Inside Drax Drax Group plc Annual report and accounts 2011 2011 Welcome to Drax Drax is predominantly a power generation business responsible Drax is so much more for meeting some 7% of the UK’s electricity demand. Currently owning than the UK’s largest, and operating the largest power station in the UK, we are committed to reducing our carbon footprint. cleanest and most Through the progressive expansion of the use of sustainable biomass, as a replacement for coal, we aim efficient coal-fired to provide a low carbon, low cost and reliable power generation business power station... well into the future. At the other end of the supply chain, through our retail arm, Haven Power, we serve the needs of over 40,000 We are focused on business sites. Our intention is to grow a significant retail business providing us with a valuable alternative maximising value and to trading through the wholesale achieving our vision electricity market. of becoming a bold, customer oriented power generation and retail business, driven by biomass innovation. 01 Drax Group plc Annual report and accounts 2011 Contents 02 Chairman’s introduction 01—49 04 Maximising the value of the Business review Drax business 06 Delivering results 08 Chief Executive’s statement Business review 16 Principal performance indicators 18 Marketplace 22 Operational and financial performance 32 Principal risks and uncertainties 36 Corporate and social responsibility 50 Corporate governance 50—80 62 Audit Committee report Governance 65 Nominations Committee report 66 Remuneration Committee report e vernanc Go 81 Group – 81—128 Independent auditor’s report Financials 82 Consolidated income statement 83 Consolidated statement of comprehensive income 84 Consolidated balance sheet 85 Consolidated statement of changes in equity 86 Consolidated cash flow statement 87 Notes to the consolidated financial s statements ial nanc 116 Company – Fi Our business Independent auditor’s report We operate both a generation and a retail business 117 Company balance sheet in the UK electricity market. This report gives a detailed account of our operations during 2011. 118 Notes to the Company balance sheet More on: 07 Our key priorities 122 Shareholder information More on: 36 49 Corporate and social responsibility 127 Glossary 02 Drax Group plc Annual report and accounts 2011 Chairman’s introduction During 2011, we delivered strong operational performance across the business. Although we experienced a good deal of uncertainty in the power-related commodity markets, I am pleased to report earnings (EBITDA) for 2011 of £334 million (2010: £392 million) and an operating profit of £366 million (2010: £279 million). In accordance with our dividend policy, the Board proposes a final dividend in respect of 2011 of 11.8 pence per share, equivalent to £43 million. This would give a total dividend for the year of 27.8 pence per share (2010: 32.0 pence per share). We continue to make progress in reducing our carbon footprint, something which is now well embedded in and central to our business strategy. In just a matter of weeks we will embark on the last stage of the largest steam turbine modernisation programme in UK history, which brings with it a carbon dioxide emissions saving of one million tonnes a year. Haven Power Limited, our electricity retail company serving business customers, made good progress implementing its IT business platform which is critical to realising its growth ambitions. We are delighted with the growth achieved in 2011 and the real value that the Group is now deriving from the company’s success. It complements well our existing trading capabilities and provides a credit efficient, direct sales channel for an increasing proportion of our power. Electricity generation from sustainable biomass remains our focus and we continue to believe that this technology has considerable potential and an important role as a low carbon, cost effective, reliable and flexible source of renewable power for the UK. I am delighted to say that our view is being echoed by those in Government and elsewhere, which is encouraging. We have continued to work with the Government throughout the year to advance the case for sustainable biomass and secure an appropriate level of support. We have welcomed the dialogue that we have been afforded and appreciate the extensive work undertaken by the Government on the biomass agenda. Earnings demonstrate good The UK’s largest ever steam business performance despite turbine modernisation programme uncertainty in the power-related nearing completion commodity markets £334m * Profit before interest, tax, depreciation, amortisation, Earnings (EBITDA)* gains and losses on disposal of property, plant and equipment 2010: £392m and unrealised gains and losses on derivative contracts 03 Drax Group plc Annual report and accounts 2011 We have enhanced our technical and commercial expertise in the emerging biomass energy sector and we are ready to increase greatly our electricity generation from sustainable biomass. However, we will only do so if the regulatory regime, including the economics of the support offered, is attractive Business review for our shareholders. On more governance-related matters and in line with the guidance given in the UK Corporate Governance Code (the “Code”), I should like to comment on how the principles relating to the role and effectiveness of the Board have been applied. There is a clear division of responsibilities between myself as Chairman and our Chief Executive, Dorothy Thompson. We have a clear statement on which matters are reserved for the Board and those which are delegated, and these are reviewed at least annually. Our non-executive directors play a major role in challenging constructively the Group’s management, particularly on matters of strategy and its development. In recent years through our formal, rigorous and transparent selection process, we have endeavoured to ensure that those ce appointed to the Board have complementary skills, experience n a and knowledge in order to improve the quality of the Board and rn e its decision making. Following publication of the Davies Report, v Women on Boards, in February 2011, the Board considered the Go recommendations of both the Davies Report and the Financial Reporting Council consultation on possible changes to the Code. Consequently, we established a policy to ensure that gender diversity is one of the factors taken into account when considering future appointments to the Board and other senior appointments. Details of the Board, its function, performance and effectiveness can be found in the Corporate governance section of this report. Throughout the business I believe we have made significant progress during 2011 and my sincere thanks go to all Group staff for their hard work and commitment, without which none of this yeyear’sar s achievements would have been possible. Charles Berry Chairman s l 20 February 2012 a i c n a n Haven Power has made good Electricity generation from Staff continue to underpin i F progress, implementing its sustainable biomass remains the Group’s achievements IT business platform for growth a key focus for the business 04 Drax Group plc Annual report and accounts 2011 Maximising the value of the Drax business Our business model Our overriding objective is to maximise the value of the Drax business whilst increasing our electricity generation from biomass, and so reducing our carbon footprint, subject to the availability of appropriate levels of regulatory support. Our profitability is determined by both the difference between the price at which we sell our power and the cost of coal and carbon, known as the “dark green spread”, and increasingly by the “bark spread” for co-firing, which is the difference between power price and renewable support and the cost of biomass. From this starting point there are several steps in the Drax value chain, with each one adding incremental value to the business and ultimately maximising the value of our business and delivering our gross margin. 1 Fuel We now make use of a range of fuels, including coal, Key facts for 2011 biomass and others which are economically advantageous. k 9.1 million tonnes of coal burnt 2 How we maximise value k 1.3 million tonnes For the last nine years we have burnt biomass in place of of biomass burnt some of our coal, when economic to do so. Beyond biomass, k 0.7 million tonnes we also have the ability to burn other fuels, such as petcoke of economically advantageous and pond fines, which can be economically advantageous. fuels burnt By diversifying our fuel sources, not only are we less reliant on a single fuel type, but we are able to capture value from commodity market cycles, and in the case of biomass avoid the cost of carbon. 2 Trading Through keeping a constant eye on the commodity Key facts for 2011 markets within which we operate we are able to optimise k 26.4TWh net the commercial despatch of our power. sales of power k 11.9 million tonnes How we maximise value of CO2 emissions As the largest power station in the UK we are able to utilise allowances purchased economies of scale through, for example, procuring fuel at k 1.2 million competitive prices. Our trading strategy to hedge our power Renewables sales with coal and carbon purchases enables us to lock in Obligation value in the near, short and long term. We are always looking Certificates sold to increase the trading options available to us, for example, for renewable power generated through our retail business. We benefit from having a physical asset to trade around and through a seamless interface with the operations side of the business we derive value from the 1 operational characteristics of the power station, such as high availability and flexibility, enabling us to extract value even when market conditions are poor.