated financial statements.

The overall net cash inflow for the year was £122 million (2018: £66 million), after cash payments for capital expenditure of £171 million (2018: £104 million), dividend payments of £59 million (2018: £53 million), net proceeds from new borrowings of £653 million (2018: net repayment of £5 million) and payments in respect of acquisitions of £692 million (2018: £nil).

Distributions

We have a long-standing capital allocation policy – a commitment to robust financial metrics that underpins our strong credit rating, invest in our core business, pay a sustainable and growing dividend and return surplus capital to shareholders as appropriate.

At the Annual General Meeting on 17 April 2019, shareholders approved payment of a final dividend for the year ended 31 December 2018 of 8.5 pence per share (£34 million). The final dividend was paid on 10 May 2019.

On 23 July 2019, the Board resolved to pay an interim dividend for the six months ended 30 June 2019 of 6.4 pence per share (£25 million), representing 40% of the expected full year dividend. The interim dividend was paid on 11 October 2019.

At the forthcoming Annual General Meeting, on 22 April 2020, the Board will recommend to shareholders that a resolution is passed to approve payment of a final dividend for the year ended 31 December 2019 of 9.5 pence per share (£38 million), payable on or before 10 May 2020. Shares will be marked ex-dividend on 23 April 2020. This brings the total dividend payable for 2019 to £63 million and delivers 13% growth on 2018.

The Group’s £50 million share buy-back scheme, which commenced in April 2018, concluded in January 2019. In total, 13.8 million shares were repurchased and are now held in treasury.

Other Information

New Accounting Standards

The impact of adopting IFRS 16 during the financial year – the new accounting standard for leases – is set out in note 8.3 to the consolidated financial statements. On transition, the Group elected to use the practical expedient available, allowing the standard to only be applied to those contracts identified as leases under the previous standards. As a result, adoption of IFRS 16 has not resulted in any retrospective changes to amounts recognised in the Group’s annual consolidated financial statements for the year ended 31 December 2018.

Adoption of IFRS 16 has resulted in a reduction of operating costs in 2019 of £7.4 million, with the costs of leases now reflected as depreciation and interest charges.

Had the standard been applied in 2018, the equivalent reduction in operating costs for the year ended 31 December 2018 would have been £6.3 million.

Restatement of Comparative Financial Information

The Group consolidated financial statements (see page 133 of the full PDF report), include comparative information for the year ending 31 December 2018.

The 2018 comparatives have been restated, from those originally published, in respect of the following items:

• Finalisation of the opening values of assets and liabilities acquired in respect of the acquisition of the new generation assets on 31 December 2018. During 2019, we concluded a completion statement process and identified adjustments to fixed asset values totalling £4 million. The net effect of these changes was a £5 million increase in consideration payable and a £3 million reduction in goodwill. See note 5.1 to the financial statements.

• Correction of an historical error identified in respect of translation of fixed assets in our US-based business into the consolidated group financial Application of the correct foreign exchange rates resulted in an increase in fixed asset carrying values at 1 January and 31 December 2018 of £34 million and £56 million respectively, with an equivalent amount recognised in the translation reserve. The correction has no impact on previously reported profit or cash amounts.

Andy Skelton
Chief Financial Officer

Remuneration At A Glance

A new Remuneration Policy which aligns with our purpose of enabling a zero carbon, lower cost energy future and rewards sustainable long-term performance

Drax has continued to evolve since the last full review of the Directors’ Remuneration Policy (the policy). The Group has a broader position in the energy market following the biomass conversion programme and the acquisitions in the Customers business and, more recently, in Generation with the successful integration of the hydro, pumped storage and gas assets.

To ensure that our approach to remuneration supports the strategy, the Remuneration Committee has undertaken a full review of the policy, taking into account the Group’s strategy, shareholder feedback and the new provisions in the Corporate Governance Code.

Our principal aims are to ensure that executive pay is closely linked to Group performance, underpins our purpose of enabling a zero-carbon, lower cost energy future; better aligns reward with delivering the strategy; incorporates targets that reflect the Group’s progress, and are relevant and transparent for the wider workforce and our shareholders.

The proposed new policy is designed to support delivery of our core business against a smaller number of stretching annual financial, operational and strategic targets, rewarding the delivery of growth, innovation and sustainability over the long term.

The proposed new remuneration structure is simplified, with annual bonus payments linked to these goals – a decision informed by engagement with shareholders.

In the long-term incentive, Total Shareholder Return (TSR) will be retained but the Group scorecard will be replaced with cumulative adjusted EPS. We feel this change will help to drive further shareholder value over the medium to longer term.

Attracting and retaining the right talent capable of delivering high quality business performance and growth is critical in achieving our strategy.

We believe the new long-term incentive, focused on rewarding stretching performance, and with extended holding requirements will enable this.

I have met a number of our major shareholders and have incorporated their feedback. I welcome further feedback on the proposed policy.

Decarbonisation, electrification and flexibility

Globally the energy market in 2019 was marked by geopolitical tension, commodity prices which varied within a relatively stable range and, most importantly, rising awareness of climate change and its implications. The UK energy market is increasingly shaped by three major trends: the pace of decarbonisation of the sector is increasing; the need for electrification and more electricity is growing as the heat and transport sectors decarbonise; and the need for flexible sources of power is greater than ever.

Decarbonisation – In July 2019 the UK Government passed legislation requiring the UK economy to be net zero carbon by 2050. Tackling climate change is high in the public consciousness and widespread engagement and activism suggests that the UK public increasingly expects the Government and industry to work together to provide solutions. To date the power sector has led the way in the UK’s efforts to decarbonise, and we believe it will have an even greater role in helping to realise net zero. In fact, to hit net zero by 2050, including the hard to decarbonise sectors such as aviation and agriculture, we envisage that the power sector will have to contribute negative emissions to the overall carbon balance.

Electrification – Decarbonisation on the scale outlined above is likely to require an absolute increase in the amount of electricity produced and consumed due to the electrification of heating and transport.

The UK Government has signalled a commitment to end diesel and petrol car sales by the middle of the next decade, which is expected to increase the number of electric vehicles on the road and further add to the demand for electrification. Furthermore, a report from the Energy Transitions Commission (November 2018) estimated that electricity’s contribution to global energy supply must rise from 20% to 60% by 2060.

Flexibility – Renewable power generation, driven by wind and solar, is increasing and is expected to provide over 80% of power by 2050. Delivered by smaller, more widely distributed, sources of generation this will mean the UK power grid will need to manage more volatility, and energy customers will increasingly need more control over the way they use or generate their own energy. The need for more flexible generation was thrown into sharp relief by the power supply issues on 9 August 2019 which saw over one million people go without power when 1.9GW of power failed in a short period of time.

On the next page we explore three aspects of Drax’s response to changes in the energy market in more detail.

Towards a net zero carbon future

Hitting net zero and limiting average temperature rises to less than 1.5 degrees Celsius will require huge investment.

1. Meeting the net zero by 2050 target

The precise path to achieve this goal is not yet certain for all sectors but it is becoming increasingly clear that carbon removal technologies and negative emissions will have a significant role to play. Organisations such as the International Panel on Climate Change and the UK’s Committee on Climate Change agree that carbon capture technologies, in particular those which could lead to the removal of carbon from the atmosphere, will be important.

Our response

In 2019 Drax produced 13.7 TWh of renewable power and we have reduced our carbon footprint by over 85% since 2012. Coal accounted for only 4% of Drax’s generation in 2019. In December 2019 we announced an ambition to become a carbon negative company by 2030. This means by 2030 Drax would be removing more carbon dioxide from the atmosphere than we are emitting.

2. Evolving mix of generation

The use of intermittent renewables, such as wind and solar, continues to increase. Flexible, thermal generation, such as coal and older gas plant generation continues to decline. This places additional pressure to balance the energy system. More distributed generation and the increase in intermittent renewables are driving increased levels of volatility in short-term prices and a need for assets to provide system support services. There is an increasing need for flexible sources of power which can provide services such as response, reserve, reactive power, black start and inertia.

Our response

Drax’s portfolio of flexible generation assets (biomass, hydro and gas) provide these increasingly important balancing services. Drax now has generation assets with a capacity of 6.5GW distributed across Scotland, northern and south east England, and options to develop generation assets in Wales and the East of England.

Drax saw a 63% increase in the value derived from flexibility in 2019 compared to 2018.

3. Changing customer behaviours and expectations

The business-to-business energy market is highly competitive and customers demand access to both low cost and renewable power. Customers want more control of their energy in order to manage both cost and their environmental impact. Energy suppliers therefore need to provide the services which customers need. Our business customers increasingly seek to create value from their portfolios through the installation of their own generation capabilities, the provision of demand side response and energy trading.

Our response

Drax is now the third largest supplier of energy to businesses and supplies more of its customers with 100% renewable power than any of its competitors.

Our investment in digital technologies is providing new opportunities, a reduced cost to serve and an enhanced customer experience.

In 2019 Drax launched a partnership with SES Water to provide an end-to-end electric vehicle offer, and a new partnership with Eaton allowed Drax to install batteries as an energy service on our customers’ property. Services like this mean Drax can open up power and flexibility markets to more of our customers and ultimately generate value for both us and our customers through our trading expertise.

See more online at www.drax.com/uk and more details about trends in the electricity sector at www.electricinsights.co.uk

Working with our stakeholders

Engaging with our stakeholders is fundamental to our success. We recognise that we need to listen to, and work with, a diverse range of interested parties to achieve our purpose: to enable a zero carbon, lower cost energy future. In this section, we explain how we have identified our stakeholders and engaged with them to inform the way we operated our business in 2019.

Stakeholder relations

High quality engagement with the full breadth of our stakeholders is key to well-informed decision-making that pays appropriate regard to stakeholder views.

Drax has a wide range of stakeholders and takes care to ensure that the Group, and the Board, has an effective strategy to identify and engage with those stakeholders.

We have a comprehensive stakeholder engagement strategy. This is detailed in the Communications Strategy, which is presented to the Board at least annually and sets out our stakeholders and provides oversight of how the Group intends to engage with them.

Engagement with stakeholders informs both our day-to-day decision making, that ensures the smooth running of the business, and the strategic decisions which help set our direction for the years and decades to come.

Drax employs dedicated teams to engage both proactively and reactively with particular stakeholder groups.

This includes a stakeholder relations team, an investor relations team, an internal relations team, a sustainable business team, a business ethics team, a media relations team and a digital engagement team.

Methods of engagement with stakeholders vary according to the issue at hand and the stakeholder concerned. The table on page 25 of the full PDF report sets out the broad stakeholder groups that we identified and engaged with during 2019. It also highlights why we engaged, how we engaged and the areas of focus.

Companies Act, Section 172 Statement

Meaningful engagement with all our stakeholder groups supports our obligations under Section 172 of the Companies Act 2006.

On pages 24 to 29 of the full PDF report we set out how the Board, and the Group more widely, has had regard to stakeholder interests when discharging its duty to promote the success of the Company.

On pages 49 and 50 of the full PDF report we explain how we seek to maintain our high standards of business conduct.

Understanding the needs of our various stakeholders is essential to our long-term success

Engagement takes place at many levels of the business and a judgement about whether Board engagement, Executive Committee engagement, senior management or working level engagement is required is made on a case by case basis. The Group Head of Public Affairs maintains a detailed map of key stakeholders, the concerns they have raised and the date of the last meeting.

Management keeps under review the relevant stakeholders who may be affected by major decisions.

To ensure clear feedback to the Board, the CEO regularly reports to the Board on key stakeholder relations activity, current issues and the relevant feedback received from interaction with stakeholders. This is supported by the Group Director of Corporate Affairs, the Corporate Affairs team and the relevant owners of direct stakeholder engagement.

Supporting the Board’s duty to promote the success of the Company, as set out in Section 172 of the Companies Act 2006, Board and Executive Committee discussions include information on stakeholders likely to be affected by items under discussion and the potential impact. This ensures that the interests of all relevant stakeholders are considered in decision-making.

The Group Director of Corporate Affairs and the Group External Affairs Director presented a detailed report on stakeholder engagement in July 2019, to both the Board and the Executive Committee. This included the Board’s response to the 42% vote against the political donations resolution at the 2019 AGM and the development of a new policy for political expenditure. You can read more about this on page 27 of the full PDF report.

In 2019, we developed a new Remuneration Policy. Nicola Hodson, the Remuneration Committee Chair, led the engagement with our shareholders, to gain their feedback on the proposed Policy. You can read more about the new Policy in the Directors’ Remuneration Report on page 86 of the full PDF report.

As part of his induction, John Baxter visited 12 Drax sites in 2019, meeting with local management to discuss the business, in particular health and safety and plant management.

On appointment as Senior Independent Director in April 2019, David Nussbaum wrote to our largest shareholders to confirm his availability to meet with them. David also attended the Group’s Capital Markets Day in November 2019 and met with a variety of investors.

Communities and local authorities

Why?

Drax is an active participant in the communities in which it operates. Good community relationships strengthen our licence to operate in those areas.

How?

We engage regularly with the communities around our businesses through supporting local initiatives, holding quarterly meetings and formal drop in sessions. For example, we invested £100,000 to support local initiatives via the Galloway Glens Landscape Partnership.

Areas of focus

Jobs and employment, local environmental impact, community initiatives and sponsorship.

Customers

Why?

Engagement allows us to better understand our customers’ needs and how we can deliver continuous improvement in customer service.

How?

Our Customers business engages with our customers through channels including social media, our website, by phone and through our complaints procedure

Areas of focus

Energy costs, customer service support, Third Party Intermediary relationships, sales and product details, energy efficiency, carbon footprint.

Government and political bodies

Why?

Constructive engagement with Government is key to Drax’s purpose to enable a zero carbon lower cost energy future

How?

We regularly engage with regulators in the UK, EU and US on a broad range of topics including the need for decarbonisation, the role of biomass and carbon capture and storage policy. For example, engagement with political stakeholders at Party Conferences through All-Party groups

Areas of focus

Energy costs, Decarbonisation and Carbon Price Support, nationalisation risks, Impact of Brexit, Capacity Market, decarbonisation, climate change mitigation, biomass sustainability, Station ROC cap, development of policy to support BECCS, delivery of UN Climate Change Conference (COP26), unabated coal closure

Biomass Cost Reduction

Building a long-term future for sustainable biomass is a key strategic objective for Drax.

The key to delivering this objective is reducing the cost of wood pellets to a level where biomass generation is economic without subsidy.

Current biomass generation at Drax Power Station is supported under two separate schemes. Three biomass units receive support under the Renewable Obligation scheme and one unit receives support under the Contract for Difference scheme. The support under both these mechanisms ends on 31 March 2027. Today, without these schemes, it is uneconomic to produce renewable electricity from biomass.

The Group’s objective is to reduce the cost of biomass by about 30% by 2027 – from around £75/MWh in 2019 to around £50/MWh. We believe that delivering this reduction will establish an economic model for unsubsidised biomass generation beyond 2027.

How will we do this?

Optimise existing capacity and generation

Drax currently uses around seven million tonnes of biomass, 1.4 million tonnes of which are self-supplied by our operations in the US Gulf.

As Drax’s pellet production business is relatively immature – its first assets were commissioned in 2015 – there are significant opportunities to optimise, improve processes and drive greater efficiencies.

Current initiatives:

A co-location agreement with sawmill operator Hunt Forest Products next to the LaSalle pellet plant began production in February 2019 and provides:

• Low-cost sawmill residues
• Reduced transportation costs
• Reduced As sawmill residues are a semi-processed material, we can reduce the number of steps in the production process, eliminating chipping, drying and debarking

A rail spur linking LaSalle to the regional rail network and our port facility at Baton Rouge was commissioned in May 2019. This increases transportation efficiency, economies of scale, reduces cost and carbon footprint.

Development of an enlarged chambering yard at the port of Baton Rouge, by the regional rail operator.

• Economies of scale in rail allowing 80-car train sets to operate from our LaSalle and Morehouse sites (previously 45-car train sets)

These initiatives and others have contributed to a 3% year-on-year reduction in cost per tonne, which represents a saving of $5 per tonne compared to 2018.

The larger projects will be accompanied by small projects to improve operational efficiency such as greater efficiency in the loading of road haulage, which saves 50 cents per tonne. Over time these improvements, when applied across the supply chain, have the potential to deliver significant incremental savings.

System Stability

How can we be the leading provider of system stability?

What’s the issue?

Keeping the lights on requires not just electricity generation, but also a range of non-generation activities which help provide stability, flexibility and reliability. These system support services include:

Inertia

The stored energy in synchronous generators which slow down the rate of changes in system frequency,

Voltage control/Reactive Power

(MVars) – Reactive power is used to manage power flows around the transmission system and helps to support voltage in the event of a system fault.

Reserve

The system operator must be able to ensure a balance between demand and generation at all times to prevent power cuts at times of peak demand. This increased and decreased generation is sometimes referred to as headroom and footroom respectively. Managing demand can also be used to the same effect.

Response

The automatic change in generation output, or in demand, to maintain a system frequency of 50Hz. This frequency response is required every second of the day.

Black Start

The ability of a generation unit to start up without external electricity supplies following a total or partial loss of power from the transmission system.

Giving customers control of their energy

There’s widespread recognition among leading science-based organisations, such as the UN’s Intergovernmental Panel on Climate Change, that sustainable biomass has a vital role to play in meeting climate targets. Sustainable biomass has three big benefits: it generates renewable electricity, supports forest growth and is a route to negative emissions using BECCS. At Drax, replacing coal with biomass to generate power has already delivered carbon savings of more than 80% since 2012.

Generation of electricity using biomass functions as a closed loop carbon system. When trees grow, they absorb carbon dioxide. Emissions from using biomass to generate electricity are balanced by the absorption of CO2 from the forests that are growing. This differs from burning coal where the emissions remain in the atmosphere.

It’s important to remember that the carbon benefits are only realised if the biomass is sustainable. There are many criteria for sustainable biomass, including taking wood from managed forests – those that are replanted after harvesting, not causing deforestation, or cutting old-growth forests or harvesting wood from protected areas.

Forests are managed for multiple objectives, including biodiversity, water management and timber production. The main timber product from a forest is saw logs. These large, high-value logs produce wood products for construction or furniture, ending up as long-term carbon storage. Around half of a saw log going into a sawmill comes out as sawdust.

In some parts of the world, that is simply burned or ends up in a landfill. Almost 40% of our wood pellet feedstock is, in fact, those sawmill residues. Of the rest, around 30% is thinnings, branches, tops and bark and 30% low-grade roundwood.

Around a fifth of the material we use to make pellets is thinnings, where trees are taken out at various intervals to allow the remaining trees to grow bigger. Thinning also stops pests, diseases and fire from ripping through the forests and supports biodiversity. Providing a market for these thinnings helps these forests thrive.

How do you know that the wood Drax uses is sustainable?

Everything we do is independently audited and we abide by all the current requirements for sustainable biomass.

The UK and EU have robust regulatory frameworks for sustainable biomass. Drax’s requirements on biomass sustainability exceed these rules. We also use external certification through the Sustainable Biomass Program (SBP), which sets a standard that is audited by independent third-party auditors.

It’s also about choosing the right feedstocks in the first place – something we’re committed to ensuring.

Achieving a positive long-term economic, social and environmental impact together.

At Drax, being a sustainable business means achieving a positive long-term economic, social and environmental impact as part of the Company strategy.

We have identified non- financial priorities that are material to our business and important to our stakeholders. Our 2019 progress and performance are reported under each priority area as follows:

Environment

Carbon Emissions

Drax has a significant role to play in the transition to a low-carbon economy and this informs our purpose to enable a zero carbon, lower cost energy future. We are committed to supporting the UK government to achieve net zero carbon emissions by 2050.

Managing Climate Change Risks and Opportunities

We are committed to the identification, management and disclosure of our climate change risks and opportunities in line with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD).

In 2019, we responded to the CDP Climate questionnaire and received a score of C. We introduced climate change as a new principal risk category (see Principal Risks and Uncertainties on page 54 of the full PDF report).

Our Negative Emissions Ambition

At the UN Climate Change Conference COP 25 in December 2019, Drax announced our ambition to become carbon negative by 2030. We have signed up to the Science Based Targets initiative to further assure that our target is aligned with climate science.

Using technologies such as Bioenergy with Carbon Capture and Storage (BECCS), Drax aims to remove more carbon dioxide from the atmosphere than it produces, creating a negative carbon footprint for the Group. Our leading ambition is only achievable with an effective negative emissions policy and investment framework for technologies such as BECCS.

Innovating to Decarbonise our Business

Carbon capture and utilisation is part of our business strategy and we made progress on this work in 2019.

Drax has set up a Bioenergy Carbon Capture and Storage (BECCS) demonstration pilot at Drax Power Station with C-Capture, a start-up from the University of Leeds. We also secured funding from the UK Government to explore the feasibility of building a second carbon capture pilot at Drax Power Station, using molten carbonate fuel cells as a technology for capturing carbon dioxide.

Social

In 2019, we enhanced our due diligence process, which assesses for risks associated with financial crime, conflicts of interest, anti-competitive behaviour, trade sanctions and other improprieties, such as modern slavery. We centralised these across the business.

Anti-bribery and Anti-corruption

Our internal processes ensure consistency with our zero-tolerance approach to bribery and corruption. Geographic risk is factored into our third-party due diligence system. Conducting business in higher risk countries must receive prior approval from the Group Ethics and Business Conduct Committee.

Following country approval, third parties are then put forward for our due diligence process. Suppliers in higher risk countries receive a higher level of initial due diligence and ongoing monitoring.

We also screen the affiliates (directors, shareholders) of these suppliers and refresh their information on a more frequent basis, compared to our lower risk suppliers. Third parties with operations in, or linked to, higher risk countries are escalated to the EBCC for review prior to engagement. Ongoing monitoring is performed with new information provided to the Group Ethics and Business Conduct Committee, as appropriate.