Drax feels the heat of rising carbon prices

It is impossible to miss - the giant Drax coal-fired power station that straddles the A1 near Ferrybridge in Yorkshire and dominates the landscape for miles around is the largest in Western Europe and supplies about 7 per cent of the UK’s electricity. Of course generating electricity from coal necessitates plenty of carbon emissions - figures show that every six months Drax creates nearly 10 million tonnes of CO2 and, under the terms of the EU’s carbon trading scheme, it must not only pay for coal but also purchase emission allowances.

It has just announced that the combined cost of coal and CO2 permits has nearly doubled over the last year from £222m to £413m.

Drax was given fewer ‘free’ emissions allowances this year and it has had to go to the carbon market and purchase permits to emit 6.5m tonnes of CO2, compared with just 3.6m tonnes last year. At the same time the market price of carbon has risen from £3 to £16.50.

Putting a price on carbon is a market-based strategy designed to change the incentives for polluting businesses. If carbon trading works, it ought to provide - over time - an incentive for polluters to invest in more pollution efficient production processes and technology.

There is some evidence that Drax is rising to the challenge - in recent months the business says that it has refitted turbines to make its generators more efficient and also taken steps to increase its ‘co-firing capacity’ a process that allows the power station to burning organic matter such as pellets made from straw to create power in alliance with coal. Their capital investment programme is scheduled to be worth over £40m this year.

For Drax the key to operating a profitable power station is to charge a higher price to its customers than the cost of generating the electricity. Their half year financial statement offers a window on the challenges facing the business. In the six months to the end of June 2008 the figures were as follows:

Average achieved price charged to electricity buyers = £53.6p per mega watt (11% higher than at the same time last year) Average fuel cost (excl. CO2 allowances) = £23.6/MWh (34% higher than at the same time last year) Average fuel cost (incl. CO2 allowances) = £31.8/MWh (72% higher than at the same time last year)

Unit costs have risen much more quickly than the final output price leading to a reduction in operating profits. Drax has been hit hard by the surging price of coal on world markets - a tonne of coal was selling for $218 in June 2008 - driven higher by the inability of countries such as South Africa to expand production sufficiently quickly to meet strong demand from China, India and many other emerging market countries.