Centrica plc (LON:CNA)

Earnings Call: H2 2014

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Feb 19, 2015

Good morning, everyone, and thank you very much for coming today. This is the first time I've had the opportunity to address you directly, having joined as Chief Executive on January 1. Our Chairman, Rick Haythornthwaite, is here in the front row, and I'm also joined today by Jeff Bell, Interim CFO, Mark Hanafin, Head of Centrica Energy, and Ian Peters, Head of British Gas. We're going to take about 50 minutes for our presentation. Before Jeff goes through the results in detail, I'll talk about the impact of oil and gas prices on the group, our response, and the thinking behind the difficult decision to rebase our dividend. I'm extremely aware how painful such a cut will be for our shareholders. After Jeff's finished, I'll talk about my impressions of the business and our response to the current environment and say more about the strategic review that we've announced today. Mark and Ian will then join us on the stage to take your questions. Since starting here 50 days ago, I've spent a lot of this time visiting our operations, meeting our teams, getting an early view of how we serve our customers, and building a deeper understanding of the group. I've also spent time since December meeting key external stakeholders, including our regulator, NGOs and opinion formers, the media, and politicians from the three main parties. These interactions have underscored the fact that Centrica occupies a vital role in the energy affairs of the U.K. in particular, and also in the U.S. and Ireland. We're a customer-facing company, and our principal role is to deliver excellence in the supply and reliability of energy and services to those customers. Although we're facing some significant challenges at present, it's clear to me that Centrica has built a solid set of positions from which we're going to be able to continue to play an important role in the developing energy markets on both sides of the Atlantic. The needs of our customers are changing, and they're demanding secure, reliable, affordable energy, and a sustainable approach to its provision. Meeting those needs is a huge responsibility. I'm already impressed by the quality of our people and their commitment to serving our customers competitively and with integrity, developing new offers and services, and providing secure and reliable energy supplies as we aim to deliver long-term shareholder value. I'd like to thank Sam Laidlaw for his leadership and development of the company over the last 8 years. As you'll have seen from our announcement this morning, 2014 earnings were significantly down, impacted particularly by the weather and falling oil and gas prices during the year. Group-adjusted earnings in 2014 were GBP 962 million, down 30% relative to 2013. Earnings per share were 19.2 pence relative to 26.6 pence in the prior year. Before Jeff takes you through our 2014 results in detail, I'd first like to cover the impact of oil and gas prices on the group, our response, and the thinking behind the board's decision to rebase the dividend. I'm extremely aware of how painful such a cut will be for our shareholders, including all of our retail shareholders. Let me start with oil and gas prices. Brent oil prices have lost about half their value, falling from $110 a barrel in July to $80 a barrel at the time of our interim management statement in November, to today's level of around $60. Gas forward wholesale prices for 2015 have also continued to fall from a forecast average level of 55 pence per therm as recently as mid-December, to 49 pence today. The current environment will have a significant effect on 2015 earnings and cash flows, with the main impact being on Centrica Energy. In addition to the effect of oil and gas prices, the gas-fired power environment in the U.K. resulted in a decision not to sell the U.K. CCGTs because final bids were materially below our hold value. Since our IMS in November, the direct impact of commodity prices and power margins, the knock-on impacts related to our ability to make asset disposals at the current time, and the impact of some systems implementation delays in British Gas Business, will have an estimated impact on planned 2015 earnings of about 2.5 pence per share. Oil and gas prices continue to be volatile, and the forward curves suggest that such low prices could continue for the next two years, and upstream margins will remain depressed while the supply chain adjusts. Like other companies involved in E&P, we are therefore taking immediate steps to cut capital investment in 2015, and further still in 2016, and to challenge all elements of operating costs. Across the group, we're also aiming to cut costs through process efficiencies, system enhancements, and simplification. I'll retain to give you more detail on our near-term actions later in the presentation. Let me now move to the subject of our credit rating, which Jeff will cover in more detail in a moment. Our primary role as a group is to supply energy and services to our customers, and we provide security for that energy both by owning gas and electricity production and also in the midstream by hedging procurement and optimization activities, including securing long-term contracts for gas and electricity. To do this efficiently requires the group to operate with a strong investment-grade credit rating. The group is currently rated A3, A-minus, but with negative outlook. At current prices, our credit ratios inevitably look more challenged and our current ratings more at risk. Given the combination of the factors I've described, and particularly the continuing lower levels of oil and gas prices and the associated loss of cash flows, and despite the strong action we're taking to cut investment levels and operating costs, we've therefore taken the very difficult decision to rebase the dividend by 30%, beginning with the final payment for 2014, which is due to be paid in June. This means that the total dividend for 2014 will be 13.5 pence per share. The interim dividend payment for 2015 will also be rebased by a similar amount. Going forward from that point, we'll continue to have a progressive dividend policy, with dividend growth in line with the sustainable growth in operating cash flows of the group. As you'd expect, we've considered a number of alternative courses of action before taking this decision. But in the current circumstances, I believe that this is a challenge which has to be grasped now and will allow the group to maintain a strong investment-grade credit rating, balance sources and uses of cash, while continuing to offer an attractive dividend for our shareholders. I'm confident the measures we're taking, including interventions on CapEx and costs, as well as the decision to rebase the dividend, will reset the group's ability to operate sustainably in this changed environment. In light of such changed circumstances, we recognize we must also test our strategy. We're therefore announcing today that we've launched a group-wide strategic review, which will be focused around the following four dimensions. Firstly, our outlook and sources of growth. Secondly, portfolio mix and capital intensity. Thirdly, our operating capabilities and efficiency. And finally, a financial framework for the group going forward. We expect to report back to you on this review by the interim results in July. I'll come back in about 20 minutes to provide you with more detail on the short-term actions we're taking in response to the current environment and some more detail on that strategic review. I'd now like to hand over to Jeff to take you through the 2014 results, balance sheet and credit metrics, and the financial outlook for 2015. Thank you, Iain, and good morning, everyone. Let me start with weather and commodity prices, both of which had a big impact on our performance in 2014. The weather first, and you can see average U.K. temperatures on the left-hand side of the slide, with the red areas representing warmer than normal temperatures and the blue area colder. As you'll no doubt be aware, 2014 was very mild in the U.K. In fact, by some measures, it was the warmest on record. As a result, residential gas consumption per household in the U.K. was down 17%, which also lowered the average British Gas dual fuel bill by about GBP 100 compared to 2013. In North America, it was a very different story, with extreme low temperatures caused by the polar vortex, as you can see in the top right. This increased demand for gas and power across North America, but also resulted in significantly higher commodity costs and additional service network charges. However, the big story in the second half of the year was the sharp fall in gas and oil prices. U.K. power prices also followed gas prices down, and spark spreads remained low. Although hedging protected 2014 earnings to a degree, as you've already heard from Iain, the rapid fall in prices has created a challenging environment in 2015. The impact of the weather, declining wholesale prices, and difficult trading conditions in both the U.K. and in North America significantly affected the group's performance. Revenue increased 11%, primarily driven by a full year's contribution from the Hess Energy Marketing business and resulted in a 62% increase in Direct Energy's revenue compared to the prior year. This was partially offset by lower revenue in British Gas due to lower energy consumption and in Centrica Energy from lower realized prices. However, adjusted operating profit fell 35%, with all business units showing lower year-on-year results. Although proportionately less profit was delivered from the highly taxed Upstream business, which lowered the overall effective tax rate, adjusted earnings were still down 30% at GBP 962 million, equivalent to 19.2 pence per share. Reflecting the decision to rebase the dividend, as Iain mentioned, the full-year dividend per share is down 21% to 13.5 pence per share. The decline in commodity prices also resulted in significant impairments in both our Upstream E&P and Power Generation businesses. In E&P, post-tax impairments of GBP 712 million were recorded, primarily related to fields in the U.K. North Sea and on our development assets in Trinidad and Tobago. In power, the combination of lower forecast power prices and a lower than expected result from the first capacity market auction in December led to a review of the carrying value of both the thermal and nuclear generation fleets, resulting in an impairment of GBP 673 million post-tax. These impairments were partially offset by profits on disposal of the three Texas power stations and the Ontario Home Services business, which together generated a profit post-tax of GBP 224 million. The total exceptional charge for the year was therefore over GBP 1.1 billion. In addition, with the rapid decline in wholesale gas and power prices on both sides of the Atlantic at the end of the year, the mark-to-market remeasurement of our energy contract positions was a loss of GBP 1.1 billion, or GBP 771 million post-tax. These positions are held against forward sales and will therefore reverse as those future sales realize. The net result of the exceptional items and certain remeasurements was just over GBP 1.9 billion and swung the group to a net statutory loss of GBP 1.1 billion. Moving on to a breakdown of operating results, you can see each of the different business units and their relative contribution to the lower profitability in 2014. In British Gas, profits were down 20% to GBP 823 million. Residential energy profit fell to GBP 439 million, 23% down on 2013, primarily driven by lower customer consumption. A drop of 2% in customer accounts and a fall in average customer consumption of 17% on gas and 5% on electricity from warmer weather were the main contributing factors. Post-tax margins reduced to 4.1% as the lower consumption and intensely competitive market meant profitability was at the lower end of what we would hope to achieve as a retain commensurate with the risks and the capital employed the business incurs in procuring and supplying energy. Residential service operating profit was down 15% to GBP 270 million. While the business delivered a 3% increase in boiler installations and retention of existing contract customers remained high, new contract sales proved challenging and overall product holdings were down 3%. The business also continues to see a gradual shift in product mix towards flexible but lower-priced product offerings. However, sales increased in the fourth quarter and the business returned to product growth. British Gas Business was also impacted by the warm weather, along with competitive margin pressures and higher bad debt provisions following the transition to our new billing system. This resulted in a fall in profit to GBP 114 million, 19% below 2013. We are still integrating the new system, which has delayed the full realization of reduced operating costs and lower bad debt. Looking forward, we would expect to see growth in British Gas residential energy and services in 2015, driven by customer account growth and more seasonally normal weather, partially offset by a delay in the full implementation of the new British Gas Business commercial model. In Direct Energy, we reported a substantial decrease in profit, reflecting margin pressures due to competitive market conditions in both residential and business energy supply and costs related to the polar vortex in the first quarter of last year. As you can see on the slide, it was a tale of two halves in the upper right-hand corner, with second half profitability in line with last year and moving towards levels the business is capable of. Even after taking into account the additional costs related to the polar vortex, DE residential profit fell, driven by the continued decline in the Ontario customer base and a challenging sales environment in both Texas and the U.S. Northeast. We see those trends continuing in the current year and largely negating the benefit of the more seasonal weather. The business is focused on continued cost improvement and new customer propositions, linking our energy and sales offerings to drive growth in the longer term. Business energy was also down on an underlying basis, despite a good contribution from the newly acquired Hess business, which is delivering ahead of its investment case. This reflected lower margins for business written in prior periods. However, average unit margins written in the second half of 2014 are significantly higher than in the same period in 2013, 35% higher for gas and nearly 50% higher for power. When combined with the expectation of more normal weather patterns and the roll-off of amortization expense from the Hess acquisition, this should result in a significant increase in profitability for business energy in 2015. In Direct Energy services, operating profit reduced to GBP 28 million, reflecting the sale of the Ontario Home Services business in the second half of the year. This masked underlying growth in other parts of the services business, with customer accounts increasing 23% and protection plans trebling to over 300,000. Overall, in Direct Energy, we would expect to see a strong rebound in operating profit in 2015, in line with current consensus. In Ireland, Bord Gáis reported an operating profit of GBP 7 million in the six months of our ownership, which included one-time integration costs. The business is performing well and remains on track to deliver EBITDA of EUR 40 million in 2015, in line with the announced investment. Turning to the Upstream, Centrica Energy's operating profit was GBP 737 million, 44% lower than last year, with gas operating profit down 48% to GBP 606 million. This reflected significantly lower European realized prices, down 17% in gas to 53.9 pence per therm and 14% in oil to GBP 54. This was only marginally offset by a slightly higher realized gas price in Canada, resulting in a price impact of over GBP 500 million year-over-year. Overall, E&P production increased 3% to just under 80 million barrels of oil equivalent, with an increase in Canadian production from a full year of the Suncor acquisition made in 2013 being partly offset by the natural decline in our European fields. European production also suffered from higher unit lifting and other cash production costs, which increased 6%, driven by supply chain inflation and the continuing change in production mix to newer, higher-cost fields. This is an area of particular focus in the current commodity price environment. However, lower operating profit was largely mitigated on a post-tax basis as the benefits of hedging forward, realized investment tax allowance on U.K. North Sea development spend, and a strong performance from the midstream gas business resulted in post-tax operating profit only being down 7% at GBP 302 million. For 2015, the impact of lower gas and oil price environments and a more normalized midstream performance is expected to result in a significant reduction in both the operating profit and post-tax earnings of the business. In power, operating profit fell by 23% to GBP 131 million. Gas-fired generation volumes increased by 12%, although lower achieved spark spreads meant the thermal fleet continued to lose money, albeit at a slightly reduced level. In 2015, we expect the thermal fleet to remain loss-making at current spark spreads. Nuclear output was down, reflecting the temporary shutdown of four reactors resulting from a discovery of the boiler spine issue at Heysham 1. As a result, our pro rata share of overall output from the nuclear fleet fell just over 7% to 11.3 terawatt-hours. The lower output and additional costs incurred related to the boiler spines were the primary contributors to a decrease in operating profit to GBP 210 million. All impacted reactors are now back in service, although operating at reduced output until planned remediation effects are taken later in the year. Wind profitability was also down with the positive impact of a profit on disposal relating to the Barrow Offshore Wind Farm sale, more than offset by a GBP 40 million charge recognized following our decision not to proceed with the Round Three Celtic Array offshore wind project. Finally, to storage. The Rough asset performed well operationally, reaching its highest-ever reservoir volume in October. However, seasonal gas spreads for winter 2014-2015 were down materially on the season before, and operating profit fell to GBP 29 million. Seasonal gas spreads for the upcoming storage season remain at similar levels to the past year. In a year where weather, prices, and market competition meant gross margin were materially lower, the business was focused on delivering cost savings initiatives to mitigate the underlying cost pressure. Overall cash operating cost increased 4% in the year from GBP 2.4 billion to GBP 2.5 billion, driven primarily by the impact of acquisitions and our continued investment in smart meters and connected homes in British Gas. Underlying costs were broadly flat as cost initiatives offset growth and inflationary pressures. In Direct Energy, over $100 million of cost was removed with the integration of the Hess and Direct Energy businesses in line with our acquisition case. While full realization has been delayed, British Gas Business remains on track to take GBP 100 million out of operating costs by 2016. However, in response to the low commodity price environment upstream and reflecting our scale downstream, we have identified further initiatives to reduce costs in the near term. In terms of net investment, organic capital expenditure was broadly flat compared to the prior year. In E&P, we spent just under GBP 1.1 billion, slightly more than planned, but reflecting good progress in the development of the large-scale Cygnus and Valemon projects, the latter achieving first gas in early January. However, as you can see on the right-hand side, we have taken action to reduce capital expenditure materially in 2015, where we are targeting a 25% reduction in E&P, and further reductions in 2016, should commodity prices remain low. In British Gas, the capital expenditure run rate decreased in the second half of the year as the new billing and customer relationship management system projects in British Gas Services and in BGB began to wind down, and we forecast a lower ongoing expenditure going forward. Overall, net investment fell from GBP 2.6 billion in 2013 to just over GBP 800 million in 2014, as disposals of non-core assets replaced the significant acquisitions in 2013. This included the Hess Energy Marketing business and the Suncor Upstream gas assets. Acquisition spend totaled around GBP 150 million, related primarily to the Bord Gáis acquisition in Ireland and the Astrum Solar business in the U.S. This was more than offset by around GBP 800 million of disposal proceeds from the sale of the Texas gas-fired power stations, the Ontario Home Services business, and our interest in the Barrow Offshore Wind Farm. Further capital was released from the sale of a 40% stake in our existing natural gas assets in Western Canada to our joint venture partners, QPI. I would like now to turn to group cash flow. As you can see on the slide, 2014 was very different in its cash flow components than the prior year. EBITDA fell by GBP 1 billion or 26%, driven by the reduction in operating profit. Operating working capital was flat, but the rapid fall in commodity prices late in the year led to a large margin cash outflow of nearly GBP 700 million, although this will naturally reverse as the forward positions unwind. Net interest in tax fell as profit reduced, and as outlined on the previous slide, net investment fell dramatically as focus shifted to releasing capital to strengthen the balance sheet and the integration of previous year's acquisitions. Dividends remained at a similar level to the prior year, with the net result of all these items being an increase in net debt from just over GBP 4.9 billion to GBP 5.2 billion at the end of 2014. Current forward curves indicate that low levels of commodity prices may persist for some time, and this would imply that cash flows in 2015 and earnings are likely to fall further relative to 2014. The change in the components of cash flow had a material effect on our financial metrics. The reduction in EBITDA has led to a significant fall in both funds from operations and retained cash flow, which in turn has made the achievement of key rating agency financial metrics more challenged. Funds from operations to net debt has fallen from 50% to 42%, while retained cash flow to net debt has fallen from 30% to 22%. The group is a large user of collateral in both the U.K. and in North America, and a strong investment-grade credit rating supports our procurement of the significant energy volumes needed to serve our downstream customers. It also supports our ability to access efficient short-term sources of liquidity and to manage the sort of volatility in commodity prices that we've seen. We therefore believe that to operate the business sustainably over the longer term, our financial metrics will need to rise over time above their 2014 levels, ensuring the business is financially resilient and able to invest efficiently in both the procurement and risk management of energy supplies, and to respond to sudden market movements, and so enable the delivery of sustainable shareholder value over time. At the center of assuring financial resilience is the need to balance the ability of the business to generate cash flow, to pay taxes, invest for growth, and pay investors, both debt and equity. The significant fall in EBITDA in 2014 has severely impacted the basic sources and uses of the group's cash. Stripping out the effect of inorganic investment activity and share buybacks, in 2013, our sources comfortably covered our uses, as you see on the slide on the top right. However, in 2014, this position reversed as lower commodity prices were the primary driver of lower EBITDA. Looking forward, even with the forecast growth in our downstream businesses, as prior year hedges roll off in upstream gas and power and forward commodity prices remain depressed, cash flow generation is likely to fall further. Immediate action is being taken to offset this trend with planned reductions in capital expenditure and additional cost actions that Iain will outline in detail in a few minutes. Further asset disposals will be challenging in the current commodity price environment, and as evidenced by our decision to retain our thermal power plants, won't be undertaken at the expense of long-term shareholder value. We will follow through on our intention announced last summer to implement a scrip dividend alternative to determine the appetite and take-up of shareholders, but we'll keep it under review as part of our overall financial framework. However, even with the planned reductions in capital expenditure, additional cost actions and the implementation of the scrip dividend, the cash flows of the group in this low price environment are forecast to be insufficient to support a strong investment-grade credit rating. We have therefore taken the decision to rebase the dividend by 30% in order to strengthen the financial position and ensure resilience in the current low commodity price environment, balance our sources and uses of cash, and ensure a sustainable payout ratio. The preceding slides have covered a lot of ground, and therefore let me summarize before handing back to Iain. To begin, 2014 was a challenging year for the business, with earnings down significantly on the prior year as weather, commodity prices, and difficult trading conditions created material headwinds. Looking forward to 2015, while we would and do expect some of the challenges from the prior year to lessen, the dramatic fall in commodity prices since our interim management statement in November has negatively impacted our current earnings forecast by 2.5 pence per share, and therefore, overall earnings in 2015 will be lower than 2014. Finally, our decision to rebase the dividend means the business is positioned sustainably and with resilience should the current environment persist to deliver long-term shareholder value. I’d like to hand back to Ian. Thank you, Jeff. I’d now like to cover some first impressions of the group relative to the changing context in which we find ourselves, the business actions we’re taking in response to the current environment, and to say a little more about the strategic review I mentioned earlier. As I said, I’ve been impressed by the quality and commitment of people across the organization. It’s very clear that Centrica’s people care about what they do and how they do it. They’re clearly determined to serve our customers and secure energy supplies and to apply their capabilities to a changing energy landscape. In my view, those changes present Centrica with at least as many opportunities as they do threats. Let me briefly talk about energy fundamentals and trends. I’ve spent the last 29 years in the world of energy, and that world is changing. Primary energy demand is still growing by about 1.5% per annum, but nearly all of that growth is now in the non-OECD. Energy intensity is falling, with energy growth diverging from GDP growth, and growth in production of greenhouse gases is diverging from energy use as the mix changes. Energy efficiency is becoming more and more important. Natural gas will be needed as a lower carbon alternative to coal. Nuclear power provides significant advantages in jurisdictions which support it. Renewables are growing at a fast rate, albeit from a low base, and the true cost of an accelerated shift to renewables is becoming apparent. Customers' expectations are changing. They’re demanding more from their energy suppliers, more information, more transparency, more services, and more options. They’re also demanding to have more control over their energy use. These trends provide as much opportunity as they do challenges. Centrica is very well-placed in both Europe and North America to play a leading role in shaping the responses to these trends. Our primary focus is on serving our customers. We carry a lot of responsibility in that regard. We’re the largest residential gas and electricity supplier in both the U.K. and Ireland. In the U.S., we’re the largest independent energy retailer. We have 18 million residential customer accounts of energy, 9 million service accounts, and over 1 million business energy supply points. We have a significant presence in energy services with nearly 9 million product holdings, both here in the U.K., where our engineers have a very strong reputation and brand, and in the U.S., where we offer energy services in all 50 U.S. states. We have a diverse energy portfolio, which underpins our ability to serve those customers securely and contributes to the efficiency of the energy value chains for the markets in which we operate and more broadly. We are a major producer and supplier of natural gas and electricity, participating along the value chain and building up our procurement, supply, and optimization capability. The 2013 acquisition of Hess Energy Marketing made us the largest C&I natural gas supplier in the U.S. We produce natural gas in three sectors of the North Sea and in Canada and Trinidad, and have a growing LNG business. Our power portfolio generated 23 terawatt-hours of electricity last year. Globally, we supply over 1.2 trillion cubic feet of gas and 156 terawatt-hours of power a year. We take this responsibility very seriously and are very focused on delivering high levels of service and energy security for our customers and for the countries in which they live. As I mentioned earlier, we are currently facing some very difficult trading conditions, but the longer-term trends and the positions and capabilities we have mean that Centrica is very well-positioned to play an important role in the evolution of energy supply and services going forward. I would now like to return to the short term and describe what our businesses are doing in response to the challenges of the current environment. For all our operations, safety, compliance, and good conduct have the first call on resources. Whatever we do to respond to this situation, risk management and assurance of our performance in these areas will not be compromised. Let me start with our E&P business within Centrica Energy. Just like other well-known players, we are making severe interventions in both capital expenditure and in production and operating costs. On CapEx, because of major projects which are under development, such as Cygnus, we have less room to reduce capital in the current year, but we have taken the decision, nevertheless, to take CapEx down in 2015 to GBP 800 million, and in 2016 to GBP 650 million. This represents additional reductions of GBP 100 million and GBP 150 million on top of existing plans in each of 2015 and 2016, and results in respective levels about 25% and 40% below those of 2014, as you can see on the chart here. We will adhere to these levels, assuming there is no material change to the commodity price environment. We are also keeping a tight control on cash production costs, engaging with our supply chain, and challenging our own direct costs, targeting a 10% net reduction in 2016 versus 2014, a saving of some GBP 100 million per annum. In the face of the fall of oil and gas prices, through these actions, it is our intention to operate the E&P business so that it is broadly free cash flow neutral over the two-year period to the end of 2016. In power, we have decided not to sell the three larger CCGTs. The bids received were well below our value in use, perhaps partly influenced by the outcome of the recent capacity auction. Humber and Langage are cash generative at the operating level in the current environment. We will retain these assets and will be taking action to make our management of the power portfolio more efficient. Following a review, we plan to close the Killingholme and Brigg Power Stations, as we've announced. Let me now turn to the downstream and the rest of the group. Our priority in the downstream is to serve customers competitively and with integrity, with the goals of winning and retaining more customers. Despite the current environment affecting other parts of the group, it was therefore important to play a leading role in recent price reductions in both the U.K. and Ireland. The recent British Gas 5% reduction in gas prices in the dual fuel variable tariff represented our view of the actual reduction in our overall costs we're likely to see in 2015. We will, of course, keep wholesale costs under review. Since that time, we've also announced new lower-priced fixed tariffs in both British Gas and through our Sainsbury's Energy offering. After setting prices competitively, our other area of continued focus is on improving service levels. Service levels improved in British Gas in 2014, with quicker average answering times in our call centers, leading to a significant improvement in our residential energy net promoter score, which reached a level of +31. We still have some way to go there. In British Gas Services, the net promoter score increased to a new record high of +68. Our recent investments in systems and training in the U.K. and North America are targeted at underpinning further improvements. As we deal with the quality of our operations in generating revenues, we'll also be paying close attention to our overall cost to serve at both the group level, and also specifically in all of the customer-facing businesses. As you can see on this chart, in the last few years, overall group operating costs have been rising broadly in line with inflation. However, this is despite successful delivery of significant cost programs in recent years. Other areas of compliance and oversight, and revenue investments in IT and new technologies are continuing to put pressure on the cost base. Costs associated with smart metering rollout are also beginning to increase headline costs. We will be reviewing the overall group organization and cost structure, looking for simplification in synergies and programs to drive standardization across like activities, and so build a set of interventions to offset inflation in our controllable costs, and stabilize the underlying cost base. This will be part of a comprehensive plan to improve our overall performance, which we're already embarking upon. In the customer-facing businesses, we must pay close attention to benchmarks. The bar on the right shows British Gas indirect costs of energy supply per account relative to the other five major suppliers in the U.K. Despite our market share, our costs are at best average, and we're clearly not yet benefiting from the expected economies of scale. This area will get significant attention without compromising our ability to improve customer service. In terms of investing for the future, we must continue to focus on the changing relationship with the customer, and as I mentioned earlier, their desire for more control of their energy use. We intend to build on our recent success with the rollout of Hive remote heating control to over 150,000 customers. Last week, we announced the acquisition of the remaining 79% of AlertMe, the company which owns the platform upon which Hive operates. The integration of AlertMe with the pipeline of products beyond Hive, which we have under development, allows Centrica to be a leading participant in the growing market for connected homes, user interfaces, and new energy management systems. Combined with the rollout of smart metering, I am excited about the potential this has to change the way our customers think about their energy and to alter their relationship with their energy and service providers. We are also continuing to develop our portfolio of innovative products and services in Direct Energy in North America. We have nearly 200,000 customers taking both energy and services from us and have partnership agreements with a range of companies to offer customers added value products and services. This gives you a sense of the short-term actions and priorities in the customer-facing businesses, in addition to the response to lower prices in Centrica Energy. Turning briefly to how the year has started for us and profitability in British Gas. Although inevitably today, there is much focus on our 2014 results and the decision to rebase our dividend, the 38,000 people who make up the Centrica team continue to deliver performance and important milestones. The year has begun with more normal patterns of demand, and we are responding to that well in our customer-facing businesses, although we have much more to do to improve on service and complaints levels and to slow the loss of customer accounts. The Valemon field in the North Sea came on stream on time on the 3rd of January. Once all 10 production wells have been drilled, the field will have cost some GBP 2.2 billion, and Centrica's 13% share in the field will add some 2 million barrels of oil equivalent to our production in 2015. The Morecambe Bay field celebrated 30 years of production. To date, this field has produced 6.5 trillion cubic feet of gas and has been a mainstay of the group since inception. The Competition and Markets Authority investigation continues, and we are closely engaged and have been responding to their requests. We fully support the investigation. We have hosted the CMA at a number of our operations to help them understand how we conduct ourselves in the marketplace. We will be having a hearing with the CMA as part of their process towards the end of March. We note the publication yesterday by the CMA of its updated issue statement, and happy to take questions on that in a minute. As I mentioned earlier, we delivered gas price reductions in both British Gas and Bord Gáis during January. This was against an uncertain wholesale price outlook and represented our best view of the reduction in our overall supply costs for 2015. I want to make a few comments now on British Gas and household bills on our residential supply margins and on where I personally stand on this very important issue. I understand the widespread concern about energy prices and the reasons for the high level of public and political interest. First and foremost, we must serve our customers competitively and with integrity. We must also work hard to explain ourselves and the investment risks that our business undertakes in supplying our customers and in helping to deliver the energy needs of the U.K. Our supply margins reflect the significant commodity price and weather risks that we carry on behalf of our customers. Transparency on prices and profits is essential if we're to ensure an informed discussion about the U.K. energy industry. This chart shows in green the average level of the British Gas customer bill for our dual fuel variable tariff over the last six years from 2009 to 2014, and the associated post-tax profit per customer shown in red. As you can see, the bill has risen from 2009 to 2013 as commodity prices rose and other elements of the bill, such as transport and distribution costs and the cost of environmental programs, also grew. The average bill fell in 2014 as a result of the rephasing of the ECO program, which we passed through immediately, and the impact of warmer weather on gas demand. Our average post-tax profit in 2009 was GBP 54 per customer, equivalent to a 5% margin, but has fallen to GBP 42 in 2014, a post-tax margin of about 4% on the average dual fuel bill and representing a profit of about GBP 0.80 per week per customer. This is the lowest margin over the last six years. The profit we make is an outcome of prices set by the market and our cost to serve. With 25 different suppliers vying with each other in the U.K. residential energy market, the levels of competition are high. We hope we can continue to achieve returns in the range of 4%-6%, which allow us to continue to reinvest in the business. We know we will have to pay close attention to service levels and, importantly, our cost to serve if we're to achieve this. I recognize it's also incumbent upon us to be transparent, to engage with all our stakeholders, and to rebuild trust in both the energy industry and in Centrica. Let me finally turn to the strategic review I mentioned earlier. This slide shows the dimensions of the review, and I'd just like to expand on them briefly. Firstly, outlook and sources of growth. Given the change in oil and gas prices, the continuing weakness in clean spark spreads, the outcome of the recent U.K. capacity auction, and the changing trends in demand and customer behavior, we'll be reassessing our medium-term view of the fundamental trends which drive our business. As part of this, we must also look at demands for more sustainable energy provision and other societal trends. We'll be aiming to establish a view and future guidance around sources of growth for the group. By growth, it's important to underscore that I mean the growth in operating and free cash flow. The levels of sustainable cash flow and its growth will clearly relate to our ability to distribute cash to our shareholders. Secondly, under portfolio mix and capital intensity, we'll be testing the businesses we wish to be in and the desired mix we wish to have going forward. This will include the balance between downstream and upstream, the capital intensity of the overall portfolio, and our priorities for investment, both revenue investment and capital. Thirdly, we'll conduct an assessment of both our capability and the efficiency of our organization. This will include overall cost to serve, the efficiency and effectiveness of each business, and of the group as a whole. We'll refresh our view of our strengths and weaknesses and determine priorities for future functional capability. Finally, we must determine the future financial framework for the group. This will cover levels of cash flow generation and reinvestment. It will also cover balance sheet considerations, including debt levels and the credit metrics we wish to operate with. These four dimensions are all interrelated. Taken together, I hope we will be able to provide a refreshed view of the future prospects of the group, both for our shareholders but also for our employees and all our other stakeholders. This review therefore represents a clear and rigorous analysis of where we are and where we will go in the future. We are currently planning to report back by the time of the interim results in July. Let me summarize. 2014 has been a very difficult year for Centrica, with external market factors impacting our results in all of our businesses. Our underlying performance was also down in some areas relative to our planned outcomes. As a result, our earnings fell by 30%. Commodity prices may have begun to stabilize, but even if they do settle at levels indicated by the current forward curves, we would expect earnings in 2015 to be somewhat below the levels of 2014. Since our IMS in November, as Jeff said earlier, the estimated impact of the current environment and other factors on our planned earnings for 2015 has been some 2.5 pence per share. As a result, we are taking strong actions to limit capital investment, reduce costs, protect cash flows, and have launched a strategic review, which we will report back by the end of July. Given the potential prospect of low commodity prices enduring for some time, and despite the reductions in investment that we have announced, we have taken the very difficult decision to rebase the dividend by 30% to protect a strong investment-grade credit rating and cash flows while maintaining an attractive level of dividend income. We recognize how painful taking this step is for our shareholders. I am honored to have taken over the role of Chief Executive of Centrica, and I believe the group is well-placed in the longer term to play an important role at the center of energy needs on both sides of the Atlantic. Our immediate focus must be very much on the responsibilities we carry in serving our customers and delivering against our near-term actions in the face of some very challenging circumstances. I would now like to invite Mark and Ian to join Jeff and me on the stage, and we will be very happy to take your questions. Thank you. While Mark and Ian are coming up here, just in terms of how we are going to do this, when you do ask a question, we would appreciate if you could introduce yourself and your affiliation. You need to press the red button. If you can remember, once your question has been dealt with, to switch it off again, that would be great. I will either answer the questions or field them to my colleagues up here. I should just say that we're joined in the audience by a number of other members of the senior management team of Centrica, including Jill Shedden, who is the Group HR Director, and Grant Dawson, General Counsel and Company Secretary, and there are a number of other senior executives in the audience. Badar Khan, the Managing Director of Direct Energy, cannot be with us in the U.K. since his wife is expecting a baby literally anytime now, so we wish them both very well. With that, let's open it up to questions. Who would like to go first? Okay, loads of hands. In the front, in the blue shirt first, and then we will go couple in the front, then we will go over to the right. Thanks. It is Martin Brough from Deutsche Bank. I had a couple of questions. One was around, I guess, the balance sheet, the cash position, the credit rating. Are there consequences in terms of the general way you have to operate if you do get a downgrade? Is it possible you might look for an actual capital increase or maybe invite a strategic partner to come in and maybe one of your upstream providers might be interested in a strategic investment if you actually need to preserve the equity in the business so you do not lose some of the long-term value that you have? The second question was really more about what do you want customers to think of when they are thinking about British Gas? What is the ultimate brand identity that you are trying to get here? Clearly, people want cheap energy. Do you want people to think British Gas, oh, they are cheap? Or do you want security? Or do you want it to be seen increasingly as innovative? Obviously, you want all of those, but people do not tend to apply all of those labels at once. If there is one thing that you really want people to think of when they think of British Gas, what would that be? Thanks. Well, thank you. Let me just touch on each of those. Now, obviously, we will deal with the balance sheet question first, and then we will come onto The British Gas question. Ian, I am sure in a minute will comment, but I certainly think British Gas is absolutely to the heart of our company, and I think our company could be central to people's energy needs. I think we need to think about how to join those two together, and I will pass it to Ian in a moment. On the balance sheet, interesting question, Martin. I think that firstly, we do not have any current plans to seek new equity or pursue partners. I think it's very important that the actions we've taken today, in our view, allow us to get underneath and with significant resilience, position the group so that we can sustainably operate in the current environment, supplying our customers and delivering value to our shareholders, given the changing circumstances of the group. We don't, therefore, need to then go out and do something else. I certainly wouldn't rule it out. If a great opportunity came along for our shareholders, of course, we would look at every option to pursue it. But right now, we don't have plans to, or the need to. But I think, Jeff, if you can cover how we've come to this decision and the sort of credit metrics and the resilience of the company and how we see that playing out, given the significant step we've just taken today. Sure. As you heard in my script, what we're really trying to do is balance three things here. We're trying to balance the sources and uses of cash, having a sustainable dividend, and the credit rating metrics that we think we need at a strong investment-grade level to support the delivery of energy to our downstream customers. As you would have seen from the slide, excuse me, at the end of 2014, those metrics were a long way short of where we think they would need to be. Clearly, our credit rating specifically is a matter for the rating agencies, and they will need to take their own view. But with where we were at 2014, and with the direction of travel in a lower commodity price environment, even with the actions we are undertaking quite significantly on CapEx, particularly on costs, there wasn't enough there to reverse the direction of travel. Therefore, we've solved for that amongst, and balanced amongst those three things, the rating metrics, sustainable dividends, and a payout ratio to make all that work. I think in terms of your question around the consequences, as Iain has said, with the direction of travel we were looking at, we did not feel that underpinned a sustainable investment-grade credit rating in particular. That would have implications for us, both in terms of additional collateral we'd have to post from a decommissioning perspective, as well as our ability to procure and hedge with the business model we have downstream, both in the U.K. and in North America. So really underpinning and providing the financial resilience for a strong investment-grade credit rating is particularly important. Thanks for that, Jeff. Ian, how do you want to be perceived? Not you. How do you want the British Gas brand to be perceived? Top of my list would be the trusted energy and related services supplier. We are already demonstrably there in British Gas Services. As Ian alluded to, the engineers are some of the most trusted people in the U.K. I would accept absolutely there is a way to go on the energy side. Then reputation for excellent service. Again, we have made good strides recently. There is a way to go. What I would pick out is a theme around giving our customers informed choice and control over their energy usage, and ultimately, that is the way to control the bill. What that speaks to is our strategy of differentiating ourselves from the market through innovation in that territory, and the AlertMe acquisition, the connected homes, and smart metering are all part of that theme. At the end of the day, I would want to be regarded as an energy partner that gave great value, not necessarily the cheapest supplier in the market. Thanks, Ian. Martin, thank you. We go right directly behind you. I think there was a question earlier, or have we answered it? Okay, we will just go in the second row on the left here and take a couple more, this one and one more in the middle, then we will go over to the right. Thank you. I'm Deepa Venkateswaran from Sanford Bernstein. I have two questions. Firstly, you've talked about the strategic review. Also, you've talked about a group-wide performance initiative. Would you be also giving details of your group-wide performance initiative in July? In the past, what we've seen is there's a bit of cost-cutting here, a bit of cost-cutting there, but we've never seen you commit to a total cost program. Would that come before July? My second question is on your generation fleet. Obviously, you've announced the closure of two of your fleet. What about the rest? Apart from Humber and Langage, you still have a few more CCGTs, which are either mothballed or under store. Do you plan to exit from those positions? Then on the nuclear, you've also impaired the nuclear assets. I just wondered whether you've taken any view on any lifetime extensions for them given the recent operational issues in nuclear. Thank you very much, Deepa. On the performance review, clearly, as you would expect, if we've taken such severe action in our E&P business, and unfortunately had to take action on the dividend, you would expect us to take our performance very seriously this year. It's not just about costs. We've got to also look at revenue generation, but we've got to be clear that Centrica can be as efficient as possible. Now, it's divided into two parts. Driving performance now for this year and the longer-term sustainable performance that we can deliver out of the portfolio. The first is something we're already all over for this year because we have to be, and that's the initial phase of a performance review. It will join to the strategic review in the area that I outlined around efficiency and our capabilities. We've now entered multiple markets, but we run them in silos to some degree. We need to be able to run them across those markets to get the efficiencies that come from the skills we've got in various functions in the customer-facing businesses. We're also a bit complicated, in my view, about how we organize the group. Again, we need to go after that. So there'll be quite a lot we've got to do in the near term, and then it will form part of the strategic review when we look at the longer term trends. On the generation fleet, just a comment that the strategic review will also clearly look, as I've said, about our portfolio and what we want to be in in the mix. Therefore, I'm not signaling today that we're going to make any other material changes other than the planned closures of the two power stations that we just talked about. Mark, the more detailed questions on CCGT nuclear. Yes. So, we have Humber, Langage, the two big power stations. We will retain two smaller ones, Barry, Peterborough. We're recommending closure of Killingholme and Brigg, and we'll be consulting with our employees about that. We will, within that though, retain the options at those sites because those are potential development sites for the future. We have a very good development site at King's Lynn for a new power station there. Of course, we retain the replant option at the existing King's Lynn plant, which didn't win a capacity auction contract in December. But we will look to see whether we can bid again on that plant. So that's the position on the CCGT fleet. Nuclear life extensions. Since we acquired our 20% share of British Energy, there has been life extensions announced on specific plants. But the overall message is that we expect across the AGR fleet, the advanced gas cooled reactor fleet, about an average of 8 years life extensions. That's still the position. It's not affected by the boiler spine problems that we've experienced last year. Then on the PWR at Sizewell, we expect a 20-year extension to 2055. So on current plans, you don't see any retirements in the nuclear fleet before 2023. Then you've got the AGRs sort of currently planned between 2023, 2030, and then Sizewell out to 2055. Mark, thank you very much. One more question in the middle, and gentleman here in the red, pink tie, then we'll go to three questions on the right. Thank you. It's Fred Barasi from Goldman Sachs. Three questions from me. Firstly, in terms of the commodity price sensitivity, is there any benefit from historical hedges still reflected in your 2015 earnings guidance? If so, can you quantify what the impact in 2016 would be of marking to market for current commodity prices? Secondly, in terms of E&P, can you give a guidance for the production profile which would be consistent with the CapEx that you're indicating in the update? Finally, can you help us to understand the EPS impact of the write-downs that you've included? Thank you. What I suggest is why doesn't Jeff address the commodity price sensitivities and the hedges that we've currently got on? You may as well also touch on the EPS impact. Maybe if you can, Jeff, just give a bit of an idea, the 2.5 pence that we've quoted, because how does that all build up? Then I'll just make one comment about the E&P production profile and pass that to Mark. So off. Sure. I think in terms of commodity price sensitivities, we obviously hedge forward in the upstream business, not similarly to how we do in the downstream business. As we enter into 2015, greater than half of our commodity is hedged coming into the year. We, of course, do that on a post-tax basis. You can imagine if you then sort of played that forward for 2016, that we would be much less hedged than 50% heading into 2016. Therefore, if you sort of take your view on commodity prices, you can get a sense based on our production and generation about what the impact of that might be. To Ian's point, in terms of the 2.5 pence we've referenced with respect to changes since the interim management statement. The vast majority of that is price related. We've seen oil prices move from $80 down to sort of $50, and then with a bit of a rebound of late. Gas prices have also fallen from sort of mid here in the U.K., sort of mid 50ps to mid 40ps and then up a little bit. The impact of all that is a little over a penny a share. There's obviously been an impact on power prices, which has also, to a smaller extent, impacted the numbers. Then, in terms of asset disposals, the ability to do that in the lower price environment has a small effect as well. We talked earlier about a bit of a delay in the realization under the commercial model in BGB, as the system is taking a little longer to implement. So those are the main components. I think in terms of the specific comments about the impairments and their impact. In gas, the impairments and the potential impact primarily relate to the U.K. and the Netherlands. The assets in Trinidad were development assets, so currently weren't producing. There is a benefit of that, but that's partly offset by the fact that decommissioning costs and our view on decommissioning costs went up, and we took an additional charge for that. So there's a small upside, but not to the extent that it would be without the decommissioning piece. On power generation, there is obviously a benefit. But at the same time, of course, particularly for the thermal assets, they were assets held for sale for most of 2014. Therefore, of course, bringing them back into the portfolio, that benefit on impairment is somewhat offset by continuing losses and the continued depreciation of those two larger stations. Thanks, Jeff. On the E&P production profile, I think just to say that obviously we've been producing at nearly 80 million barrels of oil equivalent this last year. We're still assessing the choices we make within the capital profile, but we've discussed holding the production for the next few years in the 70 million to 75 million barrel of oil equivalent range. But Mark, are there any comments on the granularity of production profile or the factors you're considering? Well, I think you're right, Ian, to point out that clearly we need to see how prices evolve. We need to see how the supply chain is reacting in terms of what happens with infill drilling and that type of activity. In broad terms, I would think this year we'd be down 5%-6%, that sort of level. For 2016, because we have some new production coming online with the in-flight projects that we've been spending heavily on in the last couple of years. We hope to hold that in the 70-75 range. The natural depletion would be greater than that, but we have these projects coming on stream, which is helpful. Sarwjit Sambhi, who is our Head of E&P, is also in the audience. After we have finished, maybe you can seek him out. Over to the right-hand side now. These two. First in the front row. Thank you. Hi. Yes. It is Dominic Nash, Macquarie, please. A couple of questions. Firstly, on the CMA report that came out yesterday, obviously you talked about the standard variable rate being potentially too high. Could you give some color on what proportion of your customers are on standard variable rate, and what would be the impact if you were going to have to adjust those down? Secondly, on tax requirements on U.K. Continental Shelf production, do you have a feel of what the tax rate needs to change to encourage investment or maintain assets in the northern Irish Sea? This final is a very quick one. Can you remind me again, what was the guidance for EPS for 2015 at the IMS, please? If I deal with the last two first. On guidance, we did not give guidance in the IMS for 2015. What we did say originally was that we expected improvement in the customer-facing businesses to be largely offset by commodity prices impacting the upstream. Clearly, our update today is that relative to what we were planning, and obviously there is a range of assessments from investors and analysts on what that meant for 2015. We have seen an additional 2.5%- Pence. Pence. Thank you. Pence per share impact on earnings, and you will have to draw your own conclusions as to what your view of that is. In terms of the tax requirements of the UKCS, I have been asked this question a lot. I start from the place that the additional 12.5% additional SCT should be removed to encourage development and continuing developments and also exploration and appraisal. I have heard other calls for all supplementary corporation tax to be removed from the North Sea. Well, therefore, it just goes to corporation tax. It is very dire at the moment in terms of what this will do to the supply chains, and I hope that the government will take this very seriously and will be addressing it in the March budget, but we will have to wait and see on that. On the CMA, just one comment. I just want to remind everyone that what we had yesterday was an updated statement of issues. It wasn't findings. But clearly, they've pointed more towards the difference between standard variable rates and fixed rates, and they've identified some issues they want to explore on different customer subsegments. So Ian, what proportion are on the standard variable rate, and any other color you'd like to give around the CMA last night? The answer to the question is 75% in round numbers of residential energies customers are on standard variable rate. Interestingly enough, the CMA did not say that rate was too high. What they were focusing on was the differential currently in the market between that and some fixed-term contracts. The key to unlocking that is what's happening with the commodity markets. We're buying- The commodity forward for our standard variable rate, anything up to 3 years. And we lock in fixed rate products off the current curve. So as the commodity markets fall quickly, which is what's happened in the last several months, there is a widening of that differential over time. Now, in theory, if commodity markets stayed flat, the two would converge. And what we are seeing in recent weeks is as the commodity markets ticked up a bit, that gap's starting to close. So that's what's opened it up. And in a rising market, there's usually been a premium to the standard variable rather than the other way around. From our point of view, we're a slight outlier against the rest of the market. Once we reduce our standard variable price on the 27th of Feb, the differential between that and our fixed price contract will be about GBP 54, which is just about the lowest in the market. So I think what the CMA are pointing to is others who have very, very big differentials. And then the last point on the CMA, there's clearly some focus on switching levels. We don't equate switching with engagement. I think they're quite different things, is the first point to make. As Ian alluded to, this is a very competitive market. In a given year, we'll lose and gain about 2 million accounts, so it's not a static base. And around 70% of our dual fuel customers, we've won both fuels off the competition in recent years. So it's a much more vibrant, active market than perhaps some of the media commentary from that would indicate. Thanks, Ian. Gentleman behind you, yeah. Thanks. It's Ian Turner from Exane. Can I ask you about the step down in CapEx over the next couple of years? Can you give us some flavor about how that splits between doing the same work but for less, and how much of it is actually stuff dropping off your slate of projects? Then similarly, for your upstream write-downs that you've announced today, can you give us some color again about those? Is that projects where you've spent money that you're not now going to proceed with, or is it a view that things that you've already bought or invested in, the cash flows in those, which undeniably are very long-term cash flows, that you've taken a view that based on quite short-term movements in the market, you've changed your value on those? Well, Mark, seeing as the CapEx stepped down, certainly initially is all about your businesses. Do you want to address that? Then Jeff, why don't you talk to the impairments then? Certainly. So obviously, as Ian said, 2015 is a little bit boxed in by in-flight projects and quite a few of those projects are third-party operated. We are hoping to cut as much as possible. So I think the interesting picture is around 2016, where we have much more freedom to act. So the way that I look at that GBP 650 million aspiration is a target, is that about 20% of it is what I consider base maintenance CapEx. That's what we need to spend to safely run the business. About 25% of the 650 is in-flight projects. Remember, Valemon, Cygnus will still be in heavy drilling program at that time. So that's the second tranche. The third tranche, 25% broadly, I would say, is high-quality development projects in Norway. So I'm thinking about Butch, Maria, Kvitebjørn, and Statfjord infill projects. I think that those projects look robust at current prices. The key is making sure we get the full supply chain benefits if those are going to go ahead. Then the final tranche, 25%, I would say is a mixture of a pared-down exploration budget, some investment targeting in Canada, some infill drilling in the North Sea to add to our hubs. I think the way you could look at that is that clearly that last tranche shouldn't be going ahead unless the economic case is there. Therefore, there's some flexibility around that. If you look on slide 20 in your book, in the rest of the group, now that the capital investment programs in IT, in particularly British Gas, are coming to an end, you're actually seeing the total investment in the rest of the group falling from a rate of about GBP 400 million to something in the region of GBP 250 million. So that's also quite material. We're taking capital down from about GBP 1.5 billion per annum over the last couple of years to just over GBP 1 billion. Obviously, quite a material shift. Thank you. Gentleman immediately- Do you want me just to take the second question? Sorry. Apologies. Yeah, go ahead. No, that is fine. So in terms of the actual impairments in the upstream E&P assets in the U.K., those are much more weighted towards the existing assets, the producing assets, and associated infill activity that we would have done under a higher price environment as opposed to the lower price environment we are in now. A much smaller proportion of that is, as you posited, related to development assets and is very much price-driven. Thanks, Jeff. Sorry about that. Gentleman behind you, and then there is one more on the right, and then we will go over to the left. Hey, good morning. It is McLaren from Merrill's. I have a few questions, please. How much of these new efficiencies you referred to are included in the new earnings guidance for this year? Sorry. On supply numbers, why the restatement, and what would net losses have been excluding the white label deals that you have in place? Thirdly, do you think that ROCE is a helpful measure for U.K. supply profitability? Can you speak about the overall scale of the collateral wrapped up in the business, please? Lastly, there's been some confusion on the rebasing of the dividend. Would you confirm, please, that the 2015 payment will be 12p? On the last point, I did say that the interim payment in 2015 would be rebased by the same amount. I just want to clarify that. Somebody asked me earlier, does that mean therefore that the 2015 dividends in total would be about 12 pence? You can deduce that from that. On ROCE, I think ROCE over a run of years as a trend can be a helpful metric. But obviously, it's massively dependent on when you got into things and how depreciated they are, and it depends, therefore, on your rate of reinvestment relative to depreciation. So it can be a bit misleading. Jeff, there was a component of that about collateral. Do you want to touch on that? Yeah. I think in terms of the overall collateral in the business, and this past year is a good example of that, where we saw quite a significant move in commodity prices and we saw roughly GBP 700 million of margin cash related to that required to be posted. Obviously, that unwinds and comes back to us as the positions unwind. We have, at times, in a rapidly rising market, you have to go back a few years for that, seen similar or even slightly larger amounts. So the actual kind of liquidity requirement can swing from GBP 1 billion one end to the better part of GBP 1 billion on the other. There are also, as I mentioned earlier, requirements around posting collateral for decommissioning costs, et cetera, depending on what our credit rating level is at. But currently, those would be between GBP 500 million and GBP 1 billion. On efficiencies, we haven't disclosed how much is in the numbers this year, but I can qualitatively say that obviously for the upstream to end up being able to deliver GBP 100 million in 2016 versus 2014 in 2016, we need to be on the runway materially, and we're not going to be hanging around with that. There are some efficiencies also that Ian has been driving into British Gas associated with both underpinning the price reduction that we made, but also looking for further savings, and we will be looking at the group level at efficiencies we can make, but we're not disclosing any number at the moment. I know it's a bit frustrating. I didn't hear your question on the supply- Restatements. It appears that you've restated the number of accounts down by a little over 100,000. Got it. Sorry. Ian? Yeah. Okay. The restatement in residential energy is actually a phasing issue. At the risk of getting a bit geeky, we have a business that puts new connections into new builds, and we've changed the way we count them from when we were putting the meter on the wall, which is how we used to do it. We now do it when the meter is actually having energy passing through it. So those are real meters. They are there. But they will eventually come onto supply later than we had in the plan. So it's a phasing issue rather than a loss issue. So that explains that one. You also had a question about white labels. I can't give you the precise number off the top of my head, but as a guidance, Sainsbury's Energy, is what you're alluding to, has around about 200,000 accounts, which we've built up steadily since 2011. The net growth of Sainsbury's last year was around about 50,000-60,000 accounts. So it's that order of magnitude, if you want to get a rough guidance. Thank you. We'll take one more question over on the right. Do you still have a question? I'm sorry. Do you have a question? I'm sorry. You had one earlier, I think, where you had your hand up. No? There's then one over at the back here, and then we're just going to take one or two there, and that's probably enough time, I'm afraid, we've got. Hello, it's Mark Freshney from Credit Suisse. Two questions. Firstly, on British Gas Business and the IT upgrade, which seems to have gone very poorly. Can you talk through the issues you're having there and any costs you've got with not being able to back-bill or increase bad debts, for instance? Also on working capital. Secondly, as part of the strategic review, I understand you've said you're looking into the group financial framework. Clearly, the big part of that for equity is the dividend, and you've already looked into that. Can you give an indication that that dividend is not going to be reviewed again as part of the financial framework review? Well, Ian, why don't you answer the BGB item? As we explained earlier on, all three businesses actually completed fairly major systems migrations last year, so that the one that had transition issues is British Gas Business. They happened right at the end of the year. This was taking out an old system that was about two decades old, with quite weak data quality. What happened towards the end of the year is we did experience some billing problems, so gross debt went up right at the end of the year. The bad debt charge in BGB deteriorated by around GBP 20 million. So that's that point. There is a full stabilization program which is mobilized, as you'd expect. We are pretty confident that the core business will be operating as we would want it to around about the end of Q1, and then we need to work through the kind of overhang of those issues. The working capital point, we would expect that to adjust in-year through 2015 as we collect the outstanding monies. We remain very confident that the GBP 100 million of overall cost savings from this program will be delivered by 2016. So it's a phasing issue we're dealing with here. But in terms of guidance, we would expect earnings for BGB in 2015 to be broadly flat with where they were in 2014. Thank you. On the financial frame, while we've obviously considered the dividend and the board has made a decision on rebasing it today, a very important part of the financial frame looking forward is going to be the relationship of growth in operating cash flow to reinvestment ratios and the capital mix of the company to the distribution policy, which I've also said will be in line with the operating cash flows of the group on a sustainable basis. But we haven't given any more guidance than that. If there is greater clarity on forward dividend policy and exactly how that will operate once we've decided on reinvestment ratios and the sort of growth that we see in operating cash flows, we would be able to give a little bit more clarity at that time. Can you rule out further rebasing of the dividend? One can never rule anything completely out, but we have obviously tried to do this so that the group will be robust in this environment going forward, and that we can sustainably serve our customers and shareholders and make sure that the group is repositioned for what is a very challenging environment going forward. Therefore, it is my sincere hope and desire that we will not be looking to make further reductions in the dividend. It would require another very significant step change in the circumstances facing the company. We have a question, I think, from Ed in the middle there, if I can just take that one and then to see if there's one or two more there. Sure. Edmund Reid from Lazard. Actually, three questions. The first one is on Sainsbury's Energy. I just wondered generally what the strategy is with Sainsbury's Energy. You rightly pointed out that the fixed price British Gas tariff is not significantly different from standard variable, but the Sainsbury's Energy one is very competitive. Is that something that you will continue to do going forward? The second question is just a definition one. When you say strong investment-grade credit rating, what does that exactly mean? Would it encompass Triple B plus, for instance? Then the final question is on smart meters. I was just wondering on the pace of the rollout. You are obviously far ahead of your competitors when it comes to smart meters. Would you continue to expedite your rollout to smart meters? Well, why don't Ian take Sainsbury's Energy and smart meters, and then Jeff comment on the strong investment-grade credit rating and what it means. Ian? Okay. Thanks, Ed. On Sainsbury's, clearly this is a partnership, so Sainsbury's have a perspective on what they want in the market for their clients as they see it. They wanted something different to British Gas. What we have put into market for their clients and their brand is effectively a no-frill, direct debit-led, internet-sold product. So it has a very different cost structure. At this point in time, smart meters are not part of that proposition. So there are material cost deltas between the Sainsbury's offer and the British Gas offer. As you probably know, Ed, the whole white label picture is under review by Ofgem, and we are expecting an announcement from them over the next couple of weeks. So it is very hard to give you a cast iron view of the forward strategy of that until I have seen where Ofgem come out. We think there is a strong argument for white labels as a distinctive part of the choice set in the industry. But let's see where Ofgem come out. On the smart meter rollout, we are committed to this. We are leading the industry. We are already seeing the benefits come through in two ways. One is in terms of the consumer behavior, where clearly estimated bills become a thing of the past, calls go down, complaints go down, and those customers are both saving energy and becoming more loyal towards the business. So we want to continue. We think it is increasingly a part of how we differentiate ourself in the market. We are a few months away from being able to scale rollout smart prepayment, which will be a breakthrough proposition in our industry, and we have got a significant lead against the competition. Given that, there's clearly a cost delta which arises from it. We're making judgment calls the whole time about not going too fast against any uncertainty that remains politically or from a regulatory point of view. But we think we've got about the right glide path to carry on through that. And I think, Ed, on the question about a strong investment-grade credit rating, we certainly would consider Triple B plus or the equivalent and above to be strong investment-grade credit rating. Okay. Thank you very much. Thank you, Ed. Are there any questions on the left there? It's your one chance. Okay. Are there any other remaining questions? There's one gentleman here in the middle. Thank you. Yeah. Hi, it's Andrew Moulder at CreditSights. I just wanted to follow up on the credit rating. If your rating goes down to Triple B, how much do you think that would increase your costs in terms of your hedging and your collateral requirements? Jeff? Well, I think, first of all, the level and how that's sort of set with the credit rating agencies is clearly their call and that's sometimes as much as art as it is science. As you start to move down to those sorts of levels and where we were at the end of 2014 and potentially moving into in 2015 and 2016, if the commodity price environment continued and we weren't taking the action we were having today, those would, in our view, be an area where it wouldn't be a strong investment-grade credit rating, and then it does increase the levels of decommissioning security, the amount of margin we're able to post for our trading business, and the boundary conditions in which we can do that in. So it would have a more significant impact than it would at A minus or Triple B plus. Just to comment on that, as Jeff showed in one of the slides, possibly our most constrained metric is Moody's RCF over net debt, and at the end of 2014, we were at 22. Moody's talk about mid-30s for an A minus rating. You can guess from that 22 isn't a territory that we want to stay in for too long. Clearly, the severity of the action we've taken demonstrates our commitment to getting back to a strong investment-grade rating pretty quickly. That just gives you the sense of, we don't want to end up in the situation where there's any uncertainty about Centrica's capability to operate with a strong investment-grade rating. Because the sustainability of our business, it's important that we don't constrain our business activity by having an inferior credit rating. Could we operate it? In theory, yes, but it would probably constrain us and might change the business model, and we don't think that's in the interests of our shareholders. One last question, and then I'll just wrap up. Thank you. It's Jamie Tunnicliffe from Redburn. Just following up on that. Given that you have cut the dividend, you're basically saying you don't see it as a very sensible business environment to be selling assets, that RCF metric is incredibly sensitive to the RCF number itself. You've done the two things which are, I suppose, the most obvious, obviously tough decisions as you've made it clear. How then, in that sort of calculation where it's such a sensitive number and you've done the two things that are more obvious, can you be confident that you've reframed the business in the right sort of shape? Well, my way of thinking about that is, firstly, we've repositioned primarily because of the fall in oil and gas prices and margins. Traditionally in the E&P business, it takes 1.5 to 2 years for the supply chain cost base to catch up with price. That means that the margins that have disappeared will start to reappear, and that's very important in thinking about the RCF. The second thing is that, as Jeff indicated, we had some end-year margin cash calls, working capital, which we would expect to wind back over the near term. So those are two things that are going to happen. They will just happen over a period of time, months, and into 2016. The third thing is the strategic review, where we've got to take a look properly at the portfolio in this context and say, do we have the mix right? Is the relative balance right? Therefore, is there anything we want to do to change the portfolio? I don't rule that out. So far from being out of ammunition to defend that, I think it's very important, though, that we are in a position with no uncertainty to be able to operate in this environment and give ourselves a little bit of time, I mean, I've been in this job for 7 weeks, to just think through what is the right course of action and mix for the group going forward. I'm far from pessimistic about this group going forward. I think we are extremely well positioned, but we just need a little bit of time to reflect. There are many other companies, including my former one, that are doing a bit of reflecting at the moment. It's been a significant shift, and we wanted to make sure for all of you and all the people you represent that we can actually reposition the company in a way that you have confidence in, therefore, that you know what you're investing in and what the picture looks like. That's why we've done what we've done. You have to wait till the summer to get a bit more of an insight into what we might then do going forward. Ladies and gentlemen, I'd like to thank you all very much indeed for coming. I hope that's given you some sense of where we are and where we're going. I do want to say one last time that putting this all into perspective, the circumstances that Centrica finds itself in are very, very different to where we were at the beginning of 2014. It would just have been inappropriate for us, and actually not responsible for us, to have not taken action now in order to rebase the dividend and, of course, to take actions on capital and costs so that your company can actually be managed on a sustainable basis in the near term as the markets settle down. I very much look forward with the team to updating you in the middle of the year or at the interims on our strategy and how we're seeing things going forward. Obviously, we'll have had another six months under our belt, and hopefully, the dramatic volatility in the commodity markets and the context that we're in will have stabilized. We will know more at that time about the CMA and what its initial findings are, as opposed to just issues. We will, of course, know who's sitting in Number 10 Downing Street. All of those things will probably help us have a lively conversation with the interim. Thank you all very much for coming. We'll be delighted to mingle with you for the next 20 minutes or so over a cup of coffee if you wish to. Thank you very much indeed.

Data Source: Quartr Last updated: Feb 19, 2015

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