Ofgem only giving Drax Group (LSE:DRX) a slapped wrist and a moderate fine removes an "overhang" weighing on the company's shares and should help the company in its quest to secure a bridging mechanism contract with the UK government, according to analysts.
The UK energy watchdog closed its investigation today, confirming that it didn't find any evidence that the wood sourced by the FTSE 250 company for its biomass burners is not sustainable or that renewable obligations certificates (ROC) were incorrectly issued.
A £25 million redress payment was significantly less than the circa-£150 million of market cap lost when the investigation was announced, said Morgan Stanley (NYSE:MS).
This "should have a positive read-across to the process of Drax potentially securing a bridging mechanism contract with the UK government", said analysts at Jefferies.
Earlier this year, the company carried out a short-term refinancing as it awaited news from the government on its £2 billion plans for bioenergy with carbon capture and storage (BECC), having gained approval to retrofit the wood chip-burning plant in January but with the government remaining schtum over whether it will provide partial funding.
"We believe the closing of this investigation could open the door to an imminent outcome of the bridging consultation," Morgan Stanley (NYSE:MS) analysts said, though they believe clarity around the financial terms will be required for the shares to get the benefit.
Ofgem did find that the company had misreported information about its timber supplied from Canada, with the Yorkshire power company also unable to provide the regulator with satisfactory evidence to show how it had arrived at the figures.
The regulator said it considered these issues essentially to be technical in nature and demanded Drax to make a payment of £25 million to its voluntary redress fund, as well as enforcing improved reporting and audit procedures for wood supply.
Analysts at RBC said the closing of the investigation is a "clear positive for Drax, removing an overhang on the stock which was ongoing since the investigation was announced".
The RBC analysts argued that the announcement "confirms no issues with biomass sustainability" - although this refers to Ofgem's statement that Drax was not found to have fallen short of the government's threshold that a minimum of 70% of biomass must come from sustainable sources in order to receive ROC scheme funding.
RBC said this was "clearly important as Drax continues its discussions with the government around the bridging mechanism" and the regulator's conclusion "aligns with Drax's previous communications that this issue was isolated to profiling with Ofgem findings specific to Canada".
Furthermore, the analysts noted that reporting issues in the period when Drax acquired Pinnacle Renewable Energy – a major producer and supplier of good quality, compressed bioenergy pellets – with no issues found in the following periods, which showed the improvements made by Drax in the process since the acquisition.
Analysts reported that Drax said the £25 million penalty will be booked in EBITDA this year, noting that this was around 1% of the company's current market cap.
The company is also said to remain "comfortable" with the consensus forecast EBITDA of around £995 million for full-year 2024.