|• FORM 20-F • AMENDED AND RESTATED TRUST DEED DATED 22 FEBRUARY 2012 • AMENDED AND RESTATED TRUST DEED DATED 21 DECEMBER 2011 • AMENDED AND RESTATED TRUST DEED DATED 2 AUGUST 2011 • LETTER OF APPOINTMENT - SIR PETER GERSHON • LETTER OF APPOINTMENT - PAUL GOLBY • LETTER OF APPOINTMENT - RUTH KELLY • LIST OF SUBSIDIARIES • CERTIFICATION OF STEVE HOLLIDAY PURSUANT TO RULE 13A-14(A) OF THE EXCHANGE ACT • CERTIFICATION OF ANDREW BONFIELD PURSUANT TO RULE 13A-14(A) OF THE EXCHANGE ACT • CERTIFICATION OF STEVE HOLLIDAY AND ANDREW BONFIELD PURSUANT TO RULE 13A-14(B • CONSENT OF PRICEWATERHOUSECOOPERS LLP|
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission file number: 001-14958
NATIONAL GRID PLC
(Exact name of Registrant as specified in its charter)
England and Wales
(Jurisdiction of incorporation or organization)
1-3 Strand, London WC2N 5EH, England
(Address of principal executive offices)
011 44 20 7004 3000
Facsimile No. 011 44 20 7004 3004
Company Secretary and General Counsel
National Grid plc
1-3 Strand London WC2N 5EH, England
(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)
Securities registered or to be registered pursuant to Section 12(b) of the Securities Exchange Act of 1934:
Securities registered or to be registered pursuant to Section 12(g) of the Securities Exchange Act of 1934: None.
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Securities Exchange Act of 1934: None.
The number of outstanding shares of each of the issuers classes of capital or common stock as of March 31, 2012 was
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act: Yes þ No ¨o
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Yes ¨ No þ
Note Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes þ No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files): Yes ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
U.S. GAAP ¨ International Financial Reporting Standards as issued by the International Accounting Standards Board þ Other ¨
If Other has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow. Item 17 ¨ Item 18 ¨
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
This constitutes the annual report on Form 20-F of National Grid Plc (the Company) in accordance with the requirements of the US Securities and Exchange Commission (the SEC) for the year ended 31 March 2012 and is dated 12 June 2012. Details of events occurring subsequent to the approval of the annual report on 16 May 2012 are summarised in the section titled Further Information. The content of the Groups website (www.nationalgrid.com/uk) should not be considered to form part of this annual report on Form 20-F.
Form 20-F Cross Reference Table
An energy networks business focused on generating shareholder value through both dividends and asset/equity growth by investing in essential assets under predominantly regulated market conditions to service long-term, sustainable, consumer led demands.
Adjusted operating profit 2010/11: £3,600m
+8% excluding the impact of timing and major storms
Adjusted earnings per share 2010/11: 50.9p (i)
US rate base 2010/11: $14.3bn
Ordinary dividends 2010/11: 36.37p
Operating profit 2010/11: £3,745m
+5% excluding the impact of timing and major storms
Earnings per share 2010/11: 62.9p (i)
UK regulatory asset value 2010/11: £20.8bn
Group return on equity 2010/11: 10.8%
Our financial results are reported in sterling. The average exchange rate, as detailed on page 57, was $1.60 to £1 in 2011/12 compared with the average rate of $1.57 to £1 in 2010/11. Except as otherwise noted, the figures in this Report are stated in sterling or US dollars. All references to dollars or $ are to the US currency.
Business analysis 2011/12
Geographical analysis 2011/12
Annual Report and Accounts 2011/12 National Grid plc 01
National Grid is an international electricity and gas company based in the UK and northeastern US. We play a vital role in connecting millions of people safely, reliably and efficiently to the energy they use.
The Directors Report, prepared in accordance with the requirements of the Companies Act 2006 and the UK Listing Authoritys Listing, and Disclosure and Transparency rules, comprising pages 8 to 107 and 184 to 189 was approved by the Board and signed on its behalf by:
Company Secretary & General Counsel
16 May 2012
The location within the main body of the Annual Report of the specific requirements of the Directors Report can be found in the checklist on page 81.
The performance of our principal businesses is reported by segment, reflecting the management responsibilities and economic characteristics of each activity.
Throughout this report, the following colours are used to indicate references to a particular segment:
Activities which do not fall within these segments are reported separately and are identified as:
Discussion relating to the Company as a whole is identified as:
If you require a full search facility, please go to the pdf of the Annual Report and Accounts 2011/12 in the investor relations section of our website and use a word search.
This document contains certain statements that are neither reported financial results nor other historical information. These statements are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. For a description of factors that could affect future results, reference should be made to the full cautionary statement on the back cover of this document and to the risk factors section on pages 41 to 43.
IFC to 79
80 to 107
108 to 183
184 to 198
Annual Report and Accounts 2011/12 National Grid plc 03
Sir Peter Gershon, Chairman
I am pleased to announce a good set of results for 2011/12. Adjusted earnings per share increased by 1% to 51.3 pence per share, compared to 50.9(i) pence per share in 2010/11. This increase is particularly pleasing in light of the significant timing differences and major storm costs incurred this year.
The Board is proposing a final dividend of 25.35 pence per share making a total of 39.28 pence per share for the 2011/12 financial year. This represents an increase of 8% from last year.
Our dividend is an important part of our returns to shareholders along with growth in the value of the asset base attributable to equity holders. This year is the last of our current dividend policy, which has been in place since January 2008. The Board has agreed a new one year dividend policy under which we plan to increase the dividend by 4% in nominal terms over the proposed dividend of 39.28 pence for 2011/12. This policy reflects the outcome from the one year TPCR4 rollover review and forecast inflation of around 3% for the same period. It will apply to the interim dividend to be paid in January 2013 and the final dividend to be paid in August 2013. We expect to announce a longer-term dividend policy after the current regulatory review is complete and its implications are clear.
This year has seen three fatalities occur. Any fatality associated with our business, whether an employee, contractor or member of the public, is deeply regrettable. Following thorough investigations, we are undertaking a wide range of measures to ensure we learn from these tragic events.
Safety is a top priority and will remain at the forefront of our core objectives. The Boards governance arrangements for the oversight of safety are being strengthened and the Chief Executive is leading a new drive to further improve our safety performance. We will always be exposed to high risk working environments on a daily basis and embedding safety procedures and principles in our people is a key part of improving our performance. We continue to foster the belief across our businesses that all accidents can be avoided.
We are mindful of our responsibility to the environments in which we operate and ensuring we continue operating in a socially responsible manner is fundamental to our continued delivery of sustainable profits and creating long-term value for our investors.
This year, we have made significant contributions across a number of areas including new education initiatives, such as the opening of the London tunnels energy education centre, our ongoing partnership with Special Olympics Great Britain and our work in the US on the engineering our future initiative. Our UK and US employees also continue to give up their time to volunteer and support community projects such as City Year. Details of a range of activities we and our employees support are available on our website.
Innovation is a key driver in our business, especially when it comes to connecting new sources of energy. The UK public debate around overhead lines versus underground cables provokes strong opinion and we are mindful of Government guidance when developing new connections and consider carefully the impact of our work on local communities. What is clear is that, at higher voltages, undergrounding is much more expensive. The right balance between landscape and affordability needs to be struck with society deciding whether it is
04 National Grid plc Annual Report and Accounts 2011/12
willing to accept the higher cost. We continue to work with those concerned to inform the debate, while also exploring innovative solutions to issues such as the visual impact of pylons (see page 50).
We have established a new energy partnership with the Buffalo Niagara medical campus which engages community stakeholders in innovative energy initiatives and helps support economic development and growth in the region. This partnership aims to set the benchmark for future energy efficient living and offers valuable insight into how people can embrace smart technologies in their everyday lives.
I am privileged to have taken over the role as Chairman of National Grid and would like to thank Sir John Parker for his personal contribution to the Companys success during his time as chairman, and for all the guidance and support he offered during my induction. I am delighted to be his successor.
A balance of skills, experience, knowledge and diversity is key to an effective Board and will remain a priority as we continue to refresh the composition of our Board over the next two years, as outlined on page 81. During the year, we welcomed Ruth Kelly and Paul Golby as Non-executive Directors. Both bring with them independence, knowledge and experience which will be invaluable as we address future opportunities and challenges.
Furthermore, Nora Brownell will join our Board as a Non-executive Director from 1 June 2012. Nora brings with her a vast amount of experience of the US energy industry and regulatory environment that will help further strengthen our Board.
Stephen Pettit and Linda Adamany will step down from the Board with effect from 30 July and 31 October 2012 respectively. Both have made an invaluable contribution to the Board, with Stephen chairing our Risk & Responsibility Committee for a number of years. I would like to thank them both for their committed service.
We must continue to develop robust succession planning for our Directors and senior management by actively looking to recruit new and diverse talent into the business, and by ensuring our existing employees are developed and challenged to reach their full potential. Attracting new talent into the business through innovative recruitment drives, the development of new recruits, our apprentice schemes and the maintenance of our graduate programme as one of the industry leading programmes, will continue to form part of our focus.
The Board is aware of the ongoing discussions and opinions being voiced with regard to executive remuneration and the heightened profile of this topic. We acknowledge this is an important area for shareholders. Our new chair of the Remuneration Committee is focused on this matter and we have taken steps to enhance our disclosures as part of the Remuneration Report starting on page 90.
The Chairmans Awards, a global employee recognition scheme, are an excellent initiative introduced by my predecessor and I am delighted to offer these my full support. This year attracted more than 160 submissions and the winners will be announced in June. They provide a perfect illustration of the talent and tireless effort of our employees to make National Grid an improved place to work and to make positive contributions to local communities. We were particularly interested in ideas to improve safety and wellbeing in the workplace and are pleased that a number of the initiatives submitted really strove to go the extra mile and demonstrate innovation.
We are again committed to setting the tone at the top and look to adopt best practice in corporate governance. Personally, I am dedicated to this approach and will continue to ensure that, as a Board, we remain engaged in exploring ways that can further improve our performance. Further details on Board evaluation and effectiveness are provided on page 82.
The Board and I remain committed to delivering increased shareholder value and returns. We are more focused than ever on improving our safety performance, recognising the need for all our employees and contractors to be able to operate safely on a day-to-day basis to enable our business to continue to operate at an optimum level.
I extend my thanks to our US employees, who demonstrated outstanding commitment in responding to the severe storms experienced earlier this year, as well as to all our employees for their hard work and dedication to the success of the Company. This reinforces my belief that we are well positioned to meet the future opportunities and challenges we face.
Sir Peter Gershon
Annual Report and Accounts 2011/12 National Grid plc 05
Steve Holliday, Chief Executive
Over the course of 2011/12, we have made good progress on our key priorities: disciplined investment; delivering improved performance and returns in the US; preparing for the new regulatory arrangements in the UK; and focusing on operational excellence across all our principal operations, in particular, through our restructuring of the US business and UK Gas Distribution. We remain at the centre of the challenge to connect future energy solutions in both the UK and northeastern US and continue to progress these through ongoing engagement with our stakeholders.
Throughout 2011/12, we have delivered good financial performance. Adjusted operating profit is up 8%, excluding the timing differences that benefited 2010/11 and the impact of two major storms in the US. We delivered another significant year of capital expenditure with £3.4 billion reflecting the sustained investment in our regulated activities. The launch of our first UK RPI linked retail bond proved a great success, raising further capital as well as securing a new investor base. We continued to manage our portfolio of businesses in a disciplined manner, releasing value through sales of two of our non-regulated businesses, OnStream in the UK and Seneca-Upshur in the US.
In November, Ofgem published final proposals for the one year (2012/13) transmission price control rollover for our UK Transmission business (TPCR4). These included real increases in revenues for electricity and gas transmission, reflecting the capital investment we have made over the current price control period.
Safety remains a top priority, as our financial and business performance must always be underpinned by a strong safety record. I must reiterate the message from our Chairman; the three fatalities associated with our business are deeply regrettable.
During 2011/12, our injury frequency rate was unchanged at 0.18. This remains an area where we must increase our efforts and strive to achieve zero injuries. Last year we focused on trends associated with high potential incidents and mitigating actions, our incident review process, and ever increasing engagement across the entire leadership team. These actions will continue to be in place going forward as we accept that more must be done to ensure all employees and contractors operate safely.
Delivering our strategy
We own and manage the networks to which many different energy sources are connected. That puts us at the heart of one of the greatest challenges facing our society: creating new sustainable energy solutions for the future and developing an energy system that can support economic prosperity in the 21st century.
This year, our programme of capital expenditure continued to be largely driven by our UK electricity and gas businesses and improvement of our networks. Highlighted in our business plans, submitted in support of the new regulatory framework RIIO (revenue = incentives + innovation + outputs), the level of investment in this area is planned to reach £31 billion through to 2021. We continue to work with Ofgem to reach an acceptable RIIO outcome for our UK regulated businesses. Details on the new framework can be found on page 25.
Following last years announcement of the changes in our US business, we have an increased local focus that has helped improve, in particular, our performance and responsiveness when interacting with our customers and regulators. Through the reorganisation, we were also able to achieve the targeted annualised cost saving of $200 million. The increased local engagement has already seen positive results. In December 2011, NYPSC approved our request to recover certain deferred costs and a portion of recent storm costs in our Niagara Mohawk electricity business. In April 2012, we also submitted important new rate filings for our Niagara Mohawk and Narragansett businesses.
In December, the UK Government published its technical update for the Electricity Market Reform bill, which is expected to be passed into legislation during the current parliamentary session. The changes proposed will be key in shaping investment decisions in new generation capacity and it is envisaged that we will assume responsibility for administration of the new framework for renewable and low carbon generation payments.
Maintaining a safe and reliable supply is a critical part of our job. Operationally we have performed well, with reliability of the UK electricity and gas transmission network at more than 99%. However, during the severe winter of 2010/11 we failed standards for uncontrolled gas escapes in all four of our networks and for controlled gas escapes in two of them, resulting in a fine of £4.3 million from Ofgem. The lessons we learnt were used to improve plans for the winter of 2011/12 when we met all our targets.
06 National Grid plc Annual Report and Accounts 2011/12
In the US, our reliability was 93%. However, these figures always exclude major storms and 2011/12 was an exceptional year for weather events. Over the summer we faced tropical storm Irene, flooding and tornadoes, while in Massachusetts, an unseasonal snow storm in October affected 92% of the communities we serve. The level of devastation experienced as a result of these storms was huge and the process of rebuilding communities and replacing infrastructure was a challenge. The response, passion and commitment of our teams and the support we received from neighbouring states, were exceptional. The process of restoring power to communities can always be improved, but in such exceptional circumstances I am proud of the efforts of all those involved.
In December 2011, LIPA announced that we had not been selected to continue to manage and operate Long Islands electricity system beyond the term of the current agreement, expiring on 31 December 2013. We are naturally disappointed by this decision, but our substantive assets on Long Island are not affected. We will continue to provide high quality services for the remainder of our contract and support the complex transition.
We remain determined to improve customer service and further understand customers needs so we can serve them in the most effective and efficient manner. This year has seen the opening of our new UK Gas Distribution customer centres, specifically designed to provide a more responsive and integrated service. The result of this and other initiatives implemented are already showing, with our customer satisfaction increasing by an average of 5.5% this year. Further improvement is important to us and will have even greater significance under the new regulatory framework, with incentives being introduced. Embedding customer focus now should enable us to be ready for this.
In the US, our results have been mixed. However, the success of the new structure and the deeper engagement with our stakeholders is already starting to improve relationships, with positive feedback being received. The elevate 2015 programme aims to design and implement more customer focused processes better aligned to meeting their needs, and by doing so, will enable greater improvement in our customer service performance.
We continue to progress efficiency initiatives across all our businesses. The UK Gas Distribution front office programme has successfully implemented replacement systems and streamlined core business processes that should help us move to upper quartile
customer performance. In addition, our US foundations project, which will integrate multiple information systems and improve control processes, is on target for late 2012 implementation. It aims to deliver a single financial system, a single cost allocation methodology and enhanced jurisdictional and functional reporting.
Our people form the foundation of our business. Personally, I remain committed to developing all of them to the best of their abilities. We need to deliver the planned increase in capital expenditure and without the correct people and capabilities we will be unable to meet this challenge.
In the UK, over the next nine years we are looking to recruit in the region of 2,500 engineers a mixture of experienced engineers and development programme trainees to support our investment programme. In the US, we also expect to fill around 800 management roles requiring an engineering background over the next 10 years. Developing talent is vital to our success and we recognise our role in enthusing the next generation of young people to pursue science, technology and mathematics at school and beyond. We are working with schools and partnerships to bring alive the opportunities that exist via the different routes into industry. Over the last year, our UK employees interacted with more than 3,900 students through work experience, Imagineering clubs and open days, and our US employees continue to be active in supporting local schools and communities. Our focus on inspiring the younger generation into engineering and science will continue on both sides of the Atlantic.
This year saw an 84% response rate to the employee survey. I am pleased with this, as the results provide a true reflection of how we are doing. Overall, our results have improved from the last survey, with customer and safety both scoring higher. There is still more work to be done on engagement and, as a leadership team across the Company, we are already starting to address this area.
The scale of the challenges we face over the next decade is significant, as we must deliver the networks to support future needs. Our job remains to connect people safely and reliably to the energy they use; this is a privileged position.
Our priorities for 2012/13 are focused towards:
Annual Report and Accounts 2011/12 National Grid plc 07
1. Sir Peter Gershon CBE,
Appointment to the Board: 1 August 2011 as Deputy Chairman, Chairman with effect from 1 January 2012
Committee membership: N (ch)
Career experience: Previous appointments include Chairman of Premier Farnell plc, Chief Executive of the Office of Government Commerce and Managing Director of Marconi Electronic Systems.
External appointments: Chairman of Tate & Lyle plc, member of the UK Defence Academy Advisory Board and HM Government Efficiency Board.
2. Steve Holliday,
Appointment to the Board: October 2002, appointed to National Grid Group plc 2001, Chief Executive with effect from January 2007
Committee membership: E (ch), F
Career experience: Formerly Executive Director of British Borneo Oil and Gas; he also spent 19 years within the Exxon Group, where he held senior positions in the international gas business and managed major operational areas such as refining and shipping.
External appointments: Non-executive Director of Marks and Spencer Group plc and Chairman of the UK Business Council for Sustainable Energy, Crisis UK, the Technician Council and a member of the Board of Trustee Directors for Business in the Community and Infrastructure UK Advisory Council.
3. Andrew Bonfield,
Appointment to the Board: November 2010
Committee membership: E, F
Career experience: Chief Financial Officer at Cadbury plc until March 2010; he also spent five years as Executive Vice President & Chief Financial Officer of Bristol-Myers Squibb Company and has previous experience in the energy sector as Finance Director of BG Group plc.
External appointments: Non-executive Director of Kingfisher plc.
4. Tom King,
Executive Director, US
Appointment to the Board: August 2007
Committee membership: E
Career experience: President of PG&E Corporation and Chairman and CEO of Pacific Gas and Electric Company from 2003 to 2007, having held a number of senior positions within the PG&E group since joining in 1998. Senior management positions with Kinder Morgan Energy Partners and Enron Corporation.
5. Nick Winser,
Executive Director, UK
Appointment to the Board: April 2003
Committee membership: E
Career experience: Previously Chief Operating Officer of the US transmission business for National Grid Transco plc having joined The National Grid Company plc in 1993, becoming Director of Engineering in 2001. Prior to this, Nick had been with Powergen since 1991 as principal negotiator on commercial matters.
External appointments: Non-executive Director of Kier Group plc and co-Chair of the Energy Research Partnership.
6. Ken Harvey CBE,
Non-executive Director and
Senior Independent Director
Appointment to the Board: October 2002, appointed to Lattice Group plc board in 2000, Senior Independent Director with effect from October 2004
Committee membership: N, R (ch), R&R
Career experience: Formerly Engineering Director and then Deputy Chairman of London Electricity and Chairman and Chief Executive of NORWEB plc.
External appointments: Chairman of Pennon Group Plc.
7. Linda Adamany,
Appointment to the Board: November 2006
Committee membership: A, N, R&R
Career experience: Various executive roles for BP in both the UK and US, including Chief Executive of BP Shipping and Group Vice President and Commercial Director, BP Refining & Marketing and until April 2008, Group Vice President, BP plc.
8. Philip Aiken,
Appointment to the Board: May 2008
Committee membership: A, N, R&R
Career experience: Formerly Group President of BHP Billitons Energy business, Executive Director of BTR plc, held senior roles in BOC Group plc and was senior advisor to Macquarie Capital (Europe) Limited.
External appointments: Chairman of Robert Walters plc, Deputy Chairman of AVEVA Group plc, Non-executive and Senior Independent Director of Kazakhmys PLC and Non-executive Director of Miclyn Express Offshore Limited and Essar Energy plc.
9. Paul Golby CBE,
Appointment to the Board: 1 February 2012
Committee membership: N, R, R&R
Career experience: Formerly Executive Director of Clayhithe plc before joining East Midlands Electricity plc in 1998 as Managing Director. Appointed as Chief Executive of E.ON UK plc in 2002, and later additionally as Chairman, stepping down from the E.ON Board in December 2011.
External appointments: Non-executive Chairman of AEA Technology Group plc, Chairman of Engineering UK, Chair of the Engineering and Physical Sciences Research Council and a member of the Council for Science and Technology.
10. Ruth Kelly,
Appointment to the Board: 1 October 2011
Committee membership: A, F, N
Career experience: Various senior roles in Government from 2001 to 2008, including Secretary of State for Transport, Secretary of State for Communities and Local Government, Secretary of State for Education and Skills and Financial Secretary to the Treasury.
External appointments: Managing Director at HSBC and Governor for the National Institute of Economic and Social Research.
11. Stephen Pettit,
Appointment to the Board: October 2002, appointed to Lattice Group plc board in 2001
Committee membership: F, N, R, R&R (ch)
Career experience: Formerly Chairman of ROK plc, Executive Director of Cable & Wireless plc and Chief Executive, Petrochemicals at British Petroleum.
External appointments: Non-executive Director of Halma p.l.c and a member of BT Group plcs Equality of Access Board.
12. Maria Richter,
Appointment to the Board: October 2003
Committee membership: A, F (ch), N
Career experience: With Morgan Stanley from 1993 to 2002, latterly as Managing Director of its Corporate Finance Retail Group; Vice President of Independent Power Group for Salomon Brothers and Vice President of Prudential Capital Corporation and Power Funding Associates.
External appointments: Non-executive Chairman of Pro Mujer UK and Non-executive Director of The Pantry, Inc., The Vitec Group plc and The Bessemer Group Inc.
08 National Grid plc Annual Report and Accounts 2011/12
Annual Report and Accounts 2011/12 National Grid plc 09
We believe creating an inclusive and diverse culture supports the attraction and retention of talented people, improves effectiveness, delivers superior performance and enhances the success of the Company. While criteria such as gender or ethnicity are important, we also value diversity of skills, experience, knowledge and expertise, as can be seen below. Our Board brings together people with different experience and backgrounds, and sometimes divergent opinions, but with shared goals.
10 National Grid plc Annual Report and Accounts 2011/12
In relation to gender diversity, as a result of the transition of our Board, see page 81, we expect the number of female Board members to fluctuate in coming months. We aspire to meet the targets set by Lord Davies by 2015 and the Board will be considering a formal diversity policy during the year ahead.
Our executive and leadership population is regularly and rigorously assessed against achievement of individual objectives and key leadership qualities to help build a sustainable development and succession plan. The Board reviews the talent pipeline to the
Executive Committee and the quality and diversity of talent further down the organisation. Individuals who are identified as potential successors to the Executive Committee within a three year timeframe also undergo an external benchmarking and assessment process carried out by an independent third party. At the same time, we have initiated a programme of executive sponsorship and mentoring of high potential female and minority ethnic managers in order to ensure increased diversity throughout the leadership of the Company.
Annual Report and Accounts 2011/12 National Grid plc 11
The Boards purpose is to create and deliver the long-term success of the Company and returns for shareholders.
There are a number of areas where the Board takes the lead, for example around corporate governance, strategic direction, financial policy including the budget and business plan and the reputation of the Company and its businesses.
The composition of the Board and the diverse skills and experience our Directors bring to the table are vital for ensuring shareholders interests are best represented and that there is sufficient constructive challenge and debate.
Our Non-executive Directors commit sufficient time to perform their duties and to understand the Company, for example through their work on the Committees, site visits, induction programmes for new Directors and meetings with management and employees.
While the Board delegates authority to its Committees to carry out certain tasks on its behalf as set out in each Committees terms of reference, available on our website it ensures that what has been discussed and any decisions taken are communicated to the other Directors. The chairman of each Committee provides a summary back to the Board at the following meeting.
For more information on the operation of the Board and its Committees refer to pages 80 to 89.
12 National Grid plc Annual Report and Accounts 2011/12
The Executive Committee has responsibility for making day-to-day management and operational decisions to safeguard the interests of the Company.
The nine members of the Committee have a broad range of skills and expertise which is constantly being updated through training and development, as well as through holding external non-executive directorships. This broadens experience and gives exposure to other companies governance frameworks and board practices. The Committee officially met 11 times this year but interaction among the members occurs much more regularly.
The Committee oversees the safety, operational and financial performance of the Company, taking management action it considers necessary to safeguard the interests of the Company and is responsible for furthering the strategy, business objectives and targets established by the Board. It approves capital and operational expenditure within its authority levels and regularly discusses, formulates and approves proposals to be considered by the Board.
Although the other members of the Committee do not sit on the Board, they all regularly attend Board meetings and other Committees (with Helen Mahy, the Company Secretary & General Counsel, attending all Board and Nominations Committee meetings as secretary) to ensure that every member is fully up to date and knowledge is shared.
Annual Report and Accounts 2011/12 National Grid plc 13
14 National Grid plc Annual Report and Accounts 2011/12
Annual Report and Accounts 2011/12 National Grid plc 15
In common with all international companies, we operate in a complex environment with a number of external factors affecting our operations.
UK energy policy
The Climate Change Act 2008 requires the UK to cut greenhouse gas (GHG) emissions by 34% from the 1990 levels by 2020 and 80% by 2050. Continuing the drive toward these goals, in December 2011, DECC published its technical update for the Electricity Market Reform bill, which was confirmed in the Queens speech on 9 May 2012 and is expected to be passed into legislation during the current parliamentary session. The changes proposed by this legislation will be instrumental in shaping investment in new generation capacity over the coming decade which, in turn, underpins our expected capital investment plans.
DECC remains committed to reducing the costs of renewable generation and published a joint report with Ofgem in March 2012 highlighting that offshore and onshore development must be considered together when looking at network development needs. Our role as system operator includes offshore networks and we will play a key role in ensuring onshore and offshore network development is coordinated.
EU energy policy
With the implementation of the 3rd Energy Package in 2011, the development of the European Infrastructure Package in 2012 and emerging EU thinking on a roadmap to 2050 (ie moving beyond the 2020 CO2 targets), the EU is another factor in the development of energy policy in the UK. The 3rd Energy Package is largely associated with the development of EU level codes, to establish EU wide rules on technical and commercial issues relating to cross border trade. These codes are the responsibility of the European networks for transmission system operators for electricity and the European networks for transmission system operators for gas, and we have been working closely with both of them. In the years to come, we expect policy to develop around greater interconnection in the electricity market and networks in the North Sea.
US energy policy
US energy policy continues to be shaped by debates over the economy, the costs and benefits of regulation, and concerns over energy security. During the year, Congress enacted an extension of the Pipeline Safety Act and debated a variety of other energy related legislation including a clean energy standard, energy efficiency, renewable energy incentives and cyber security. The most significant changes however, came in the form of new US Environmental Protection Agency regulations. These included rules for mandatory reporting of GHG emissions from electricity and gas utility facilities and the promotion of the Mercury and Air Toxics Standards rule and the Cross-State Air Pollution Rule which will help to ensure air and water quality.
Federal agencies continued their investment in energy efficiency as a direct reflection of the Obama administrations priorities. This has manifested itself in large projects at federal facilities in all of the Companys service areas and we are working with a number of Government facilities to assist in this endeavour.
At the state level energy policy continues to be an active arena, particularly in the northeastern US, driven by interest in promoting energy efficiency, maintaining reliability, and deploying renewable technologies that help states meet environmental and energy diversity goals. New York has promoted a broad energy policy
agenda, including renewed focus on transmission development, a state energy plan, responsible exploration of shale gas, a mandated utility-based loan programme to increase efficiency installations with recovery through customer bills, and promotion of solar technology. Massachusetts continues to focus on climate and energy initiatives including the recent establishment of a GHG inventory programme. Rhode Island enacted several pieces of legislation in 2011 that will promote renewable technologies at the distribution system level, as well as significantly boost the support for gas energy efficiency programmes.
The economic uncertainty within the eurozone has led to volatility in financial markets during the year, however, we have not experienced any adverse effects. Instead, as the UK is seen as a safe haven, its bond yields have fallen and this has had a positive effect on our cost of debt. We continue to monitor developments as it may affect our ability to access capital markets or the financial strength of our counterparties.
Inflation in the UK has declined from its peak in September 2011 but remains above the long-term trend. Our UK regulated revenues are linked to inflation and this has therefore led to higher revenues (see below for an explanation of the UK regulatory regime). We also have index-linked debt so our financing cost increases with inflation, providing a partial economic offset.
In the US, the economic recovery was sluggish early in the year but accelerated towards year end, leading to recent declines in the unemployment rate. Unlike the position in the UK, we sell gas and electricity directly to consumers in the US and so are exposed to bad debt risk, which is affected by unemployment rates. Some of our rate plans include protection against such risk (see page 28), but in most cases they do not cover the full cost.
The Gas Act 1986 and Electricity Act 1989, as amended (the Acts), provide the fundamental legal framework for gas and electricity companies. They establish the licences for electricity generation, transmission, distribution and supply, and for gas transmission, distribution, shipping and supply. The licences established under the Acts require each of our business activities to develop, maintain and operate an economic and efficient network and to facilitate competition in the supply of gas and electricity in Great Britain. They also give the licensed businesses statutory powers, such as the right to bury our pipes or cables under public highways and the ability to use compulsory powers to purchase land to enable the conduct of our businesses.
Energy networks are regulated by Ofgem which operates under the direction and governance of the Gas and Electricity Markets Authority. Ofgem has established price control mechanisms that set the amount of revenue that can be earned by our regulated businesses.
Price control regulation is designed to ensure our interests, as a monopoly, are balanced with those of our customers. Ofgem allows us to charge reasonable, but not excessive, prices giving us a future level of revenue sufficient to meet our statutory duties and licence obligations, and also to make a reasonable return on our investment.
The price control includes a number of mechanisms to achieve its objectives, including financial incentives designed to encourage us to: continuously improve the cost and effectiveness of our services; manage and operate our networks; provide quality customer service; and invest in the development of the network in a manner that ensures long-term security of supply.
To ensure that our licensed businesses are operating efficiently, and consumers are protected, we operate under eight price controls in the UK, comprising two for our UK electricity transmission operations, one covering our role as transmission owner (TO) and the other for our role as system operator (SO); two for our gas transmission operations, again one as TO and one as SO; and one for each of our four regional gas distribution networks. In addition to the eight price controls, our LNG storage business has a price control covering some aspects of its operations. There is also a tariff cap price control applied to certain elements of domestic metering and daily meter reading activities undertaken by National Grid Metering.
Current price controls
The current price control mechanisms for our gas distribution business will expire on 31 March 2013. The price controls for our transmission business were extended for one year and will now also expire on 31 March 2013. The extension included real increases in revenues for electricity and gas transmission next year and a base real vanilla return of 4.75%. The revenue increase partly reflects the capital investment we have made over the current price control period which forms part of our total UK RAV, which at 31 March 2012 was over £22 billion.
The current price control mechanism establishes the amount of money that can be earned by our regulated businesses is restricted by what is referred to as an RPI-X price control. The RPI-X allowance is based on Ofgems estimates of efficient operating expenditure (opex), capital expenditure (capex) and asset replacement, together with an allowance for depreciation and an allowed rate of return on capital invested in our businesses. The RPI-X price control takes the RPI as its inflation benchmark and subtracts X, an efficiency factor, from it. For example, at a time when annual inflation was 3%, a value for X of 2% would allow our regulated businesses to raise prices by no more than 1%.
The RAV, which represents the value ascribed by Ofgem to the capital employed in our regulated businesses, is adjusted to reflect asset additions, removals, depreciation and the rate of inflation.
Future price controls
It is estimated that we will need to invest over £31 billion during the RIIO period, partly to facilitate the move to a low carbon economy. This will include the gas and electricity networks developing smarter grids, meeting environmental challenges and securing energy supplies.
In light of the challenges around the evolving energy environment and the significant investments required, Ofgem has introduced a new regulatory price control framework to replace the existing framework which has been in use for over 20 years. This is known as RIIO: revenue = incentives + innovation + outputs.
Under this regime, networks will be encouraged to deliver outputs, such as agreed levels of safety, reliability and environmental performance, while ensuring timely connections for customers, improving on customer satisfaction and (for UK Gas Distribution only) complying with social obligations. The networks will be incentivised to deliver these innovatively and efficiently. During the price control review process, Ofgem will assess what an efficient level of expenditure would be to deliver these outputs and will then set the revenue levels accordingly.
The RIIO price control will last for eight years with a mid-period review at four years.
The fundamentals of how our revenue is derived under RIIO are not that different, but the mechanics of how capex and opex (totex) are treated has changed, as demonstrated below. A fixed proportion of totex goes into the RAV (slow money) with the remainder remunerated within the year (fast money).
We have developed our business plans in conjunction with our stakeholders and have reflected their views and feedback in our updated plans, submitted to Ofgem in March and April 2012 for our UK Transmission and UK Gas Distribution businesses respectively. Full details of these business plans can be found on our website.
Ofgem will issue their initial proposals for the first RIIO price control period in July 2012 and their final proposals in December 2012. We will continue to work with Ofgem as the RIIO price controls are finalised, aiming to secure positive opportunities to invest for long-term profitable growth and reasonable returns.
Our operating environment continued
With an eight year price control period replacing the previous five year controls, there will inevitably be a larger exposure to potential variance against our forecasts; for example, on our electricity transmission business a different mix of generators may look to connect to the system than those we have assumed in our baseline plan. In order to understand the impact that different outcomes might have, we have modelled a range of credible future demand and generation scenarios using the scenarios developed with stakeholders through the UK Future Energy Scenarios process. The impact of these alternative scenarios against our baseline capital investment forecast (which uses the gone green scenario) is illustrated below:
Building on our existing risk management approach, we have developed an innovative risk model to better understand the risks that our business will face, how those risks might best be managed and to evaluate the relationship between uncertainty mechanisms and the required rate of return. We have shared this model with stakeholders, including Ofgem, who have been broadly supportive of it.
Following discussions with stakeholders, we have therefore proposed a number of regulatory mechanisms, which would adjust our allowed investment levels over the period of the price control to ensure there are no inappropriate windfall gains or losses for our networks or consumers as a result of reality diverging from the assumptions we have made in forecasting the next eight years. In doing this, we have maintained the principle that risks should be borne by the party best able to manage them.
Further information on these mechanisms and the risks they seek to reduce is available on our price control stakeholder engagement website: www.talkingnetworkstx.com.
In the US, public utilities retail transactions are regulated by state utility commissions, including the New York Public Service Commission (NYPSC), the Massachusetts Department of Public Utilities (MADPU), the Rhode Island Public Utilities Commission (RIPUC) and the New Hampshire Public Utilities Commission (NHPUC). Utility commissions serve as economic regulators in approving cost recovery and authorised rates of return. The state commissions establish the retail rates to recover the cost of transmission and distribution services, and focus on services and costs within their jurisdictions. FERC regulates the wholesale transactions of public utilities, such as interstate transmission and electricity generation, and provides for the cost recovery of these services.
Utility commissions are also charged with serving the public interest by ensuring utilities provide safe and reliable service at just and reasonable prices. They establish service standards and approve mergers and acquisitions of public utilities. FERC also regulates public utility holding companies and centralised service companies, including those of our US businesses.
All the states in which we operate have deregulated the commodity or supply component of electricity and gas utility services. Customers in deregulated states have the option to purchase electricity or gas services from competitive suppliers.
Utilities in the US submit a formal rate filing to the applicable state regulatory body requesting a revenue adjustment in a proceeding known as a rate case. The rate case process is conducted in a litigated setting and, in the states in which we operate, it can take six to 13 months for the commission to render a final decision. In all states, the utility is required to prove that its requested rate change is prudent and reasonable. At FERC there is no defined process for adjudicating a rate case. FERC allows rates to be put in place before a final decision is reached, however, a refund may be required if the outcome is unfavourable. The utility may request a rate plan that can span multiple years.
During the rate case process, consumer advocates and other intervening parties scrutinise and often file opposing positions to the utilitys rate request. The rate case decision reflects a weighing of the facts in light of the regulators policy objectives. During a rate case, the utility, consumer advocates and intervening parties may agree on the resolution of aspects of a case and file a negotiated settlement with a commission for approval.
Gas and electricity rates are established from a revenue requirement, or cost of service, representing the utilitys total cost of providing distribution or delivery service to its customers. It includes operating expenses, depreciation, taxes and a fair and reasonable return on certain components of the utilitys regulated asset base, typically referred to as its rate base. The rate of return applied to the rate base is the utilitys weighted average cost of capital, representing its cost of debt and an allowed ROE intended to provide the utility with an opportunity to attract capital from investors and maintain its financial integrity. The total cost of service is apportioned among different customer classes and categories of service to establish the rates, through a process called rate design, for these classes of customers. The final cost of service and rate design are ultimately approved in the rate case decision.
The revenue requirement is derived from a comprehensive study of the utilitys total costs during a recent 12 month period of operations referred to as a test year. Each commission has its own rules and standards for adjustments to the test year which are intended to
arrive at the total costs expected in the first year new rates will be in effect, or the rate year, and may include forecast capital investments in determining rate year rate base. Often, known and measurable adjustments are made to test year data to reflect normal operating conditions. In Massachusetts, only limited adjustments to this test year are allowed, which are required to be both known and measurable. New York and Rhode Island allow more comprehensive adjustments to the test year.
In summary, the US regulatory regime is based on a building block approach intended to allow the utility to recover its cost of service and earn a return on its investments.
Our rate plans
We have five sets of electricity rates and seven sets of gas rates, covering our electricity distribution operations in upstate New York, Massachusetts, Rhode Island and New Hampshire, and our gas distribution networks in upstate New York, New York City, Long Island, Massachusetts, Rhode Island and New Hampshire. Distribution and transmission electricity services in upstate New York continue to be subject to a combined rate that is billed to end use customers. In New England, retail transmission rates reflect the recovery from our end use customers of wholesale transmission charges assessed to our electricity distribution companies. Wholesale rates for our electricity transmission network in New England and New York and for our Long Island generation business are subject to FERC approval.
We have regulatory arrangements that provide for the recovery of our historical investments and commitments related to our former electricity generation business that were stranded when some of our US subsidiaries divested their generation assets as part of industry restructuring and wholesale power deregulation in New England and New York. We have recovered most of our sunk investments in generation assets and revenue associated with stranded cost recoveries will decline significantly in future years.
Our rate plans are designed to produce a specific allowed ROE, by reference to an allowed operating expense level and rate base. Some rate plans include earned savings mechanisms that allow us to retain a proportion of the savings we achieve through improving efficiency, with the balance benefiting customers.
In addition, our performance under certain rate plans is subject to service performance targets. We may be subject to monetary penalties in cases where we do not meet those targets.
Allowed ROE in context
One measure used to monitor the performance of our regulated businesses is a comparison of achieved ROE to allowed ROE, with a target that the achieved should be equal to or above the
allowed. This measure cannot be used in isolation, however, as there are a number of factors that may prevent us from achieving that target in any given year:
We work to increase achieved ROEs through: productivity improvements; positive performance against incentives or earned savings mechanisms such as energy efficiency programmes, where available; and, through filing a new rate case when achieved returns are lower than that which the Company could reasonably expect to attain through a new rate case.
Features of our rate plans
We are responsible for billing our customers for their use of electricity and gas services. Customer bills typically comprise a commodity charge, covering the cost of the electricity or gas delivered, and charges covering our delivery service. Depending on the state, delivery rates are either based upon actual sales volumes and costs incurred in an historical test year, or on estimates of sales volumes and costs, and in both cases may differ from actual amounts. A substantial proportion of our costs, in particular electricity and gas purchases for supply to customers, are pass-through costs, meaning they are fully recoverable from our customers. Our charges to customers are designed to recover these costs with no profit. Rates are adjusted from time to time to ensure any over- or under-recovery of these costs is returned to, or recovered from, our customers. There can be timing differences between costs being incurred and rates being adjusted.
Revenue for our wholesale transmission business in New England and New York is collected from wholesale transmission customers, who are typically other utilities and include our own New England electricity distribution businesses. With the exception of upstate New York, which continues to combine retail transmission and distribution rates to end use customers, these wholesale transmission costs are incurred by distribution utilities on behalf of their customers and are fully recovered as a pass-through from end use customers as approved by each state commission.
Our Long Island generation plants sell capacity to LIPA under a power supply agreement, approved by FERC, which provides a similar economic effect to cost of service rate regulation. The contract expires in 2013 and new contract negotiations are underway.
In addition, in December 2011, LIPA announced that, after a lengthy competitive bid process related to the management services agreement, we had not been selected to continue to manage and operate Long Islands electricity system beyond the term of the current agreement, which expires on 31 December 2013.
Our operating environment continued
The objectives of our rate case filings are to ensure we have the right cost of service with the ability to earn a fair and reasonable rate of return, while providing a safe and reliable service to our customers. In order to achieve these objectives and to reduce regulatory lag, we have been requesting structural changes, such as revenue decoupling mechanisms, capital trackers, commodity related bad debt true ups, and pension and other post-employment benefit (OPEB) true ups, separately from base rates. These terms are explained below the table on the opposite page.
The chart below shows the progress we have made on these regulatory principles (excluding New Hampshire). We continue to work towards implementing these regulatory principles across our US business.
Although many of our rate plans feature revenue decoupling, in some cases decoupling applies only to some classes of customer. As a result, the proportion of revenues which is decoupled is 91% for our electricity businesses and 64% for our gas businesses for 2011/12. Transmission and generation revenue is effectively decoupled.
We have ongoing regulatory filings associated with downstate New York deferrals and tax refunds and the disposal of New Hampshire businesses. Progress continues in these areas. Below we summarise significant developments in rate filings during the year.
Upstate New York 2012 rate filing
On 27 April 2012, we filed a one year rate plan filing for our upstate New York electricity and gas businesses, to take effect from 1 April 2013. The filing included a request for an increase in electricity delivery revenue of $131 million. This would be more than offset by approximately $190 million per annum of rate reductions related to the recovery of certain past deferred costs, resulting in an overall net decrease of approximately $59 million to customers. The filing also includes a request for an increase in gas delivery revenue of $40 million, which would be partially offset by a net decrease in deferral recovery of $29 million. The filing is based on an ROE of 10.55% for the one year rate filing, and includes annual reconciliation mechanisms for certain non-controllable costs.
The filing, which is expected to take 11 months to review and to conclude in March 2013, includes investments of $454 million and $82 million in the electricity and gas businesses respectively. The increased electricity service costs also include the creation of a $29 million sustainable storm fund.
Upstate New York deferral filing
On 16 December 2011, NYPSC approved Niagara Mohawk Power Corporations request to recover $240 million in deferred costs ($211 million related to deferred environmental, capital expenditure, and pension costs included in our July 2011 deferral filing, $25 million related to recent storm response costs, and $4 million related to carrying charges and other adjustments). This amount will be collected over 15 months, effective from 1 January 2012. In addition, NYPSC approved the removal of $573 million from Niagara Mohawks rates related to stranded cost recoveries.
New York State review
In February 2011, NYPSC instituted a New York State proceeding to review its site investigation and environmental remediation (SIR) expenditure policies. The proceeding directed New York States utilities to assist in developing the future scope of utility SIR programmes including cost containment, cost allocation and methods for minimising the impact on customers of SIR cost recovery. A Recommended Decision was issued on 3 November 2011 the proceeding is open and ongoing.
Rhode Island 2012 rate filing and appeal of ruling in 2009 rate filing
On 27 April 2012, we filed a new rate plan for our Rhode Island electricity and gas businesses, to take effect from 1 February 2013. The filing requests increases in electricity distribution revenue of $31 million and gas delivery revenue of $20 million, based on an ROE of 10.75% with annual reconciliation mechanisms for certain non-controllable costs such as pensions and OPEB, property taxes and commodity bad debt true up.
In order to ensure the new investments are effectively implemented, the new filing sets out the case for new rates, cost of service allowances and other needs for the businesses. The capital spending programme for these two utilities is addressed annually outside of this filing. The current levels of approved capital investment for the year which commenced on 1 April 2012 are $61.9 million for the gas system and $56.5 million for the electricity system. The filing is expected to take nine months to review and to conclude in January 2013.
On 23 January 2012, the Rhode Island Supreme Court issued its decision on our appeal of RIPUCs decision in its 2009 rate case. The Court reversed RIPUCs decision to impose National Grids capital structure onto Narragansett but affirmed their decision to disallow 50% of our incentive compensation. On 11 April 2012, RIPUC adopted a settlement resolving the capital structure aspects of the rate order, which we had appealed. The settlement authorises Narragansett a capital structure comprised of 48.78% common equity, an overall rate of return of 7.31%, and an additional $3.2 million electricity rate increase, effective from 23 April 2012.
In February 2011, NYPSC selected Overland Consulting Inc., a management consulting firm, to perform a management audit of our affiliate cost allocations, policies and procedures. The audit of these service company charges seeks to determine if any service company transactions have resulted in unreasonable costs to New York customers for the provision of delivery services. If potentially material levels of misallocated or inappropriate costs are discovered, at the direction of NYPSC, the investigation will be expanded to prior years to determine if they have been charged to the New York utilities. A report of this review to NYPSC is anticipated in 2012.
28 National Grid plc Annual Report and Accounts 2011/12
* Both transmission and distribution, excluding stranded costs
A mechanism that removes the link between a utilitys revenue and sales volume so that the utility is indifferent to changes in usage. Revenues are reconciled to a revenue target, with differences billed or credited to customers. Allows the utility to support energy efficiency.
A mechanism that allows for the recovery of the revenue requirement of incremental capital investment above that embedded in base rates, including depreciation, property taxes and a return on the incremental investment.
§Commodity related bad debt true up
A mechanism that allows a utility to reconcile commodity related bad debt to either actual commodity related bad debt or to a specified commodity related bad debt write-off percentage. For electricity utilities, this mechanism also includes working capital.
¯ Pension/OPEB true up
A mechanism that reconciles the actual non capitalised costs of pension and OPEB and the actual amount recovered in base rates. The difference may be amortised and recovered over a period or deferred for a future rate case.
Annual Report and Accounts 2011/12 National Grid plc 29
The following chart demonstrates the alignment between the elements of our strategy, the strategic objectives that will enable us to deliver it, the risks we face and what we have delivered this year.
30 National Grid plc Annual Report and Accounts 2011/12
Use this as a road map to the content on pages 32 to 55.
Annual Report and Accounts 2011/12 National Grid plc 31
Delivering our strategy
Our people are the foundation of what we do. It is through their actions that we will deliver our strategy; ensuring we have a skilled, engaged and dedicated workforce is essential to this. Delivering a safe and reliable network is the number one priority for our people. We also remain committed to being an innovative leader in energy management and to safeguarding our global environment for future generations.
The relationships we hold with our regulators, customers and communities continue to be important; we have made changes to forge even deeper relationships and broaden our engagement with stakeholders.
We continue to invest to create organic growth and evaluate other investment opportunities as they arise. Any investment we make will fit with our strategic goals, deliver a reasonable return and maintain the balance and spread of our businesses.
We are committed to developing our employees to the best of their abilities and to ensuring we have access to the widest possible pool of talent to meet the current and future requirements of our business.
Building an engaged workforce
We measure how engaged our people are through our employee engagement index, calculated from certain questions in our employee survey. Our 2012 employee survey included 68 questions and was completed by 84% of our employees. The results allow us to identify specific areas where we are performing well and those areas we need to improve.
We have undergone a significant amount of change within our US business having completed the transition to the new jurisdictional operating model including identifying 1,150 roles that have been removed from our structure. Significant change affects each employee differently and, as expected, this has affected our 2012 global employee engagement index, which has decreased compared to the last results in 2010. We are now embarking on a review of our UK operating model to ensure that it is scalable and structured correctly to deliver the increasing capital investment programme and to be successful under the new RIIO price control framework.
We want to make sure our people are as fully engaged as they can be. To demonstrate our ongoing commitment to this important area, one of our 2012/13 shared priorities is to increase levels of employee engagement across all our teams. We have created a Company wide framework called engaging for performance that explains what we believe contributes to increasing engagement, which in turn results in higher levels of performance.
Survey reports are produced at Company wide, region, business unit, function and team levels and associated action plans are created. The engaging for performance framework provides managers with access to practical and easy to use tools and guidance to support them when developing team action plans.
Communicating for success
Good communication helps employee engagement and we have multiple communication channels to ensure our more than 25,000 employees have access to information that is relevant to them and so that they feel connected to the business. We use our intranet site to make announcements, share our achievements and to communicate what we have learnt and other information useful to our people. We also have various open forums where senior leaders share key topics relevant to our business. These provide our people with the opportunity to ask questions and connect with leadership. We produce a monthly magazine and use various team forums and other traditional communication methods such as email broadcasts and discussion boards.
Aligning individual and corporate goals
The incentive plans for our Executive Directors include financial measures such as earnings, returns and cash flow which align their interests with the success of the Company. See the Remuneration Report section of Corporate Governance on pages 90 to 106 for more information.
Our strategy is cascaded to employees. This ensures that the objectives of each employee align with those of the Company and the actions required to deliver the strategy are allocated to and shared by all our people, connecting them to our corporate goals.
Our performance, talent and reward management process for managers links incentive compensation to an assessment of both what the individual has achieved and how those outcomes have been achieved, with reference to their individual objectives. This provides ongoing incentive for all managers to contribute to the achievement of our strategic goals and ensures that our top performers are recognised for their contributions.
32 National Grid plc Annual Report and Accounts 2011/12
We have reviewed the leadership, business and technical capabilities that we will need to ensure we are successful, including: driving process excellence; innovation; and stakeholder management. We are designing tools and processes to help elevate our capabilities in those areas and they will be supported by training programmes and other learning opportunities. We have invested in a range of technologies that will enhance the learning experience and reduce the cost associated with training delivery. We endeavour to continually improve the quality of our new talent development programmes and our focus on this has external recognition, including 2010 Ofsted grade 1 outstanding performance rating and UK Learning and Skills Improvement Service Beacon status.
Our graduate scheme is well regarded and we have continued to be an employer of choice. In 2012, we were ranked 84 in the Times Top 100 graduate employers, an improvement on 2011 when we entered the Top 100 for the first time. Our graduate retention levels are good, standing at 86%.
The foundations of leadership programme, aimed at the next generation of managers, continued to run throughout 2011. For our female employees, we also continued to provide access to the Springboard and Spring Forward development programmes in the UK and Women Empowered in the US. We appeared in the Times Top 50 Employers for Women 2012, appearing in the list since 2006.
Promoting inclusion and diversity
We aim to develop and operate our business with an inclusive and diverse culture, ensuring equal opportunity in recruitment, career development, training and reward for all employees regardless of race, gender, nationality, age, disability, sexual orientation, gender identity, religion and background. Where existing employees become disabled, our policy is to provide continued employment and training wherever practical. A focus for 2011/12 was creating a level playing field in the organisation. These policies support the attraction and retention of the best people, improve effectiveness, deliver superior performance and enhance our success.
Our employee resource groups, which cover areas including gender, ethnicity, disability, faith, sexual orientation, veterans and new employees, continue to have good membership. These groups deliver opportunities for professional development, networking, supporting our community relations activities and increasing the broader understanding of inclusion and diversity through workshops, presentations and other educational events.
Information on our inclusion and diversity policies can be found on the corporate responsibility section of our website.
Attracting the best people
As a result of our extensive capital investment plans in the UK, we need to increase our employee numbers in key parts of our business, particularly engineers and other technical roles. In 2011/12, we have recruited more than 450 engineers and, over the next nine years, we expect to recruit over 2,500 more.
We are establishing medium- and long-term talent pipelines and have launched an engineering entry programme for recent graduates with science, technology, engineering or maths (STEM) degrees. The two year comprehensive and structured training programme will provide a blend of practical experience with traditional training programmes and will help the recruits develop project management and development expertise, as well as
increase their technical knowledge and gain specialist experience of the energy sector. On successful completion, they will be appointed to a permanent role.
With an ageing workforce and declining interest in STEM subjects by young people, pressure on recruitment will continue for many years. Our long-term talent programmes will help to provide us with the expertise we need to be successful well into the future. This year in the UK, we worked with more than 3,900 school students giving them an insight into engineering, the energy sector and National Grid. We delivered 22 open days, ran two residential work experience week courses for nearly 100 15 year olds at our training centre, supported seven engineering education scheme projects, delivered 30 STEM enhancement days and many talks in schools. In the US, we face similar challenges to ensure we have access to top quality, well trained candidates to maintain the number and quality of our workforce over time. Over the next 10 years, we expect to fill around 800 management level roles that require an engineering background and we run a number of initiatives similar to those in the UK. In addition to our work in the US with school aged children to inspire interest in STEM subjects, we work with local community colleges on their energy utility technology programmes designed to give students the technical and practical skills required to work on the construction or maintenance of power lines. We also run our own engineering pipeline programme and have recently completed the second year. This six year development programme is designed to inspire promising students to become engineers and provide them with an opportunity for fast tracked employment with us.
Safety and reliability
Providing safe and reliable services is what our customers expect.
Keeping our people and the public safe
While our employee lost time injury frequency rate was 0.18, the same as 2010/11, this year we have seen accidents leading to the deaths of two members of the public and one contractor. We have investigated thoroughly and learnt from these tragedies.
We recognise the need to reinvigorate and reinforce our safety agenda across the Company. All our senior leadership team are asked to be visible safety leaders actively engaging with employees to drive our safety ambition forward and ensuring lessons learnt from any incidents are acted on as appropriate.
Further development of our safety culture will be critical to navigating the heightened risks that come with our expanding capital investment programme. Key parts of the business have undertaken safety culture surveys to capture what our employees think about how we manage safety and help us identify areas where we need to improve. We are committed to ensuring that everyone has the expertise, and exhibits the right behaviours, to work safely and without harm. We will also leverage our size, and learn from our partners, to identify best practices and ensure these are shared and implemented across our business.
A recent area of focus has been deploying a major accident hazard framework and risk methodology and standards that build greater structure into process safety and risk management. These standards have been developed collaboratively by technical specialists in the UK and US. The requirements are being discussed
Annual Report and Accounts 2011/12 National Grid plc 33
Delivering our strategy
How do we deliver? continued
with all of our relevant businesses and teams to ensure they are implemented and applied consistently. A review process has been established using technical specialists and third party independent assessors to aid sharing and consistent application of standards.
Our Executive Committee monitors progress against our safety goals monthly and the Boards governance arrangements for the oversight of safety are being strengthened.
Our licences and regulatory agreements set out reliability targets and these are linked to our revenue streams. Excluding the impact of storms in the US, we are pleased to report that we have substantially met all our reliability targets for the year. We failed one target in Massachusetts, however, due to our good performance against other targets for the state, this had no financial impact. After failing to meet some of our emergency standards of service last year and being fined £4.3 million by Ofgem, we are also pleased to report that we met all our standards of service in the UK this year.
Reliability is achieved through four interrelated actions: planning our capital investments to meet changing demand and supply patterns; designing and building robust networks; risk based maintenance and replacement programmes; and detailed and tested incident response plans.
Our UK Future Energy Scenarios publication outlines our forecasts for energy needs in the UK up to 2050. We use this to inform our capital investment plans and ensure our networks will deliver what is required in the future. In the US, we are taking part in the Eastern Interconnection Planning Collaborative, funded by the US Department of Energy, and working with other utilities, regulators and independent system operators to model future energy scenarios and consider their effects on the future of the electricity transmission grid by 2030.
Our construction teams work closely with our engineers to ensure that the networks designed and built will meet internal and external technical specifications and deliver the required levels of reliability once brought into service. Our UK Transmission business, where the majority of our capital investment will be undertaken, is PAS 55 and ISO 9001 certified, and has detailed procedures in place governing a project throughout each phase of scoping, design, commissioning and the transition to normal operations. Key roles on each project are defined and owners assigned, along with appropriate independent checks to ensure quality is maintained.
We collect and analyse a large quantity of data relating to network reliability including faults, failures and defect information. Using this information, asset health indices are assigned to the major equipment groups. These are then considered together with safety, system and environmental criticality to give replacement priorities that feed into our maintenance and replacement programmes.
Planning for a disaster can take a number of forms. In December, our US team worked with the Department of Homeland Security, FBI, local law enforcement and fire departments and other government agencies in a simulated attack on one of our generation plants. The simulation tested our emergency response plans, validating the plans already in place and identifying areas for improvement.
Our commitment to reliability extends to our efforts to restore electricity and gas to customers in a timely manner when an outage occurs. Major flooding of the Mohawk River, in the area of the Amsterdam and Rotterdam Junction in New York, led to significant damage to our gas facilities at several locations and resulted in
approximately 440 customers losing their gas supply. Permanent repairs to the damaged facilities would have taken months, an outcome unacceptable to both us and our customers. We embarked on a plan to bring in LNG, a remedy with little or no precedent in New York. With extensive work by our crews and cooperation of NYPSC, New York State Departments of Transportation and Environmental Protection, the local fire department and others, we were able to successfully restore gas services within a week. Our service territories were in some cases seriously affected by storms this year which resulted in large restoration efforts across our businesses. While we try and learn lessons from these events and improve how we deal with them, our responses to some of them, such as tropical storm Irene and the October snow storm, are subject to investigations by a number of our regulators.
Modernising our networks is an essential part of our continued growth. In the US, we anticipate receiving a regulatory order this summer to carry out a $44 million pilot in Worcester, Massachusetts. We expect to test customer choice with a goal of reducing energy use by 5% as well as implementing new distribution grid equipment that has the potential to make capital investment more efficient, reduce losses, improve reliability, and assist with storm restoration as we modernise the grid. This pilot will serve to show what will be possible across the US business.
As a responsible business, we are committed to protecting the environment for current and future generations.
Investing in and running electricity and gas networks means we use energy and raw materials, and produce waste. Our goal is to reduce any adverse effect we may have and we look for ways to improve the environment. We embrace new technology and methods to use resources more efficiently and sustainably, seek to responsibly refurbish existing assets and reduce waste through recycling and materials efficiency.
Reducing greenhouse gases
We have continued with our climate change and energy efficiency programmes and remain committed to our targets of a 45% reduction in Scope 1 and 2 greenhouse gas (GHG) emissions by 2020 and 80% by 2050. Refer to the glossary on page 193 for a definition of Scope 1 and 2 emissions. We continue to look for new technology or more efficient equipment that will help us achieve these goals and we have outperformed a number of targets for emissions during the year, including some tied to incentive revenues. Our total Scope 1 and 2 emissions for 2011/12 were 8.7 million tonnes carbon dioxide equivalent. This represents a 55% reduction on our 1990 base line. We have refreshed our rolling five year GHG reduction plans and, although our 2011/12 outturn is better than our 2020 target, we have many challenges through the next few years that will require considerable focus in the business.
We have a number of ongoing initiatives that have helped achieve these results. Some of our gas distribution networks in both the UK and US consist of old metallic pipe, which contributes significantly to the gas losses from our system. We have replaced around 2,500 kilometres of this leak prone pipe during the year across our UK and US businesses and have estimated the replacements in the UK will achieve the equivalent of a 3% reduction in gas losses each year.
34 National Grid plc Annual Report and Accounts 2011/12
In the UK, we also now use computerised pressure management equipment that matches system pressures with demand, improving safety, driving considerable reductions in gas losses and, consequently, reducing the level of our greenhouse gas effects. We also continued our focus on reducing the losses of SF6, a powerful greenhouse gas, from high voltage switchgear on our system through improved leak detection and repair processes and continue research to identify alternatives.
Supporting the move to a low carbon economy
In the UK, we are already developing networks to facilitate new generation, eg commissioning Cleve Hill substation to enable London Array Limited to connect the worlds largest wind farm.
In the US, we are investing in oil to gas conversions in customer premises and installing gas infrastructure and services to support new construction. Over the last three years we have connected over 120,000 new gas heating customers. Demand for new interconnections of green generation in the US is on the rise with a 70% increase in the applications received in New York and New England in 2011. These included combined heat and power, farm waste, fuel cells, hydro, solar and wind projects. In response to this escalating market demand we have created two new groups within our business to process the requests efficiently and ensure they are connected in accordance with the appropriate technical standards and the applicable state tariffs.
We recently installed 32 new electric vehicle charging stations in Massachusetts under the Coulomb Technologies ChargePoint America programme. Through programmes such as these, we offer our customers more sustainable energy options that help to protect the environment.
Stakeholders views form an integral part of the way we do business and make decisions.
Meeting the needs of stakeholders
Our stakeholder engagement principles include:
For example, in the course of developing our electricity and gas transmission and gas distribution business plans for RIIO-T1 and RIIO-GD1, we held 26 workshops, talking directly to several hundred stakeholders with a broad range of interests. We produced three written consultations, held numerous forums and focus groups, undertook in-depth telephone interviews and surveyed opinions from over 10,000 customers. We used an independent third party to facilitate our stakeholder engagement so we could be sure we were not unwittingly influencing, misunderstanding or misinterpreting what our stakeholders were saying. For our Worcester smart grid pilot, we held a two day appreciative inquiry summit to engage with the local community including local government, businesses and households. We recognise active participation from a broad
cross section of the community will be important to complete the pilot successfully.
Our regulators remain an important area of focus for our stakeholder engagement activities. Through our new US jurisdictional focus, we are better able to communicate with our regulators, ensuring they have a point of contact that understands their perspective and is committed to meeting their needs. We have also opened an office in Brussels to establish a stronger and more visible presence with EU institutions and policy makers on key strategic issues facing us in the years to come.
Participation by our employees on other bodies allows us to engage more broadly, and we aim to be supportive of roles on industry boards and other groups. For example, our US vice president, engineering standards and policy, currently sits on the US Department of Transportations Technical Pipeline Safety Standards Committee. Engagement such as this allows us to participate in and inform debates as they occur and to learn from the best practices of others. In the wake of the San Bruno gas explosion, the US Government passed into law the Pipeline Safety, Regulatory Certainty and Job Creation Act. Some of the new rules and safeguards coming out of the law are a direct result of the issues discussed by the Committee.
Improving customer service
We recognise the importance of good customer and community relationships. Success is evident from the improved results in our key Ofgem customer satisfaction studies in the UK as shown in our KPIs on page 39. We participate in four studies in the J.D. Power and Associates customer satisfaction study in the US. Our target goal was a one quartile improvement in each of the four studies. We achieved this in the Business Gas study. However, in the Business Electric and Residential Electric studies, we remained in the same quartile and in the Residential Gas study we fell one quartile.
In late 2011, we opened our new integrated UK Gas Distribution customer centres in Hinckley and Leicester, which combine cutting edge technology and specialist training to offer a fresh approach to customer service. The new technology provides greater visibility of all the work we are doing, allowing our employees to respond more effectively and resolve more enquiries on the first call, resulting in improved service and customer satisfaction. The centres provide our customers with a single point of contact 24 hours a day, seven days a week to ensure we can always maintain a high level of service and meet our commitments. The importance of this work in the UK will be reinforced by requirements under the new RIIO price control, where customer satisfaction is a specific output measure linked to our potential revenue.
Working with our communities
We believe that helping local businesses is one of the best ways to help the communities we serve. If they are strong and growing we will be too. Through our community investment initiatives, we aim to identify and support local projects that can have a positive effect in the communities in which we operate.
In the US, since 2003, our economic development grants have totalled $53 million and have helped create or retain more than 19,000 jobs. In December 2011, we provided $1 million to Albany, New York for use in their State Street revitalisation. The grant will help build new footpaths, underground conduits, decorative lighting and other amenities. This revitalisation programme is expected to help the citys economic growth by attracting more businesses, residents and visitors to the area.
Annual Report and Accounts 2011/12 National Grid plc 35
Delivering our strategy
How do we deliver? continued
We have even extended our outreach to include the communities in which our key suppliers operate. The Global SpirIT initiative raises funds for the education of underprivileged children in India, where we have been working with IT suppliers for over 17 years.
Balance and spread of businesses
We deliver our returns to shareholders through a balance of equity growth and cash returned in the form of a growing dividend. This is supported by the complementary features of the businesses which, together, make up our group.
National Grid today consists of a balanced blend of distinct regulated businesses in the UK and US and some non-regulated businesses, primarily in the UK. This includes a mixture of cash generative developed assets with minimal investment requirements (such as our existing interconnectors and National Grid Metering), businesses with low to medium levels of growth and positive cash generation (such as our UK and US distribution businesses) and businesses with high levels of investment and growth (such as our UK electricity transmission business and potential new non-regulated investments).
We continue to develop our balance and mix of businesses through cycles of investment and cash generation. Our target is to maximise shareholder value while delivering appropriate levels of both cash generation, to support dividends, and investment in assets, to support equity growth and future revenues.
We consider a number of factors when assessing any current or future business contribution to the group. This includes its contribution to cash flows and earnings, its asset base growth and funding requirements and the regulatory or commercial framework applying to that business. On an ongoing basis we review the business balance, considering our strategic objectives and long-term growth opportunities.
Where an individual business is not expected to exhibit the range of characteristics we are looking for within a reasonable timeframe, or where we are offered a higher value for the business than we might place on it, we will consider selling that business. In the last year, we have sold Seneca-Upshur, a gas and oil exploration and production business in the US, and our OnStream non-regulated metering business in the UK and we await the final regulatory approvals for the sale of our Granite State Electric and EnergyNorth businesses in New Hampshire which we announced in December 2010.
We aim to maximise our returns within the constraints of our regulatory agreements, while continuing to invest for future growth.
We have seen a good financial performance this year with positive movement in all our financial KPIs excluding the impact of timing differences and major storms, where relevant.
Capital investment programme
A feature of our price controls and rate plans is that we earn a return on our regulated asset base. As a result, as our regulated asset base increases our returns should similarly increase. We continue to invest in our regulated asset base and, in the UK, our RIIO
submissions have reflected a need for investment over the eight year price control in excess of £31 billion for our UK Transmission and UK Gas Distribution businesses. This is dependent on the location and number of new connections required and, if achieved, will represent an average cumulative annual growth rate in our regulated asset value of over 8%.
This amount of investment will not be without its challenges: obtaining planning permission for major projects is time consuming and can create delays; finding and developing enough people with the right skills will be difficult; and managing the costs of key inputs that are forecast to increase faster than the rate of inflation due to worldwide demand for these products, will also pose a challenge.
In the US, we will continue to invest in our regulated asset base with a focus on modernising and maintaining our network and, where appropriate, increasing its capacity. For example, work is underway with FERC and other utilities on the construction of the New England East-West Solution. This is a new transmission line in southern New England that will increase capacity in a constrained area of the grid and once completed will represent a significant investment in a new transmission asset.
We continue to look for smart investments in non-regulated businesses and are assessing expansion plans for our Grain LNG business.
Despite the Government withdrawing funding for the proposed carbon capture and storage (CCS) project at Longannet, we believe CCS to be an important element in the Governments strategy to achieve its carbon reduction targets. We are working with several UK emitters to develop CCS projects; these are seeking funding through a Government competition that is scheduled for the second half of 2012.
Work continues on plans for an interconnector between the UK and Belgium, a joint project with the Belgian transmission system operator which will be the first electricity link between the two countries. The 1,000 megawatt undersea cable will run between Zeebrugge and Richborough and is expected to enter commercial operation in 2018.
Remuneration from investment
In the UK, we work closely with Ofgem and the Health and Safety Executive, the main safety regulator in the UK, to balance the needs of all stakeholders for a safe and reliable network with a price control that provides the required return to allow us to operate our businesses effectively. We will only accept a price control settlement if we believe that it achieves this balance. In the US, some of our rate plans do not include capital trackers and therefore spend on capital programmes may be unremunerated until we file a new rate case. We carefully track our capital spending compared to our rate allowances and, when we believe additional spending is required, we may file a new rate case.
For more information on the features of our price controls and rate plans, refer to pages 25 to 29.
Incentives and outperformance
In the UK, achieving output targets to earn incentive revenue is a key element of our ability to provide superior financial returns. Our price control plans have historically included a range of incentive mechanisms and under RIIO the importance of incentive revenue will increase. Examples of our current incentive mechanisms include:
36 National Grid plc Annual Report and Accounts 2011/12
Our US rate plans generally do not feature the same variety of incentive mechanisms used in the UK, however, some include earned savings mechanisms that allow us to retain a proportion of the savings we achieve through improving energy efficiency, with the balance benefiting customers. In addition, the electric generation power supply agreement with LIPA contains a performance-based incentive and penalty mechanism. We may earn or lose up to $4 million depending on how well we operate the generation units as measured by reliability, efficiency and capacity metrics.
Under our UK price controls and some of our US rate plans, our revenues include an imputed cost of debt. We manage our interest rate risk using fixed- and floating-rate debt and derivative financial instruments including interest rate swaps, swaptions and forward rate agreements. Where we actively manage our interest rate risk, we seek to minimise total financing costs (being interest costs and changes in the market value of debt), subject to constraints, with the aim of outperforming the imputed cost of debt. The Finance Committee regularly monitors performance by comparing the actual total financing costs with those of a comparable, passively managed, benchmark portfolio.
We are undertaking a number of transformation initiatives to improve the efficiency and effectiveness of our operations.
Our global information systems (IS) transformation project will replace ageing IS infrastructure that currently limits our ability to deliver reliable IT systems and inhibits the creation of platforms for growth. Under a partner provided approach, our IS services will offer a more flexible, cost effective, transparent and responsive delivery model. Our UK Gas Distribution front office programme has progressed significantly during the year and is already showing benefits. The final deployment of the system, which will help our repair and construction teams, is on track to complete ahead of the Olympics this summer. More information on these programmes can be found in the case studies on pages 48 and 49.
In the US, we are replacing two legacy information systems along with a range of ancillary systems. This change, in conjunction with various process improvement initiatives within our US finance function, simplifies our cost allocation methodology, allows better jurisdictional reporting and improves controls over our financial reporting processes.
Each of these transformation initiatives contributes to our ability to support our future growth, improve operational performance and efficiency, and respond to the needs of our stakeholders.
As discussed on pages 24 to 29, our allowed revenues are set in reference to an expected cost to deliver our services. We must manage our costs closely within that framework as, without the permission of our regulators, we may not be able to increase our revenues to compensate for cost overruns. We set budgets and assign owners for cost centres within the business who are responsible for delivering set outputs within that budget.
Annual Report and Accounts 2011/12 National Grid plc 37
Delivering our strategy
Annual Report and Accounts 2011/12 National Grid plc 39
Delivering our strategy
The Board is committed to the long-term success of the Company and the protection of our reputation and assets. It ensures we maintain a sound system of internal control in order to safeguard the interests of our shareholders.
Our system of internal control, and in particular our risk management process, has been designed to manage rather than eliminate material risks to the achievement of our strategic and business objectives while also recognising that any such process can provide only reasonable, and not absolute, assurance against material misstatement or loss. This process complies with the Turnbull working party guidance, revised October 2005, and additionally contributes to our compliance with the obligations under the Sarbanes-Oxley Act 2002 and other internal assurance activities.
In accordance with the UK Corporate Governance Code and the schedule of matters reserved to the Board, the Board retains overall responsibility for our system of internal control and monitoring of its effectiveness. Our system of internal control is based on thorough and systematic processes for the identification and assessment of business critical risks and their management and monitoring over time. In depth reports are provided from both line managers and internal assurance providers such as corporate audit, corporate risk and ethics and compliance. These reports are provided to the Committees in relation to their specific areas of responsibility and they, in turn, provide reports to the Board.
The Board reviews the effectiveness of our internal control process, including around financial reporting, on an annual basis to ensure it remains robust and to identify any weaknesses. The latest review covered the financial year to 31 March 2012 and included the period to the approval of this Annual Report and Accounts. It included:
Risk management process
Our risk management process is designed to protect value and enhance performance by building vigilance, agility and resilience into our management process. The process ensures that risks are assessed against a uniform set of criteria, continuously managed and regularly reported in a visible and structured manner. The output informs management decisions and provides assurance to management and the Board, helping to safeguard our assets and reputation.
Our risk management process is based on comprehensive bottom-up and top-down assessments of a wide range of risks, which typically include strategic, operational (including safety and reliability), financial and project risks. All businesses and the corporate and global functions that support them, prepare and maintain risk registers to capture their key risks and the actions being taken to manage them. Executive Directors and other senior management review, challenge and debate these bottom-up results, producing an overall evaluation of the risks facing the Company. The Executive, Audit and Risk & Responsibility Committees review the risk profile and any changes to it in accordance with their terms of reference, and the Audit Committee reviews the overall risk management process.
In the last year, a number of enhancements to the process were initiated. The corporate risk function was reorganised and brought into the strategic planning and corporate development function to provide appropriate regional focus in line with the new operating model and to forge stronger links with strategic planning activities. The Board considered the characteristics of our corporate risk appetite and the outcome will determine the appropriate risk appetite for us in the pursuit and delivery of our corporate strategy. New reporting formats, including dashboards incorporating risk timings and mitigation objectives, were developed and rolled out to focus the risk management debate toward future actions. Also, the implementation of a governance, risk and compliance system that will improve our ability to link risks, automate risk metrics and capture associated assurance data has commenced.
Compliance management process
Our enterprise wide compliance management process is consistent with, and complementary to, our risk management process and provides assurance to senior management on the effectiveness of control frameworks to manage key internal and external obligations, and also highlights any instances of significant non compliance with those obligations. External obligations are driven primarily by key legal and regulatory requirements, while internal obligations focus on compliance with our corporate policies and procedures.
In examining a business areas compliance performance, we look for any actual or potential instances of non compliance and consult with other assurance providers. Before issuing an opinion on an areas compliance control framework, we obtain the views of experts in the field such as internal safety and environmental specialists.
The Executive, Risk & Responsibility and Audit Committees each receive a report twice a year setting out our key internal and external compliance obligations and any significant non compliance with those obligations, together with compliance opinions and action plans to improve controls where necessary.
Our risk management process has identified the following risk factors that could have a material adverse effect on our business, financial condition, results of operations and reputation, as well as the value and liquidity of our securities. Any investment decision regarding our securities and any forward-looking statements made by us should be considered in the light of these risk factors and the cautionary statement set out on the back cover.
Delivering our strategy
Risks to delivery continued
Annual Report and Accounts 2011/12 National Grid plc 43
Delivering our strategy
Risks to delivery continued
When appropriate, management implements processes, procedures and controls to minimise the likelihood of a risk occurring or the potential impact if it does occur. Below are examples of the actions implemented to address the risks discussed above. It is not possible to eliminate a risk and even where a response is in place and effective, a risk may still occur.
44 National Grid plc Annual Report and Accounts 2011/12
Annual Report and Accounts 2011/12 National Grid plc 45
Delivering our strategy
Risks to delivery continued
46 National Grid plc Annual Report and Accounts 2011/12
The Board considers that it is imperative to have accurate and reliable information to enable informed and timely decisions to be taken that further our objectives. Key elements in managing information assurance risks include education, training and awareness.
These initiatives emphasise the importance of information security, the quality of data collection and the affirmation process that supports our business transactions, evidencing our decisions and actions. All communication channels, including training for doing the right thing, make it clear that the accurate and honest reporting of data and other information must never be compromised. These initiatives are supported by the letter of assurance process in which managers affirm, among other things, they have control frameworks in place to ensure data and other information is reported accurately. In line with ongoing transformation initiatives, we continue to monitor and evolve our control processes.
In addition to the risk management process set out on the previous pages, we have specific internal mechanisms to govern the financial reporting process and the preparation of the Annual Report and Accounts. Our financial controls guidance sets out the fundamentals of internal control over financial reporting which are applied across the group and the group accounting guides provide guidance on our accounting policies. Teams of controls specialists are embedded within the business to provide support in developing, implementing and operating effective internal controls and ongoing assurance to management that financial controls are both designed and operating effectively.
Within our processes we have system, transaction and oversight controls. In addition, our businesses prepare detailed monthly management reports which include analysis of their results along with comparisons to relevant budgets, forecasts and prior year results. These are presented to and challenged by senior management within Finance, including the Finance Director, the group financial controller and the global tax and treasury director. The Finance Director, in turn, presents a consolidated management report to the Board.
These reviews are supplemented by quarterly performance reviews, chaired by the Chief Executive. They discuss historical results and expected future performance and involve senior management from both operational and financial areas of the business.
Working with management, including the Chief Executive and Finance Director, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as at 31 March 2012. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives, however the effectiveness of any system of disclosure controls and procedures has limitations including the possibility of human error and the circumvention or overriding of the controls and procedures. Even effective disclosure controls and procedures provide only reasonable assurance of achieving their objectives. Based on the evaluation, the Chief Executive and Finance Director concluded that the disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed in the reports that we file and submit under the Exchange Act is recorded, processed, summarised and reported as and when required and that such information is accumulated and
communicated to our management, including the Chief Executive and Finance Director, as appropriate, to allow timely decisions regarding disclosure.
Our management, including the Chief Executive and Finance Director, has carried out an evaluation of our internal control over financial reporting pursuant to the Disclosure and Transparency Rules and Section 404 of Sarbanes-Oxley. As required by Section 404, management is responsible for establishing and maintaining an adequate system of internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act). Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management evaluation of the effectiveness of the Companys internal control over financial reporting was based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that our internal control over financial reporting was effective as at 31 March 2012.
PricewaterhouseCoopers LLP, which has audited our consolidated financial statements for the year ended 31 March 2012, has also audited the effectiveness of our internal control over financial reporting. Their attestation report can be found on page 111.
During the year, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, it.
Annual Report and Accounts 2011/12 National Grid plc 47
Delivering our strategy
48 National Grid plc Annual Report and Accounts 2011/12
As we enter each new year, we assess our strategy and set priorities for the coming period. These priorities cover a broad array of actions that will collectively, over time, deliver our strategy. Some examples of the actions taken this year can be found in the How do we deliver? section on pages 32 to 37. In this section, we provide a closer look at some of our priorities and how we have performed against them during the year.
Annual Report and Accounts 2011/12 National Grid plc 49
Delivering our strategy
What we delivered this year
50 National Grid plc Annual Report and Accounts 2011/12
Annual Report and Accounts 2011/12 National Grid plc 51
Delivering our strategy
What we delivered this year
52 National Grid plc Annual Report and Accounts 2011/12
Annual Report and Accounts 2011/12 National Grid plc 53
Delivering our strategy
What we delivered this year
54 National Grid plc Annual Report and Accounts 2011/12
Annual Report and Accounts 2011/12 National Grid plc 55
56 National Grid plc Annual Report and Accounts 2011/12
We report our financial results and position in accordance with IFRS.
In considering the financial performance of our businesses and segments, we analyse each of our primary financial measures of operating profit, profit before tax, profit for the year attributable to equity shareholders and earnings per share into two components.
The first of these components is referred to as an adjusted profit measure, also known as a business performance measure. This is the principal measure used by management to assess the performance of the underlying business.
Adjusted results exclude exceptional items, remeasurements, stranded cost recoveries, and the amortisation of acquisition-related intangibles. These items are reported collectively as the second component of the financial measures.
Accounting policy T on page 117 explains in detail the items which are excluded from our adjusted profit measures.
Adjusted profit measures have limitations in their usefulness compared with the comparable total profit measures as they exclude important elements of our financial performance. However, we believe that by presenting our financial performance in two components it is easier to read and interpret financial performance between periods, as adjusted profit measures are more comparable having removed the distorting effect of the excluded items. Those items are more clearly understood if separately identified and analysed. The presentation of these two components of financial performance is additional to, and not a substitute for, the comparable total profit measures presented.
Management uses adjusted profit measures as the basis for monitoring financial performance and in communicating financial performance to investors in external presentations and announcements of financial results. Internal financial reports, budgets and forecasts are primarily prepared on the basis of adjusted profit measures, although planned exceptional items, such as significant restructurings, and stranded cost recoveries are also reflected in budgets and forecasts. We separately monitor and disclose the excluded items as a component of our overall financial performance.
Reconciliations of adjusted profit measures to the total profit measure, that includes both components can be found on page 120.
As discussed on pages 24 to 29, our allowed revenues are set in accordance with our regulatory price controls or rate plans. We calculate the billing rates we charge our customers based on the estimated volume of energy we believe will be sold during the coming period. The actual volumes sold will differ from this estimate and therefore our total actual revenue will be different from our total allowed revenue. These differences are commonly referred to as timing differences. If we collect more than the allowed level of revenue, the balance must be returned to customers in subsequent periods, and if we collect less than the allowed level of revenue we may recover the balance from customers in subsequent periods. The amounts calculated as timing differences are estimates and subject to change until the variables that determine allowed revenue are final.
Our operating profit for the year includes an estimated in year over collection of £18 million (2010/11: £274 million over collection; 2009/10: £163 million under collection) and our closing balance
of over-recovery at 31 March 2012 was £90 million. All other things being equal, the majority of that balance would normally be returned to customers in the following year. The table below shows adjusted operating profit and operating profit, adjusted for timing differences.
Our financial results are reported in sterling. Transactions for our US operations are denominated in dollars and so the related amounts that are reported in sterling depend on the dollar to sterling exchange rate. As the average rate of the dollar at $1.60:£1 in 2011/12 was weaker than the average rate of $1.57:£1 in 2010/11, the same amount of revenue, adjusted operating profit and operating profit in dollars earned in 2010/11 would have been reported as £135 million, £21 million and £26 million lower respectively if earned in 2011/12. In 2009/10, the average rate was $1.58:£1; if the revenue, adjusted operating profit and operating profit in dollars recognised in 2009/10 was earned in 2010/11 it would have been reported as £29 million, £3 million and £4 million higher respectively.
The balance sheet has been translated at an exchange rate of $1.60:£1 at 31 March 2012 ($1.61:£1 at 31 March 2011).
Our financial KPIs are set out on pages 38 and 39.
Total shareholder return (TSR)
We measure TSR as a KPI on a cumulative three year basis. The measure reflects changes in our share price and also assumes that dividends paid to shareholders over that period were reinvested in our shares. Cumulative TSR for the period from 1 April 2009 to 31 March 2012 was 51% (1 April 2008 to 31 March 2011: 4%; 1 April 2007 to 31 March 2010: -3%). This reflects the fact that, following a sharp fall in equity prices amid the turbulence in the financial markets during 2008/09, the subsequent recovery in the following three years has reversed these losses and resulted in further growth in TSR.
Group return on equity
We measure our performance in generating value for our shareholders by dividing our annual return by our equity base. We have changed the calculation methodology for group return on equity to better align with the methodology used for our new return on capital employed (RoCE) metric discussed on page 59.
Our annual return consists of the groups adjusted earnings, amended for regulatory and accounting differences including, where applicable, timing differences, the impact of inflation on our UK RAV, pension and other post-employment benefits, certain capital related operating costs, the exclusion of non debt related interest, and changes to the tax expense resulting from the tax impact of these adjustments. Our equity base consists of opening capital employed less opening net debt. Opening capital employed consists of opening UK RAV, plus opening US rate base, plus the opening net book value of assets and liabilities of our non-regulated businesses and joint ventures, plus opening goodwill. Opening net debt is adjusted for significant individual transactions during the year such as rights issues and significant acquisition or disposal activities.
Annual Report and Accounts 2011/12 National Grid plc 57
Financial performance continued
Using the revised methodology, we monitor our performance using the annual return each year. For 2011/12, our group ROE was 10.9%, compared with 10.8% in 2010/11 and 12.6% in 2009/10. The return in 2011/12 was in line with the prior year but was restrained by the significantly higher US storm costs. Excluding the higher major storm costs, the 2011/12 return was 11.3%, the increase driven by growth in the Companys pre timing earnings. The high return in 2009/10 was primarily driven by inflation fluctuations in the UK affecting our allowed revenues and interest expense associated with our RPI linked bonds.
Regulated controllable operating costs
We measure regulated controllable operating costs as a proportion of our regulated assets, as measured by our UK RAV and our US rate base.
This ratio decreased to 6.7% in 2011/12, compared with 7.2% in 2010/11 and 7.5% in 2009/10 on a constant currency basis, reflecting cost savings in our US business following the restructure and the efficient growth of our regulated asset base.
Adjusted earnings per share
We monitor our financial performance during the year by measuring adjusted earnings per share. This and other profit measures are described on the following pages.
Dividends and dividend cover
The proposed total ordinary dividend for 2011/12 amounts to £1,401 million or 39.28 pence per ordinary share. This represents an increase of 8% over the previous years ordinary dividend per share of 36.37 pence.
The table below shows the ordinary dividends paid or payable by National Grid for the past five financial years.
Dividends expressed in dollars per ADS in the table above reflect the amounts paid or payable to ADS holders, rounded to two decimal places.
The final dividend proposed in respect of each financial year is reported in the financial statements for the following year. Therefore, the proposed final dividend for 2011/12 of 25.35 pence per share, amounting to approximately £905 million (assuming all dividends are settled in cash), will be reported in the financial statements for the year ending 31 March 2013.
58 National Grid plc Annual Report and Accounts 2011/12
In order to deliver sustainable growth, we must be disciplined in the way we manage our balance sheet. The principal measure we use to monitor financial discipline is interest cover, being a measure of the cash flows we generate compared with the net interest cost of servicing our borrowings. The table below shows our interest cover for the last three years:
The primary reasons for the increase in 2011/12 were a fall in finance costs driven by interest rates on short-term instruments combined with benefits from our 2010/11 debt buy back programme partially offset by a small decrease in our operational cash inflows for the year.
Return on capital employed
RoCE is designed to provide a performance comparison between our regulated UK and US businesses and is one of the measures that we use to make strategic and investment decisions around our portfolio of businesses. Our RoCE calculation is a post-tax return on assets measure based on an IFRS operating profit adjusted, where applicable, for timing differences, the impact of inflation on our UK RAV and differences between the treatment of certain costs by regulators and their treatment in the financial statements, including taxation, pension and other post-employment benefits, and certain capital related operating costs. We also deduct taxation at the statutory rate. The capital employed is the opening UK RAV and opening US rate base.
The table below shows the RoCE for our businesses over the last three years:
The increase in UK RoCE is due to higher operating profit following the benefits of inflation on our RPI-X price controls partially offset by growth in our asset base. The fall in the US RoCE is due to higher storm costs, partially offset by savings driven by our restructuring. Excluding the impact of higher major storm costs, the US RoCE would have been 7.6%, an increase of 0.5% compared with 2011.
The following chart shows the five year trend in adjusted profit attributable to equity shareholders of the parent (adjusted earnings) and adjusted earnings per share.
The following chart shows the five year trend in profit attributable to equity shareholders (earnings) and earnings per share.
In accordance with IAS 33, all earnings per share and adjusted earnings per share amounts for comparative periods have been restated as a result of shares issued via scrip dividends and the bonus element of the rights issue.
Diluted adjusted earnings per share and diluted earnings per share are shown in the table below:
The principal reason for the dilution in each year relates to employee share plans.
Annual Report and Accounts 2011/12 National Grid plc 59
Financial performance continued
Adjusted operating profit
The £105 million decrease in adjusted operating profit in 2011/12 to £3,495 million is primarily due to:
Partially offset by:
Other operating costs were relatively flat year on year, reflecting reduced costs in our US Regulated segment as a result of the restructuring, offset by higher costs within the UK due to inflation and additional staffing costs to support both the GDFO system implementation in our UK Gas Distribution business and the ongoing increase in our capital investment programme in UK Transmission.
The £479 million increase in 2010/11 to £3,600 million was primarily due to the favourable timing differences that adversely affected the current year and increased revenues in our US Regulated segment following the introduction of new rates in several of our utilities.
More information can be found in the discussion of our segments on pages 62 to 71.
Adjusted net finance costs
The £217 million decrease in adjusted net finance costs in 2011/12 to £917 million is primarily due to lower interest rates on short-term instruments; lower debt repurchase costs that had peaked in the prior year due to the use of surplus funds from the rights issue; the benefit of lower average net debt as a result of those buy backs; and a favourable variance in pension interest primarily due to a higher than expected rate of return on US pension assets. The slight increase in 2010/11 compared with 2009/10 primarily reflected lower net pension interest due to higher plan assets and higher rates of return on those assets, offset by higher accretions on index-linked debt following the return of UK inflation.
Adjusted tax for 2011/12 was a charge of £755 million (2010/11: £722 million; 2009/10: £553 million). This represents an effective tax rate of 29.2% (2010/11: 29.2%; 2009/10: 28.0%). The 2011/12 effective tax rate before exceptional items, remeasurements and stranded cost recoveries did not change from 2010/11 because a fall in prior period tax credits was offset, primarily by a 2% reduction in the UK corporation tax rate and a change in the UK/US profit mix where higher UK profits were taxed at UK tax rates, which are lower than those in the US. The increase in the rate from 2009/10 to 2010/11 mainly arose from a change in the UK/US profit mix where higher US profits were taxed at US tax rates that are higher than those in the UK. More information on taxation can be found in note 5 to the consolidated financial statements.
Exceptional items, remeasurements and stranded cost recoveries
Exceptional charges of £122 million in 2011/12 consisted of restructuring charges of £101 million, environmental charges of £55 million and impairment charges of £64 million, offset by net gains on the disposals of two subsidiaries of £97 million and other net gains of £1 million.
Exceptional charges of £350 million in 2010/11 consisted of restructuring costs of £89 million, environmental charges of £128 million, impairment costs and related charges of £133 million and other charges of £15 million, offset by net gains on disposals of three subsidiaries and an associate of £15 million.
Exceptional charges of £268 million in 2009/10 consisted of restructuring charges of £149 million, environmental charges of £63 million and other charges of £67 million, offset by net gains on disposals of £11 million.
Exceptional finance costs and remeasurements
There were no exceptional finance costs in 2011/12. There were £73 million of exceptional finance costs during 2010/11 relating to the early redemption of debt following the rights issue in June 2010, offset by £43 million of exceptional interest income relating to tax settlements in the US. There were £33 million of exceptional finance costs during 2009/10 relating to the early redemption of debt. Financial remeasurements relate to net gains and losses on derivative financial instruments, 2011/12 included a loss of £70 million (2010/11: £36 million gain; 2009/10: £81 million gain). The financial element of commodity contract revaluations was nil in 2011/12 (2010/11: nil; 2009/10: £1 million loss).
Stranded cost recoveries
Stranded cost recoveries decreased by £88 million to £260 million as the costs were substantially recovered during the year. (2010/11: £348 million; 2009/10: £369 million).
Taxation related to exceptional items, remeasurements and stranded cost recoveries changes each year in line with the nature and amount of transactions recorded.
In addition, exceptional tax from 2011/12 included an exceptional deferred tax credit of £242 million arising from a reduction in the UK corporation tax rate from 26% to 24% applicable from 1 April 2012. A similar reduction in the UK corporation tax rate in 2010/11 from 28% to 26% resulted in a £226 million deferred tax credit in that year.
An additional exceptional tax credit of £59 million arose in 2010/11 from settling a number of KeySpan pre acquisition items with the US tax authorities. In 2009/10 a £41 million exceptional tax charge arose due to a change in US tax legislation under the Patient Protection and Affordable Care Act.
More information on exceptional items, remeasurements and stranded cost recoveries can be found in note 3 to the consolidated financial statements.
60 National Grid plc Annual Report and Accounts 2011/12
Reconciliation of adjusted operating profit to total operating profit
Adjusted operating profit is presented on the face of the income statement under the heading operating profit before exceptional items, remeasurements and stranded cost recoveries.
Reconciliation of adjusted operating profit to adjusted earnings and earnings
Adjusted earnings is presented in note 6 to the consolidated financial statements, under the heading adjusted earnings.
Reconciliation of adjusted earnings per share to earnings per share
Adjusted earnings per share is presented in note 6 to the consolidated financial statements.
Reconciliation of adjusted profit before tax to total profit before tax
Adjusted profit before tax is presented on the face of the income statement under the heading profit before tax before exceptional items, remeasurements and stranded cost recoveries.
Reconciliation of adjusted operating profit excluding timing differences and major storms to total operating profit
Adjusted operating profit excluding timing differences and major storms is discussed in the Business Review.