Earnings Call: H2 2010

Feb 24, 2011

Let our own team settle. Very good. Well, good morning, ladies and gentlemen, and welcome to the Centrica preliminary results presentation. As usual, Nick will review the financial performance of the company, and Sam will then comment on the strategic priorities, the operational highlights, and the future prospects for the group. Before handing over to Nick, I wanted to make a number of points. 2010 was an excellent year in total, with strong performances from British Gas and their related service businesses, and an increasingly pleasing return from our North American activities under reinvigorated leadership. Our upstream businesses faced the challenge of unfavorable wholesale price conditions, but the quality of the management was demonstrated by the skillful integration of Venture, the successful hit rate in our drilling program, the relationships built in our nuclear partnership, and the efficiency of our plant operation. As announced yesterday, we are particularly pleased to have concluded a three-year contract with Qatargas. LNG has an important role to play as domestic sources of gas decline. This agreement is the conclusion of three years of patient and very hard work by Sam, Mark, Nick, and the rest of the team. We intend that this groundbreaking transaction marks the beginning of a longer-term working relationship with the world's largest LNG exporter. Downstream, the overall margin achieved in the year was at the top end of our range, but was heavily weighted towards the first half, with a mixture of lower costs and cold temperatures in the early months, counterbalanced by reduced prices and rising wholesale markets in the second half. By contrast, we have entered 2011 with warmer weather, lower consumption, and higher wholesale prices. Management remained focused on reducing costs, improving service, and creating competitive edge, and are clear on the necessity of achieving financial returns that will permit the major investment program that is required to meet the competitive, legislative, shareholder, and national requirements for a sustainable, profitable, long-term business model. I am also pleased that we will be recruiting 2,600 people into skilled jobs this year as part of this investment program. A valuable contribution to the U.K. economy, alongside our tax contribution of over GBP 700 million. My final point is on board policy. We seek to achieve a balance by rewarding shareholders through increased dividend when appropriate to our financial performance, delivering improved service and competitive pricing for customers, and caring for the disadvantaged in the community through attractive financial terms and support in energy efficiency measures. As a board, we are aware of our responsibilities and look to the government and regulators in providing a fair and level playing field, efficient and effective planning measures, appropriate financial incentives for long-term investment commitments, and importantly, a climate of public opinion that recognizes the critical role of sustainable energy in our society. We believe it is through this combination that the current success of Centrica will be preserved and developed for the future to the benefit of all stakeholders. I will now hand over to Nick. Thank you, Roger. Morning, everybody. As usual, let me start with some commodity price context. As you all know, 2010 was a year of rising gas and power prices. Gas prices, of course, are still well short of parity with oil. But if you remember, they were just 30 pence per therm this time a year ago, despite the high demand we had at the time due to the cold weather. Whereas today, they are up around 55 pence a therm. The forward curve would, of course, imply that that will be sustained through 2011 with very little seasonal variation. Power prices in the U.K. have followed gas prices up, as you would expect, but spark and dark spreads, of course, have been depressed under GBP 10 for much of last year and forecast to remain so for the rest of this year. In contrast to the U.K., North American gas and power prices remain very low. Shale gas has left the market well-supplied without the need for LNG imports, and that has resulted in a complete disconnect between prices elsewhere in the world. Against that commodity price backdrop, our business did perform very well. Clearly, the cold weather at both ends of the year helped, as did a strong operating performance, particularly some good gas production results, and a much improved performance from Direct Energy in North America. You can see the group figures here. Revenue up to GBP 22.4 billion. That reflects the higher residential consumption and the higher gas production, offset by lower average retail prices, both in the U.K. and in North America. Adjusted operating profit up almost 30% to GBP 2.4 billion, with all three main business units well ahead of 2009. I will come back and give you the divisional breakdown in a second. The interest charge was up quite significantly, and that reflects the cost we incurred buying back around half a billion pounds worth of bonds as we look to make the balance sheet more efficient. The tax rate up to 37%, reflecting the increase in proportion of profits coming from the more highly taxed upstream following the Venture acquisition, albeit that effective rate does reflect some benefit from a release of excess provisions as we agreed our tax returns with the revenue up to including 2007. All that left earnings at GBP 1.3 billion, which translates to 25.2p per share. That increase in earnings, together with our confidence in the medium-term outlook for the business, has enabled us to raise the dividend to 14.3p. That is an increase of 12%, well ahead of RPI. Indeed, I think you could say that is superior to the RPI plus 2% that some other companies target. Here is the divisional breakdown. You can see immediately the strong contribution from all three main business units. I will look at each of them in turn, starting with the U.K. Downstream British Gas, where profits were up some 20% to GBP 1.2 billion. The main driver within that was, of course, residential energy. You will remember that we led the market down with a price reduction of 7% back in February last year. That competitive price position, combined with our good service, meant we were able to increase customer numbers, adding around a quarter of a million customers in residential energy. We finished the year with almost 16 million customers. Average gas consumption was up around 11% per household, reflecting the cold weather at both the beginning and at the end of the year. That led to increased revenue, and in the first half, enabled us to expand margins as commodity prices remained low. The second half, however, was a quite different picture. We had rising wholesale prices, necessitating the retail price increase we put through in December. As you can see in the top right chart, that squeezed margins down to around 4% compared to the 8.9% that we achieved for the year as a whole. We continued to drive good growth in services, adding customers in all product categories and increasing the number of installation jobs we did by over 30% with a more competitively priced offering. We did incur some additional costs in services as we negotiated and then implemented the new working practices with the engineers. Of course, we did have higher call-outs during the cold weather. Those together did squeeze our margins a little bit, but with a higher revenue base, we were still able to increase profits to GBP 241 million. British Gas Business had another very strong year. We continue to focus on customers where we can add significant value, moving away from the higher volume, lower margin business. That did mean that, combined with average lower prices, the revenue base reduced, but we were able to expand margins, as you can see from the bottom right chart, and come in with profits up over 25% to GBP 233 million. Moving to the Upstream. Here, the results, of course, include the first full-year contributions from the Venture acquisition and the British Energy investment. As a result, profits up almost 50% to GBP 771 million. Within that, we had a very good gas and oil production performance, as you can see. That obviously reflects the acquisition of Venture and the addition of air assets to the portfolio, but also a very strong operating performance from Morecambe. On the other hand, bottom left there, you see realized gas prices were down as commodity prices fell, particularly in the first half. That was only partly offset by the higher average oil price that we realized. That did mean that although volumes were up 40%, profits were up just 30% to GBP 581 million. The Power segment now includes our 20% share of the operating profit of British Energy, and that is what accounts for the increase in profit over 2009. Nuclear output was actually somewhat disappointing given the outage at Sizewell, but still contributed 9.7 terawatt hours, as you can see. Our own CCGTs generated 22.8 terawatt hours, slightly down on 2009, reflecting the lower spark spreads and lower load factors that resulted from that. However, with optimization, we were able to realize spark spreads are still over GBP 11 despite those lower average market prices. Finally, within Centrica Energy, the I&C segment, the GBP 36 million there, that will be the final loss from that segment. Most of the main contracts have ended, and what is left in I&C, we will fold into the Gas and Power segments for 2011. Storage had another good year, with profits largely unchanged at GBP 169 million. We do actually have slightly lower average SPU prices, but we are able to cover that with better optimization. However, as you know, summer-winter differentials have narrowed considerably, and we are looking at much lower SPU prices for the coming storage year. As a result, profits from this business are likely to halve in 2011. In North America, Direct Energy had a very good year. You will remember we had some one-offs in last year's result, but even if you strip those out, profits are up almost 10% to $234 million. That $234 million was despite a loss from the Upstream, GBP 46 million loss, which reflects the low commodity prices which hit our Upstream, Canadian Upstream gas profits, and also resulted in losses from the CCGTs and the wind contracts in Texas. The strong performance within Direct Energy were on the supply side, both residential and business. Residential customer numbers were actually slightly down, but falling commodity prices meant that we were able to expand margins at the same time as reducing prices. Without the bad debt write-off that we suffered in 2009, profits came in at GBP 177 million. We continue to expand in the B2B market, particularly in electricity supply. As you can see from the bottom left, despite lower average prices, we actually increased revenue and more than doubled operating profit to GBP 88 million. Services within North America were slightly down in terms of profit, and we had transaction integration costs within Clockwork, which meant that that is yet to have any significant impact on the figures. However, the integration has gone well, and we will be looking for a significant step up in contribution from Direct Energy Services this year. In terms of the cash flow, cash generation remained strong, EBITDA now well over GBP 3 billion. We did have a working capital outflow as prices and cold weather towards the end of the year pushed up working capital, but that was more than offset by a margin cash inflow. CapEx was at a more normal GBP 1.7 billion, just under. I will come back and give you a breakdown of that in a second. That left net debt at GBP 3.3 billion. Here is the breakdown of the CapEx numbers. As you can see, Upstream U.K. is the most significant element. Within 2010, we had three main projects, Seven Seas, Chiswick, and F3-FA. We are looking at another increase in CapEx within Upstream this year as we start three new major projects, York, Rhyl, and Ensign. For Power, 2010 includes the final payments on the new CCGT at Langage. It also includes our share of the CapEx on the new Lincs wind farm. In 2011, for Power, Lincs will be the biggest single item, and we will also continue to spend on nuclear new build ahead of the final investment decision expected next year. The acquisitions in 2010, the GBP 600 million you see down the bottom there include the additional stake we took in Statfjord, bought from Shell, the investment made in Trinidad, and our two North American acquisitions, Wildcat Hills for the Upstream and Clockwork for Services. The balance sheet remains strong, net debt to EBITDA of around 1.1 times. That gives us the ability to fund the CapEx program that I have just outlined for 2011, and to continue to invest in the business beyond that. We have used our strong cash position together with the increased availability of bank facilities to finance that half a billion-pound bond buyback I referred to earlier, as well as improving our debt structure, making it more efficient. That has also improved our maturity profile, as most of the bonds we bought back had been due to mature in 2012 and 2013. We put GBP 300 million of deficit payments into the pension fund, and together with some favorable movements in equity prices relative to bonds, that has enabled us to reduce the deficit as measured for accounting purposes under IAS 19, at least, to less than GBP 250 million. We did suffer a number of exceptional items in 2010, mainly due to the low gas and power prices in North America and also the low spark spreads in the U.K. We wrote down the existing gas fields we owned in Alberta before the Wildcat Hills acquisition, made a further provision against the Texas wind farm contracts, and wrote down three of the older CCGTs in the U.K. In summary then, a strong performance in 2010, both operationally and financially, with all three main business units contributing to the profit improvement. Looking into 2011, it will be more challenging for the Downstream business without the benefit of the exceptional cold weather we had last year, and with a higher wholesale price to contend with. The Upstream will see rising unit costs, but it will of course benefit from those higher commodity prices, and we are looking for a better output performance from nuclear and from wind. We will also be looking for growth from Services and from North America, whereas storage will be down due to the lower seasonal spreads, as I said earlier. Overall, we are comfortable with where market expectations are right now, around 27 pence per share, recognizing that it is still early in the year and we do operate in competitive markets. We do continue to invest in the business with an increase in organic CapEx plan for this year. We will see some benefit in the 2011 results from that, albeit quite a lot of the investment is in medium and longer term projects, which position the business for future growth. With that, I will hand you over to Sam. Thanks, Nick. Well, thank you very much, Nick, and good morning, everybody. As you have heard, 2010 was a strong year for Centrica. We achieved a significant increase in earnings, up 16% year on year. Operating profit grew in all of our businesses. Downstream, we added over half a million customer accounts, having taken the lead on reducing prices and also on the quality and flexibility of the services we offer. Upstream, the enlarged business performed well with strong production volumes and excellent drilling success. In North America, we have made encouraging progress, particularly in energy supply, through a combination of improved operational performance and selective acquisitions. With our distinctive combination of strong cash flows and a program of carefully targeted investments, Centrica is well-placed to deliver further growth. We have made real and measurable progress across each of our strategic priorities that we announced a year ago. First, our priority to grow British Gas. In residential energy, we led the market by cutting prices last February. However, rising wholesale prices and non-commodity costs from the second quarter of 2010 onwards required us to increase our prices, although we were able to hold off doing so until December. To offset the effect of higher prices, we have made it a priority to help customers manage their energy use. Underlying gas consumption has reduced by more than 20% over the last five years, and we are actively helping customers to make further, for example, through better insulation and by installing more efficient boilers. We achieved a further marked improvement in our residential net promoter score, and we also retained first place in the Morgan Stanley Energy Supply Survey. Over the course of the year, we added 267,000 residential energy accounts, reflecting both our competitive prices and high service levels. We have also increased the number of customers who take both an energy and a services product, up by 121,000 over the year. Earlier this year, British Gas became the new energy partner in the Nectar Energy Loyalty Program. We also entered into a partnership with Sainsbury's Energy, providing us with a new channel for growth. In the first few weeks since its launch, over 750,000 customers have registered on Nectar, and the initial interest in the Sainsbury's Energy partnership has been encouraging. We are also making real progress in our services business, and this is an area of competitive advantage for British Gas. Over time, we expect that services will play a defining role for the energy company of the future, forming the basis of long-term sustainable growth. In total, we added over 265,000 services customer accounts over the year, with growth in each of our core products, and particularly encouraging growth in central heating contracts towards the end of the year. In addition, over 6 million of our services accounts are now on an insurance-based product. We also reached agreement with our engineers on working arrangements, which has allowed us to improve the flexibility of the service that we offer and meet the challenge of the very cold weather in December. These new working patterns, together with the steps we took to prepare for winter, enabled us to reach up to 35,000 customers a day during the exceptionally cold weather. That is around double the number for a typical winter's day. We also increased the number of new boiler installations by more than 30%, mainly as a result of more competitive pricing. We remain confident that delivering substantial growth in the contribution from the services business with our improved same-day service, better productivity, and lower supply chain costs. But we face a tough economic climate, so it may take a little bit longer to achieve the growth than previously envisaged. Our strategy is to continue to focus on the quality of the services we offer, our ability to reach customers quickly with a proven distribution network and a trusted engineer workforce. With attractive customer propositions and the capability to undertake the work efficiently, we are well-placed to deliver further growth in a competitive market. British Gas Business also continues to perform very strongly. Operating profits have increased by 25% on average over each of the past five years in BGB, reaching over GBP 230 million in 2010. Margins have improved to around 8%, reflecting the success of our volume to value segmental growth strategy, which has seen us move away from high-consuming single-site industrial users to focus on our SME and multi-site customer base, where our retail skills can give us a significant competitive advantage. We continue to deliver a high level of service at competitive prices. As a result, customer retention remains high. In business services, we significantly increased the scale of our activities with the Connaught Gas and Electricity Services transaction. This brought us a workforce of over 400 engineers together with more than 20,000 customer accounts, and we are now developing a complete services offering to business energy customers. In new energy, we remain committed to leading the industry in energy efficiency, and we have adopted a go early strategy aimed at revolutionizing energy use in the nation's homes. We have now installed over 250,000 smart meters, and we have also launched market-leading propositions that enable our customers to take advantage of the latest technology. We have also made a number of small acquisitions in new technologies, including microgeneration, specialist insulation, and home energy management. In the social housing sector, we have won the Scottish Government Energy Assistance Program, and we have also been awarded the contract to run the Welsh Assembly's new program. We have entered into a commercial arrangement with Mears to bid jointly on repair and maintenance contracts in this important sector. Next, our priority to deliver value from our growing upstream business. Upstream gas and oil had an excellent year. The acquisition of Venture has transformed the business. The integration went well, staff retention remains high, and we now have real depth of expertise as a leading operator in the U.K., Norway, the Netherlands, and Trinidad & Tobago. Total production volumes were up 43% year-on-year, reflecting strong asset performance and higher production volumes from Morecambe. In our drilling program, 11 out of the 15 wells showed positive results. Together with the Trinidad and Statfjord acquisitions, which we completed during the year, our reported reserves increased by 9%. That is equivalent to replacing over 160% of our production. We plan to drill at least 11 wells this year, maintaining our position as one of the most active drillers in the North Sea. We also brought 23 LNG cargoes to the U.K., up from 15 the previous year. The agreement we announced yesterday of a three-year LNG contract with Qatargas will create a unique strategic relationship with the world's number one LNG exporter. The contract will provide enough gas to meet around 10% of the total annual U.K. residential demand, or 25% of British Gas's requirements, delivered to the Isle of Grain facility. We also have approved this morning the development of the York and Ensign gas fields, investing around GBP 450 million, over half of which will be in 2011. These developments offer attractive returns, and we estimate that they will add over 30 million barrels of reserves. In addition, we continue to look for opportunities to increase our reserves through acquisitions where we can add value. The chart shows our upstream gas and oil production profile. As our existing production declines, ongoing investment and development will be required to maintain production at around the 300 BCF per annum level. You can see the significant contribution from Statfjord with its long, stable production profile. Included within the core and in-flight section, shown in orange on the chart, are fields already in development or planned for development within the next three years. These include Cygnus, which is in detailed engineering, and also Ensign and York. These developments will form an important part of our future development plans. In power generation, we achieved strong reliability across our CCGT and wind portfolios. Our new gas-fired power station at Langage is performing well, having entered full commercial operation last March. Nuclear contributed over half of the power generation operating profit in 2010. The business is well-placed to benefit from higher power prices as part of a balanced portfolio of low-carbon generation assets. We were pleased to secure the five-year life extensions for Hartlepool and Heysham, which extends their accounting lives to 2019. Work continues on new nuclear build. Subject to the outcome of consultation over electricity market reform, we expect to make our final investment decision on Hinkley Point in 2012. In offshore wind, all major contracts have been awarded on the Lincs project, and onshore works have begun and offshore construction will commence next month. In gas storage, Rough once again delivered excellent operational performance. The exceptionally cold weather saw the net reservoir volume hit a new low last March, followed by a record injection season over the summer, and unusually high levels of demand in the final quarter of 2010. Despite these high levels of demand, the winter-summer price spread has narrowed significantly, which will affect Rough's profitability in 2011. As we announced last year, our Caythorpe project remains on hold at the present time. Work, however, continues on Baird with a final investment decision later this year. We've made encouraging progress towards our third strategic priority to build an integrated North American business. Our downstream performance here has been particularly strong, delivering double-digit returns on capital employed. Although upstream, our profitability continues to be adversely affected by low wholesale commodity prices. In residential energy supply, we've improved customer retention and cut the level of bad debt in Texas. We've also successfully launched an innovative prepayment offering using our experience from the U.K. market, and we continue to enter new competitive markets in the U.S. Northeast, which is an attractive source of growth for Direct Energy. We maintain our focus on the most valuable segments of the market. As a result, we saw the attrition of low-value customers in the first half of last year. However, we've been increasing our customer base in the Northeast, adding 90,000 customers in Pennsylvania and Maryland. In Ontario, the market environment has become more difficult, with the Energy Consumer Protection Act impacting both customer acquisition and retention. However, we continue to see solid returns from our Alberta business. In North America, business energy division has had a very strong year, achieving an improvement in sales activity and power volumes. We focused on the most attractive segments, improved our service, and tightened our cost control. As a result, the business achieved a substantial improvement in net promoter score and higher margins, which improved to over 3%. The business is therefore well-placed for continued organic growth. In services in North America, the integration of Clockwork is progressing well. The transaction was completed in July, making Direct Energy the market leader in the home energy services market to provide a platform for growth through Clockwork's established franchise model. Upstream, low gas and power prices significantly affected the returns from the business. We continued to look for investment opportunities where we can add value. The Wildcat Hills acquisition enabled us to add over 240 BCF of reserves at an attractive price, and at lower unit cost than our existing gas production. The transaction also improves the vertical integration in the business so that Direct Energy is now able to meet around 35% of our customers' gas demand from our own production. Overall, we made real progress in North America as we move towards our ambition of doubling the contribution from this business. North America represents an important opportunity for growth, competing for capital alongside the other investment opportunities available across the group. In summary, Centrica has achieved substantial growth in 2010, making good progress in each part of the business. We delivered strong operational performance, continued to improve our service levels and our safety record, which has been an area of continued focus. As a result, we delivered a strong financial performance with operating profit up by 29% and EPS up 16% on the year. We therefore proposed a 12% increase in the full-year dividend for 2010, reflecting the significant increase in earnings. We expect to achieve continued growth in 2011. Market conditions remain competitive, particularly in the U.K. downstream energy supply. However, we are well-positioned for growth across much of the rest of the group. We have an investment program for 2011 of some GBP 1.5 billion, over two-thirds of which we expect to direct towards our U.K. gas and power upstream businesses. We remain alert for value-enhancing acquisitions and carefully targeted investments, both upstream and downstream, where there is an appropriate fit with our portfolio. Centrica is distinctive with its balanced business model, which is able to perform well in both high and low commodity price environments, with strong organic cash flows, a robust balance sheet, and a range of attractive investment options. With that, let me hand over to questions. Thank you. Very good, Sam. Thank you. As always with questions, if you could say who you are and where you're from, and remember to press the microphone button. We got the full team here, as you know, on the front row. Sam and Nick will lead on the answers and I'm sure parcel out the difficult questions to the team, as is the normal way. We also got two non-executive directors here today, but they're not looking to answer many questions. If we could start the first question, please. Fine. Let's start right at the back, please. Hello. Ajay Patel at UBS. Three questions if I can. Firstly, for 2011, could you give us guidance for volumes on the upstream, both Morecambe and non-Morecambe, if possible? Secondly, around North America and residential energy, I just wanted your thoughts around how sustainable the 7% margin is, or is there room for improvement? Anything, sort of color there would be nice. Lastly, are you currently comfortable with your current capital structure, or will you look at further ways to improve it, maybe via further buybacks of debt? Thanks. Well, Ajay, why don't I take the first one, which is around production volumes for 2011. As you saw, we produced just over 50 million barrels equivalent in 2010. We would expect and that was the result of Morecambe operating at very high levels. We do have some maintenance planned for Morecambe this year so that overall our production numbers will be about 5% lower this year. But still very much in line with our 50 million barrels a year long-term guidance that we give. In terms of the split, a little bit under 1 million therms of that will come from Morecambe. The second question, I think, was around margins in North America. We continue to take costs out of the business. Obviously we had good margins in Texas. We also, I think, had much better debt collection in Texas. We're installing prepayment meters. But I'll let Chris Weston also just give you some color commentary between the Northeast and Texas margins. Yeah. As Sam said, we have improved operations in Texas, which has allowed us to expand the margin this year, both in terms of debt and reducing the operating costs. We have been slightly fortunate in the way the commodity price has stayed low throughout the year, but I'm confident that we will see the margin remain where it is at the moment. Northeast margins are slightly lower, but that is a growing business. We're investing more in cost of acquisition to grow it very quickly. I would expect the margins there to expand slightly. But overall, I think within residential, 7% is probably around about right. I will let Nick deal with the third part of your third question, which was around capital structure. Yeah. Thanks, Ajay. Obviously, the balance sheet remains strong, as we said, debt to EBITDA around 1.1 times. Clearly, everything we are doing, we will measure against the benchmark of returning cash to shareholders. Equally, I think we do see a big investment opportunity. I appreciate some projects have moved to the right, but you saw the step-up in organic CapEx for the upstream business. I think we continue to see bolt-on acquisition opportunities, North America and in the North Sea. So I think we are comfortable where it is at the moment, but we will keep it under review as we go forward. Thank you. Okay. Sorry, Mark. Just wanted to add a supplementary, I think probably to your first. I would just like to add a comment, Sam, on Morecambe. Sam mentioned Morecambe production this year, around 1 billion therms. Obviously you will be looking at something like a 35% reduction from last year and thinking that is a very big number. I would just like to give some background to that. 2008, if you remember, sorry, 2009, we rested the field for broadly half of the year, recharged the pressure. Produced in 2010 at exceptionally high levels and really did not have a shutdown. I think we were shut down for 3 days. The combination of resting the field, not shutting down, having a major shutdown this year, that is what is behind that big change in number. The decline of the field is still in the normal range that you would expect for a North Sea field in the sort of 15% range, the underlying trend. Thanks, Mark. Okay, we will go to this side now, please. Thank you. Nick Heslop from RBC Capital Markets. On the services side, Sam, you said that you thought there would be a delay. You had previously spoken about doubling the profitability there on a 3-year view, is from memory. I am just wondering whether there is a competitive change there, given there has been the odd deal in that sector. Then secondly, whether there are any other factors that are causing that to move out, and whether you could put a new timeline on achieving that doubling of profits. Yeah. We are certainly not signaling a big change in 2011, but we are saying for 2012, it might take us a little bit longer to get to that target. That is in part because two things occurred in 2010. We spent a lot of time, I think, working on a new agreement with the unions, which we now have very good support for. Therefore we, if you like, started this growth trajectory a little later. Of course, we also had the cold weather, which meant that we were doing a lot of boiler repairs, and so we sort of started a little bit further behind. This is, as I say, 2011, we still see strong growth. We still see good growth in 2012, but we might not get quite to that number in 2012, but we get there a few months later. No legislative changes for the better. No, no legislative changes, and I think you mentioned competition. We are seeing more competition in the marketplace, undoubtedly. But I think we have a premium proposition with the in-day service that we can now offer and our promise to customers, if they call us before 1:00, to get there the same day. We have done a lot, not only with the workforce but also with the supply chain to actually reduce costs and ensure that the parts are delivered on time. But we are not seeing any regulatory threat in that area. Actually, the fact that we have moved to an insurance product means that actually we also have a higher standard of selling to go through and that we are FSA-registered for that business. I think that is something that we are proud of. I might just add to that we indicated GBP 1.2 billion of operating profit from British Gas in 2012, and we achieved that in 2010, of course. We are still comfortable with that as an overall objective. Clearly, the precise mix. British Gas Business, as you saw, was doing extremely well and we are looking for good growth there. So I think we feel comfortable with the overall shape of British Gas and some of the mixed things may change. Okay. Fine. Lakis Athanassiou, we will do you. Lakis Athanassiou, Evolution Securities. A few questions. Just on weather normalization, could you give an indication of what the unit consumptions would have been under normal weather for gas and for electricity in BGR? Also along that line, could you give us an indication of how much higher your wind production would have been if you'd have achieved a P50 type production level for your existing assets? In BGB, could you give us an indication of, with the margin improvement, how much of that is mix and therefore permanent, and how much of that is related to volume? Also, just a couple of questions on strategy. In new nuclear, clearly with the consultation suggesting fixed prices, that is firmly outside of your strategic remit, and I'm just wondering what your thinking now is on new nuclear development and how you sit within that on, essentially, on power generation that will achieve fixed prices if we go that route. Also on the Qatar deal. 3 years, probably NBP related, great, but clearly you guys would want a longer term. How do you think the Qataris will be set up for that ongoing, and what's preventing them from doing something like that, say, a 10-year PPA now? Just a thing on Trinidad. Well, hold on. Trinidad, your reserves you put in at about 170. You had 266 at the announcement. Something in a footnote about production sharing. Could you just give a bit of color on that, please? That's about 7 questions, Lakis. But we'll try and work our way through, Sam. Yeah. Yeah. If we can go back to the first one, which was, I think as I understood it, what would consumption have been with normal weather? I think the point is obviously, gas consumption was up 11%. I think it's very hard to honestly tell, because I think we've seen such unusual weather patterns in 2010. Whilst we've done a lot of work, and I mentioned it in my remarks, showing that over the last 5 years, there's been a reduction of some 20% in gas demand. I actually think that you can't sort of take 5% off last year because I think actually normalized weather would've been higher than that. But Phil, do you want to comment on it? Yeah. On elec it was probably 2%-3% and on gas probably maybe 4%, something like that on an underlying. But as Sam said, it was very extreme weather. You asked a question about BGB. Most of that is permanent margin improvement. It largely comes from ensuring we capture the margin that we actually think we're writing. One of the issues we had was we would sell a piece of business at a fixed price and not be quite as tight on the hedging and locking in the margin. We've worked quite hard, sort of self-help, to improve margin capture nowadays. So I'd say that's the permanent feature to the way we run the business. 8% a good number going forward? There was a bit of weather in that as well, probably. Yeah. Six. Your second question, Nick, is Nick and I interpreted it differently. Were you seeking to normalize for wind or for gas production? No, wind production. Wind production. The load factor was 29% in 2010, and if you take the mix of onshore and offshore we've got, we expect to move more like 35 in a normal year. 35. Okay. Yeah. I think you had a strategic question around new nuclear and the electricity market reform. Our position on this is you are absolutely right that one of the options on the table is a contract for differences, which amounts to some extent to a fixed price. We think there is another way of getting there which actually would also be good for new nuclear, which would be through a premium feed-in tariff, which would be a similar sort of mechanism to ROCs in that it would still leave investors with the exposure of obviously of construction costs, but also with the base power price, but there would be an agreed supplementary tariff. We think that that, in many respects preserves the competitive market and therefore has some distinct advantages. We also think that actually it probably is going to encourage more competition. If we are unable to agree what the level of the premium feed-in tariff should be, and therefore because people have very divergent views about future gas prices and power prices, then actually you gravitate back to the pragmatic solution, which is the contract for differences. So we are not religious about this. It is essentially what will give us a good return for getting new nuclear going. We have been very clear all along in our partnership with EDF and with the government that actually unless we have satisfactory returns in new nuclear, then it is not an investment that we can make. Could you see yourself selling your position, basically the return CapEx position once the deal has been fixed with government? If it goes fixed, still retaining, say, a PPA, just so that effectively to a fund or something like that? Well, I think if you have a contract for differences, then clearly you have a fixed price, and that is something that is easily securitizable if you wanted to do so at that stage. That completes the list. No, I think you had a Trinidad and Tobago. Yes. You had a question around the Qatari contract. I think it is in the nature, and actually if you look at the history of negotiations by other counterparties with the Qataris, quite understandably, I think they want to start with a short-term deal and make sure that it all works and iron it out before they turn it into a longer-term deal. Clearly the intention on both sides is to turn this into a longer-term transaction. How we price it remains to be seen on what the market conditions are at the time. I think the question on Trinidad was around the reserves that we announced when we made the initial acquisition, and you are right. Those were the entire net reserves. The reserves that we are reporting in the annual report and in the statements today are actually net entitlement reserves. They are reduced for the fact that some of that gas will actually go to the government. So it's not a write-down or anything like that? It's not a write-down of the numbers, no. Okay. Right. We'll try Ed, please. I'm afraid I've only got two questions. The first question is on the price rise, whether that had an impact on gross churn in British Gas Residential and how much that was? Secondly, throughout your presentation, you mentioned that the U.K. retail energy market is highly competitive. Ofgem are doing a review of the energy market. I read a number of press comments saying that there's likely to be a referral to the CC. I was just wondering how you kind of reconcile those two things. Okay. I think in terms of the price rise which happened on the 10th of December, I think a number of price rises were happening around the same time. Ours was not the first. We did, as a result of that, I think, see a slight increase in churn, but also during the month of December, because of the very cold weather, we also, and I suspect all our competitors also, saw lower sales because actually people were unable to get out and sell quite the same amount. I think where we've seen January, actually, we've seen a modest impact on our overall customer numbers, but we haven't yet seen the big potential benefit that we expect to see from Nectar and from the Sainsbury's deal, and we haven't seen the benefit of the fact that we're now back being, from the 2nd of March, the cheapest on electricity, the cheapest on dual fuel, and we were the cheapest on online. I think that will obviously have a positive impact going forward. I think in terms of the Competition Commission or prospect of it, let me give you some context here. We've obviously had a number of investigations over the years from Ofgem, and we had a probe, as you know, 18 months ago, which was very detailed. I think that came up with some clear recommendations. We are fully compliant with all of those recommendations. I think it's not clear that all the industry is, and therefore, I think quite understandably, Ofgem have launched this further investigation to ensure that everybody's compliant, particularly on areas such as doorstep selling, where we have the technology to give all our sales force a tablet and ensure that the price propositions are accurate, not just to the customer, but also right down to the street level, that our bills are actually totally transparent, and our annual statements, which have won awards from Which? and Consumer Focus are accurate, and that our financial reporting is transparent. Now, it's not obvious that everybody in the industry is in that position, and therefore, quite rightly, I think Ofgem want to deal with it. The last resort is clearly, and an option is to go to the Competition Commission. But it's, in our view, let's fix the things that are imperfect in this market rather than having a root-and-branch review, which we think would be damaging for investor confidence at a time we're going through the electricity market reform, and we actually need to get new power stations built and new sources of gas coming into the country. Our clear position on this is, let's focus on what's broken rather than a 2 to 3 year, and all the advice is that actually a CC inquiry has never been done in less than 20 months. And in an industry such as this, which is complex, it would be a probably 3-year process, and we think that is unnecessary and would be a mistake at this stage. If it happens, so be it. We're ready to handle it. But I think it's not what the industry needs at the moment. Thank you. We have nothing to fear at all, but we're certainly not recommending that it's a good idea for the company or the industry, just to be clear on the message. Right. If we go over here, please. Thank you. Ashley Thomas from MF Global. The GBP 170 million of out of the money contract provisions that you've charged in 2010, can you give me a rough feel of how they benefit 2011 and 2012? Is it broadly half/half? And then secondly, could you help my understanding as to why the provisions increased in the second half compared to the first half, given that obviously the forward curve, the wholesale price actually increased over that period? Yeah. The split is actually roughly two-thirds, one-third, 2011, 2012. I think the way we'd characterize it is a benefit to our input cost. I think you shouldn't assume that's going to flow straight through to the bottom line. It just allows us to have a lower cost base, and therefore be relatively more competitive on pricing. In terms of why the provision went up is we closed out some more contracts. So we had some gas that we'd bought at relatively high prices some time ago that was in the portfolio. We closed out some of those in the first half. We closed out more in the second. Okay. But just in terms of my understanding, if they were uneconomic in the first half, wouldn't they have been more uneconomic in the first half, and therefore- Well, we closed them out, and so those contracts are gone and paid the cash cost up front. It wasn't a provision. It's a cash cost of closing out those contracts. Okay, so it's just a discretionary- Done. Thank you. Go for the middle. It is Martin Brough from Deutsche. Just two questions on the residential side or the British Gas side overall. The first around bad debt, just to get an idea what kind of levels you are seeing in 2010. What are your expectations for 2011, 2012 as you begin to get interest rate tightening and obviously measures coming through on the fiscal side from the government? On the second side around the Green Deal smart meters, is there any more visibility in terms of the financing of that? The infrastructure providers out there that are willing to come in and fund other than meters or things like solid wall insulation? How is the legal framework going in terms of the bill that is going through at the moment in terms of the loan scheme and potentially finding buyers for securitized bonds and that kind of thing? The first question, Phil handled both of these. The bottom line of the bad debt situation on residential, we are not seeing a deterioration, partly because certainly a lot of our customers are now on direct debit and a lot of our customers are on prepayment meters, but Phil? Yeah, it varies between 1.5%, something like that, 1.5, 2%. It's been falling largely again, from self-help, as Sam said. We've now moved a number of customers on direct debit are now 56%, whereas two years ago it was about 46%. Things like Energy Smart, where you put your own reading in and things that we've also got what we call DD Flex, where customers can take a short holiday to help manage their payments within a 12-month period. That's all driving forward on improving cash collection. In BGB, we are seeing an underlying trend increase in bad debt and insolvencies still. But again, if we catch it soon enough, as we are doing with new systems which we've been putting in, we're still seeing a reduction net in bad debt. The Green Deal and smart meters is obviously very interesting for us because it could potentially be a huge opportunity for growth in the servicing business. We are leading in the installation of smart meters. We've said we will, what we call go early on Green Deal. By going early, what we mean is that we will do the financing ourselves of the install in the customer's home, and collect that money, if you like, on our balance sheet before we securitize, before there is an asset class to be securitized. We'll do that this year. I think we would expect by the end of this year that we'll have clarity from DECC on what's in the package. I think there is a sense that solid wall in some shape or form will be there, and we've bought into a solid wall insulator, which looks like quite a good business to me. I think there'll be clarity around how the financing is actually going to work. Where does the risk lie? What default rates are we expecting, and does it stay with the supplier or with the investor? So I think there's still work to be done, but my sense is that we're making quite good progress. Okay. No, that was it. No, to Kevin the point. Okay, fine. Will, please. Hi, it's Mark Freshney from Credit Suisse. Just three very quick questions. Firstly, given the turmoil that we're seeing in the Middle East and North Africa, what are you seeing on the physical supplies of gas front? Are you tempted to accelerate some of your hedging in the downstream businesses in response to that? Just secondly, given the movement in the reported IFRS accounting deficit for pensions, I know that you've got, I think, a three to four-year deal with the pension fund trustees. Does that deal with the pension fund trustees still stand? Just thirdly, on Caythorpe versus Baird, given that Caythorpe is much further ahead in therms of the FEED studies and so forth, having been carried out, why is it that Caythorpe is almost on the back burner and you are still looking towards assessing Baird for an FID in the second half of this year? Okay. Well, let me start with the one around are we seeing differences in the supply market as a result of the tensions in the Middle East and the gas supply market. The answer is, we're not. Clearly, the gas that is oil-linked that goes to Asia, the LNG that goes to Asia, will clearly be over time as those indexes work through, that will result in a higher cost gas. But it hasn't yet had an impact on the U.K. spot market. Clearly, if there are significant supply disruptions in Southern Europe, then it may work through into the supply spot market, but that hasn't yet happened, and obviously that's something we look at, and it's one of the things we take into consideration in our hedging program, but I don't think we can go further than that. I think in terms of your second question, which was around the movement in pensions, yes, we have got a lower deficit, but actually we're coming to the end, and Nick might mention we're coming to the end of the payments we're making into the- Yeah, as you say, the last valuation was as at March 2009, and that had a three-year significant deficit payments, and then an agreement was what happened after that. We've actually paid all that first three years. We've paid all of those deficit payments now pretty much, apart from a few single digit million. That's our choice because with the tax rates coming down, it made more sense to pay it early. So everything's paid now. The next valuation is at March 2012, so it's a little way off, and then we'll have a new agreement depending on what the deficit is at the time. Yeah, I would caution that trustees, the way they look at pension deficits doesn't always align with IAS 19, so you may get a different outcome to the one implied by the accounting numbers. I think your third question, Mark, was around Caythorpe and Baird. In that, yes, you're right, we have put the Caythorpe project on hold. The two projects are very different. The Caythorpe project basically is fast cycle time, small onshore project where we put the gas in and out of the ground at a relatively rapid rate, and is designed to take advantage of short-term volatility in gas prices. With the levels of gas prices and the volatilities we've seen this year, on our future modeling, we didn't see a satisfactory return on that project. The Baird project, which we're still moving ahead with at the moment and we're still in engineering for, actually requires winter-summer differentials. It's more analogous to the Rough project that we already have. Now that too, as a result of compressed winter-summer differentials, is by no means certain that project will proceed. But we're continuing to do the engineering to get the costs as low as they can. I think much will depend on the shape of the forward market going forward. What kind of summer-winter spread would you need for that Baird project to be economic? Well, I think that's a matter that's competitively sensitive because it's not the only project that's out there at the moment, but higher spreads than we're seeing today. Okay. Understood. Yeah. Got it. Okay. Thank you. Thanks. Andrew Mead from Goldman Sachs. I just have two questions, one on the CapEx. Beyond 2011, given the projects you've now also added to the list, what's the sort of outlook for the CapEx going forward beyond 2011? The second question is a very simple one, just on the North American Upstream gas. If it's not making any money, why doesn't the volumes come down in therms of production? Is there inflexibility in the contracts that stops you turning the gas off? Yeah. Nick talked to the guidance on the CapEx, and I'll talk about North American gas and also let Chris add to it, too. Given the guidance for 2011 of GBP 1.5 billion of organic CapEx, that's good for the next two or three years. Obviously, any one year, depending on the precise timing of some of the bigger projects. If you remember back to the capital markets, say, guidance, we were showing numbers that went above that. That very much depends on the storage projects, Baird in particular. Depending on whether they go ahead or not, we could be above the GBP 1.5 billion. But GBP 1.5 billion is still a good number at storage. I think in therms of North American gas production, the Wildcat Hills gas production that we've added is lower cost base than our legacy gas production, if you like. Even at low gas prices, on a cash basis our gas production is making good money. On a full cycle basis to cover the full depreciation then at current prices, it's around breakeven, but actually on a cash basis, it's still strongly positive. If we look forward at the futures market, which has got a little bit of contango in it, not much, then actually it's a positive income operation. Chris, do you want to add to that? Just to add to that, we did make a profit this year in Upstream gas with a small contribution from Wildcat Hills. We should make a profit next year as well because the costs that we enjoy from Wildcat Hills will improve the cost position overall. Some assets within the portfolio won't, they're higher cost, but overall, I would expect to make a profit this year, even in a depressed market. You're on a good point, Andrew. It is a make or buy decision in the sense that if you can turn wells off easily and bring them back on, you would. But for some of these older wells, actually, getting them restarted again isn't that simple. It's not like Morecambe in that respect. Okay. Fine. Let's go here. It's Peter Atherton from Citigroup. A couple of questions, please. Can you run us through the cost pressures, I guess particularly in British Gas, that you're looking at networks, the various government environmentally driven charges and tariffs, and your internal costs? Secondly, on this underlying reduction in gas demand from the residential sector been running at sort of 3%-4% for the last few years. At what point does that put serious pressures on the value of the residential businesses as an industry? How do you think as an industry you're going to cope with that? Are you going to seek to get much higher margins structurally over time, or is it going to be a question of gaining market share to keep absolute profit levels up? When do you hit that position? Is it the middle of the decade as the Green Deal, hopefully from government terms, really kicks in? Finally, can you run through what your return on group capital numbers have looked like over the last 12 months, where they've moved to, and where you see them trending over the next few years? Okay. I think clearly if you look at the British Gas cost base, we continue to take costs out of the business, and net, that's a positive story. But equally, we are funding future growth. Phil, do you want to just talk a little bit about those two moving parts? Because we've got two areas of significant investment, if you like, the whole smart metering world. Also we have a big systems program to actually enable us to basically take costs out of the business and cross-sell between the energy and services side. I'm not sure quite what guidance you're looking for in terms of the future. Clearly, you saw in the electricity transmission charges this time we're up 16% on much smaller volume growth. So that's the effect of the last price control review now working through. We've got a new gas control review. The last one was quite positive to us. It kept prices down, and therefore we haven't seen that increase. Do I think that the control review in gas will push prices up? Yes, I think we do. As we expect the CERT and CESP and what's now called the ECO, the new Energy Company Obligation, I think that's all going to drive up costs. Now, traditionally, we've expected and have proven we can recover that from our customers as part of just an ongoing operating cost at the gross margin level. Obviously, what we've got to do is get our own internal costs down, and we have been doing that. We do think there is more to come. If I take online, for example, two years ago, we were doing 2 million online transactions. We probably do nearer 18 million this year. Last week we had 900,000 separate contacts on our website. So that's really starting to take off and drive self-help. The more we can do of that- the more we can keep our own costs down. I think, as Sam said, we've got some quite big changes to come through this year on systems, particularly joining up services systems with energy. As you know, we've probably not invested enough on the services side in the past. We're now ready to invest that, and that should drive what we call cross-serve, cross-bill, and drive cross-sell, and that's why I think we're still optimistic about our growth in joint customer numbers. Is that investment going to be OpEx or is it involved CapEx numbers? It comes through in OpEx in the main. You depreciate the systems fairly quickly. Is that a large part of that investment? We are two-thirds of the way through that investment. I think your question around reducing demand over time, and can we compensate for that as a result of, A, reducing our OpEx along the lines we've discussed as a result of increasing cross-sell, as a result of increasing customer numbers, the answer to that is absolutely, that's the plan. The last question on return on capital. Obviously, the group as a whole today is, it is very high return on capital, over 20% post-tax. Clearly, that reflects the mix of business with the downstream, which does not have much capital employed against a smaller upstream business, which is growing. The upstream does include Morecambe, which of course is in the books at very low value and therefore high returns. So over time, that will come down because we are investing more into the upstream, and clearly the mix and balance of the business is shifting more towards the more capital-intensive parts of the business. Okay, fine. Right at the back. Morning. Terry from Exane BNP Paribas. Two questions, please. A follow-up question on U.K. gas prices. You seem to be pretty bullish on global gas LNG demand in yesterday's press release about the Qatar deal. What is your view on the prices overall for the U.K.? Second question, if I am not wrong, you did not provide any view on the consensus expectation for 2011. You did it last year. Why is that? Are not you comfortable with this level? Thank you. I think I have the second. Sorry. I'll get it. I didn't get the second one, but Nick did, so that's okay. Let me deal with the first one, which is our view on U.K. gas prices. This clearly has always been a very volatile market. I think many people were surprised by how much the gas price increased in the second quarter of 2010. I don't think it would be a mistake given the volatility of market conditions and what's going on in the Middle East and everything else to give predictions at this stage. I think the big point for us is that the business is now much better balanced, and if we have rising gas prices, our upstream is able to benefit from that. If we have falling gas prices, then actually, we should be able to grow market share. So we now, I think, have a much stronger business, and we're not going to forecast gas prices. I think that would be an error. Yeah, I think your second question was on expectations for 2011. I think we have said in the statement, and I said during the presentation, we are comfortable with where market expectations are right now, which is at around 27 pence per share. It is early in the year, clearly, and it's a competitive market. Within that, there's clearly pressure on the downstream business without the very cold weather and with rising wholesale prices. Against that, the upstream will benefit from those rising prices. We're looking for growth out of services in North America. Storage we've touched on today, explaining how we expect profits there to halve in 2011. But overall, happy with the 27 pence a share, but it is early in the year. Okay, fine. Jamie Tunnicliffe from Redburn. Just coming back to Baird again. I mean, but I think you might have said in the past that you were engaging with the government. Is that right? If there would be any change in the way that large offshore gas things could be done to make investment in that a more supported project. Is that right or not? Do you expect anything from them? Because it's obviously quite an important thing that could improve security of supply. Yeah. I think at the moment it's premature to expect any change in legislation or whatever to support gas storage. I think everybody's focused at the moment, Jamie, on electricity market reform, and we need to get that forward moving through the legislative process, and that's absolutely the priority to ensure that we have good levels of security of supply, good reserve margins in electricity for the second part of this decade. I think actually when you look at how we've just got through an extremely cold winter, and we did have big levels of depletion as the slide showed in rough, but nevertheless, the fact that we've got more LNG coming into the country and LNG is becoming increasingly important, I think demonstrates that whilst we do need to have more storage, we've probably got a little bit of time on this. What we're really focusing on doing with Baird is to re-engineer the costs and actually reduce the costs as low as we possibly can to ensure that we really have a fit-for-purpose facility there. If, when we've done all that, and when we look at the winter-summer differentials and the market going forwards, and we do all our modeling and analysis and we still can't make the numbers work, then we need to have some serious engagement. But we're not at that point yet. Okay. Did you have a second question or that was the only question? I think that was it. One over there. Yeah, morning. It's John Musk from Nomura. Can I ask a strategic question based around EMR? There are predictions under EMR that up to about 70% of generation's going to be under some sort of feed-in tariff. Under that model, what is the benefit of having an integrated generation and supply business if they're not really acting as a hedge for one another? If, I think some of your competitors perhaps are already looking at this issue and other issues in their own businesses, there are suggestions of people exiting the U.K. Would you look to acquire any of those businesses and how do you balance the mix between upstream and downstream under EMR? Well, I think the first point I'd make is that obviously we hope the EMR moves forward as quickly as possible so that we can get new nuclear build, so we can get more offshore wind build. This is a very long-term, gradual shift that's going to occur, and I think the numbers are actually lower than 70%, but whatever the number ends up being, we're not going to get there till the year 2025, or probably 2030. So this is a very long-term, gradual transition that is going to occur. I still think that actually, when you look, and Mark will like to comment on this, but when you actually look at the analysis as to how much electricity is still going to be competitively priced, and it's still going to be a very large chunk of it, and therefore the integrated model will continue to have good benefit. Mark, do you want to Yeah. Mark, I think you're absolutely right, Sam. It's a very gradual process. If you chart a sort of prediction of what is market-priced electricity versus something that's more of a premium feed-in tariff, in the next 10 years, it's quite a small proportion. I don't think it immediately challenges the business model, but as Sam said, we have a slight preference for the premium feed-in tariff. It preserves the wholesale market. But implementation is as important as theory in this, and we need to be practical as we work on that. We still see a long life ahead. Any more questions this morning? That then completes the session. Thank you all very much for coming. Thank you. Thank you very much.