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Drax Reports Acquisition Deal Amended To Mitigate Risk To 2019 Capacity Payments

Drax Group plc. (DRX.L) said that it has reached agreement with Iberdrola on revised terms for the acquisition of Scottish Power's portfolio of pumped storage, hydro and gas-fired generation at the previously agreed price of 702 million pounds in cash, subject to Drax shareholder approval.

The revised contractual arrangements are designed to mitigate the risk to 2019 capacity payments arising from the recent suspension of the Capacity Market.
On 15 November 2018, the General Court of the European Union issued a ruling annulling the European Commission's 2014 decision not to undertake a more detailed investigation of the UK Government's scheme establishing the Capacity Market.

The Ruling imposed a "standstill period" while the European Commission completes a further state aid investigation into the Capacity Market. Payments to generators scheduled under existing capacity agreements and the holding of future capacity auctions have been suspended.

Contracted capacity payments make up a significant proportion of the earnings of the Portfolio. For the period from 1 January 2019 to 30 September 2022, the Cruachan pumped storage hydro asset has contracted capacity payments of £29 million, the Galloway run-of-river hydro assets have contracted capacity payments of £5m million, and the Combined Cycle Gas Turbine assets have contracted capacity payments of £122 million in aggregate.

Drax believes that the most likely outcome is that the European Commission will re-approve the existing Capacity Market in its current or a broadly similar form.

Drax and Iberdrola have agreed a risk sharing mechanism in respect of capacity payments for the period 1 January 2019 to 30 September 2019, worth 36 million pounds. If less than 100% of these payments are received and the gross profit of the Portfolio for the full year 2019 is lower than expected, Drax will receive a payment from Iberdrola of up to 26 million pounds. The mechanism also gives Iberdrola the opportunity to earn an upside of up to 26 million pounds if less than 100% of these payments are received but the Portfolio performs better than expected in 2019.

Under these arrangements, if less than 100% of these capacity payments are received: Iberdrola will make a payment to Drax if the 2019 Gross Profit is less than 155 million pounds. The payment will be an amount equal to 72% of any shortfall in the 2019 Gross Profit below 155 million pounds. The amount of the payment is capped at the lower of the amount in respect of capacity payments due to the Portfolio but not received and 26 million pounds; and

Drax will make a payment to Iberdrola if the 2019 Gross Profit is more than 165 million pounds. The payment will be an amount equal to 72% of any amount by which the 2019 Gross Profit exceeds 165 million pounds. The amount of the payment is capped at the lower of the amount in respect of capacity payments due to the Portfolio but not received by Drax and 26 million pounds.

If subsequently Drax receives any capacity payments in respect of the period 1 January 2019 to 30 September 2019, Drax will pay 72% of those amounts to Iberdrola capped at the amount paid by Iberdrola to Drax under the mechanism.

The Portfolio is expected to generate EBITDA in 2019 in a range of 90 million pounds to 110 million pounds, from gross profits of 155 million pounds to 175 million pounds, of which around two thirds is expected to come from non-commodity market sources, including system support services, capacity payments, ROCs and the Daldowie energy-from-waste plant.

If, in light of the Ruling, the contracted capacity payments payable in 2019 in respect of the Portfolio are not received or accrued in 2019, the expected EBITDA for the Portfolio in 2019 would be reduced by up to 47 million pounds (from a range of 90 million pounds to 110 million pounds) down to a range of 43 million pounds to 63 million pounds before considering mitigating factors.

Drax believes that the arrangements agreed with Iberdrola mitigate in economic terms the majority of the risk that those suspended capacity payments will not be paid.

Assuming performance in line with current expectations and if all capacity payments due in 2019 are received before the end of 2019, net debt to EBITDA is expected to fall to Drax's long-term target of around 2x by the end of 2019. If capacity payments are not received in 2019, net debt to EBITDA is expected to fall to around 2x during 2020.

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