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UK EU exit vote prompts biomass market uncertainty

24 Jun 2016 18:40 (+01:00 GMT)
UK EU exit vote prompts biomass market uncertainty

London, 24 June (Argus) — The EU is likely to continue a state aid investigation into the contract for difference (CFD) subsidy that the UK government awarded to generator Drax for its unit 1 coal-to-biomass conversion regardless of the UK's vote to leave the EU following a referendum yesterday.

"EU law continues to apply to the full to and in the UK until it is no longer a member," the European Parliament, European Council, Council of the EU and the European Commission said today. A transition period means there will be little immediate difference to the market, traders said.

The investigation is too advanced for UK energy ministry Decc to be likely to go against any EU pronouncement on the investigation, one UK-based trader said.

Exchange rate volatility immediately following the result is expected to be short-lived as the market reacts and then rebalances. The pound fell sharply against the dollar following the vote, but the euro has also weakened. Baltic and other European wood pellets will continue to be cheaper than US supply, one Baltic producer said.

In contrast to UK power prices and subsidies, most long-term contracts for biomass supply to the UK are not priced in pounds. Drax, the UK's largest wood pellet consumer, said in February that it has a hedging strategy to sell the forward biomass-fired spark spread — the so-called ‘bark spread' — where it is economic to do so. The company also announced unrealised gains of £124mn ($171mn) in 2015, principally related to its foreign currency hedging programme to support biomass procurement. Drax had no comment to make on the results of the referendum.

US firm Enviva's 15-year contract to supply UK company MGT Power with 1mn t/yr of wood pellets from 2019 is priced in pounds. But the pricing "adequately compensates" for the currency risk, Enviva said in February. And 20pc of Enviva's 800,000 t/yr contract to supply wood pellets to Czech energy firm EPH for its 420MW Lynemouth power plant in the UK is denominated in pounds. The economic effects of the UK leaving the EU, including potential currency moves, would be "a long-term, open issue", Enviva chief executive John Keppler said last month.

Most market participants anticipate that the UK will maintain its current renewable energy goals. But there is debate about whether the UK will continue to be bound by the EU greenhouse gas (GHG) reduction targets for 2030. One way for the UK to justify its position outside the EU would be to be greener than others, one UK trader argued. Others were less optimistic. The future attitude towards renewables will be "very important" to the market, one Portuguese trader said. And others argued that the potential for an economic downturn would dictate the UK's renewables policy going forward.

In the medium-to-long term, the subsidies on which the UK biomass market relies could be at risk, a trader said. Although such a move would not be immediate, "if economics start to bite, Decc will look for savings, and one of the first savings they might make is renewable subsidies", he said.

Enviva does not anticipate its existing contracts with UK utilities to be affected as they are "fundamentally independent from the broader EU Brexit", Keppler said last month.

But most long-term contracts include a clause whereby they are subject to government regulations, a market participant said, which could potentially render them void if the regulatory landscape changed to such a degree that biomass-fired generation in the UK is no longer viable.

"If the UK does pull back on subsidies, many smaller suppliers will go bust," he said, adding that the market was already contending with considerable oversupply.

The prevailing atmosphere of uncertainty could dampen prospects for future investment in UK biomass projects, some traders said, particularly from firms based elsewhere.