Earnings Call: H2 2009

Feb 25, 2010

Very good. Well then, good morning, ladies and gentlemen, and welcome to the Centrica preliminary results presentation. This morning, I will provide a brief overview before handing over to Nick for his review of the numbers. Sam will then set out the progress we have made with 2009, marking the successful culmination of a three-year program to deliver our strategic priorities. As we turn to the next phase in our development, we have established four new strategic priorities, which will shape the future direction of the group. Sam will expand on these in his presentation. Centrica has performed well in 2009. This was achieved in a year when wholesale commodity prices declined sharply and global economic conditions continued to deteriorate. While lower wholesale gas prices led to a substantial reduction in operating profit for our upstream U.K. business, our U.K. downstream business, British Gas, performed strongly. We have continued to improve our operation efficiency and have delivered a marked improvement in customer service levels. As a result, our competitive market position is much improved, and you will have seen our recent price reduction, which made us the cheapest major supplier of gas and power to the residential market. In North America, we are well-positioned in key deregulated markets, and we will consider opportunities to build a more integrated business model over the medium term. In this low-price environment, we also took the opportunity to address our U.K. energy hedge position. The acquisition of Venture Production and a 20% stake in British Energy have transformed our upstream activities in the U.K., creating a growth business in its own right. We are confident that these long-term transactions stand us in good stead for the future, enabling us to maintain a balanced business, well-placed to target investment in areas of greatest return. The industry as a whole is entering a significant investment phase as the U.K. moves towards a lower-carbon future whilst maintaining security of supply. The government has a vital role to play in providing the stable investment climate, planning regime, and appropriate market support mechanisms that will be required to enable these investments to be made. 2009 has been a transformational year for Centrica and much has been achieved. We have established a robust, competitively aligned, and integrated model. Under Sam's leadership, we are well-placed to build on our capabilities to deliver strong growth and superior financial returns for our shareholders. With that, I will now hand over to Nick. Thank you, Roger. Morning, everybody. As usual, let me start with some commodity price context. Obviously, 2009 was a year of low gas and power prices, without the recovery that we have seen in oil prices. Clearly, that is good for our downstream business, but less positive for the upstream. Those low prices did come off a period of high prices in 2008, of course, and the effect of those high prices was still being felt through 2009 because of the hedging. If you look into 2010, the forward curve implies continued low gas and power prices for much of the year, albeit with some contango in the curve, which imply higher prices for next winter. If we look at the lower chart, the low gas prices did translate into reasonably good spark spreads, obviously good for our CCGTs. The forward curve does imply lower spark spreads for 2010, albeit they are better than dark spreads even through next winter. With that backdrop, here are the key financials for the group. Revenue was up some 5% to almost GBP 22 billion, helped by some FX movements, but also driven by good growth in business energy sales on both sides of the Atlantic and by growth in the U.K. residential services business. Total operating profit was down to GBP 1.85 billion. I will give you a breakdown of that in a second. But that reduction was more than offset by the lower tax rate, as profits shifted away from the heavily taxed upstream. The net result was a healthy 22% increase in earnings, which enable us to maintain earnings per share at 21.7 pence, despite the high number of shares outstanding following the rights issue. The dividend we have struck at 12.8 pence per share, an increase of 5%, maintaining our record of delivering real growth each year. So here is the divisional breakdown of the results, and you can see immediately the shift of profit from the upstream to the downstream as commodity prices fell. If I start with the U.K. downstream, British Gas recorded profits of over GBP 1 billion for the first time, an increase of over 40%. I will give you the detail on that. All three of the businesses within British Gas contributed to the increase. Starting with residential, here the profits recovered from the squeezed margins we had in 2008. We came in this year with margins of 7.6% on revenue that was largely unchanged, which drove the profit of almost GBP 600 million. You will remember the cold weather in December just gone, and this time a year ago, February, it was quite cold as well. For the year as a whole, 2009 was in fact slightly colder than 2008. Despite that, you might have seen average consumption per customer for gas was actually down by 7%, but that lower volume was offset by higher average retail prices, hence the unchanged revenue. Despite the low spot prices, unit commodity costs for gas were actually slightly up in 2009 over 2008, the effect of hedging. They were down for electricity. The net effect of those commodity price movements and our retail price movements led to overall higher gross margins, which were sufficient to absorb higher energy efficiency obligations, higher bad debt costs, and to allow us to restore the net margins. Moving across to the top right, Residential Services performed very well in difficult economic conditions. Profit up over 20% to GBP 233 million. Product holdings increased by 5% with good growth in plumbing and drains and in home electrical. Good cost control helped by the integration. The cost savings from the British Gas integration meant we were able to expand the services margin again, coming in at over 16%. In the bottom right, the Business Energy Supply performed equally strongly, increasing both revenue and margins, giving profit of GBP 183 million, up over 25%. We had higher average customer numbers in that business, following the E4B and BizzEnergy deals at the back end of 2008, and higher average selling prices, and that more than offset lower average consumption, higher unit commodity costs, and higher bad debt costs. For British Gas as a whole, we are on track to deliver the GBP 100 million of operating cost savings that we are looking for from the integration. Indeed, we expect to go beyond that, albeit we plan to reinvest the excess in strengthening the brand and establishing the platforms to develop growth areas further. Moving to the Upstream, profit there down to GBP 525 million, reflecting the low wholesale gas price. Here is the detail on that. You can see gas production profits were down substantially to GBP 444 million, despite the inclusion of four months of results from the Venture acquisition. Gas volumes were actually down 30% as we shut Morecambe in for large parts of the year when it was more economic to buy from the wholesale market rather than produce from our own reserves. That does in fact hurt reported profits, but it does preserve long-term value. We did produce more oil courtesy of the Venture assets, but unit selling prices of both gas and oil were down, albeit not down as much as the market was down. Again, the effect of hedging. Of course, the Upstream earnings are heavily taxed, so that operating profit fall was not that significant when you get to the bottom line. In contrast, Power Generation did very well. The low gas price fed into good spark spreads, and that helps our CCGTs. We also had a good contribution from the new wind farms, and that gave us profit overall of almost GBP 150 million. That figure does include one month of our 20% share of British Energy, of course. The I&C losses were much reduced, coming in at less than GBP 100 million. Volumes in that business were half what they were in 2008, partly due to us terminating a contract early in the year, but also because our customers took less when they could buy more cheaply from the wholesale market. The loss did come in even lower than we had been forecasting. We had expecting to be hit by some costs related to a flexible procurement contract connected to the Sean field. However, we gave notice to terminate that contract as a result of an onerous contract provision against it, which removes the ongoing charge from our results. That did come with an exceptional cost, and I will show you that later. Just coming back to the British Energy and Venture transactions, we have completed the provisional fair value accounting exercise for each of them. As you know, that does result in an uplift to the fixed asset values in both cases, almost GBP 1.3 billion, as far as our share of British Energy is concerned, GBP 650 million for Venture. That, of course, increases depreciation going forwards. That is all non-cash, of course. Therefore, we will be focusing on the results before that incremental depreciation. If you want to adjust for it, the ongoing after-tax impact is just under GBP 100 million, which works out at 1.9 pence per share. The other important assessment we have made is reserves recognition following the Venture acquisition. The audit we have had done has confirmed that the reserves and contingent resources that we assumed in our investment case are indeed there. However, we are taking a somewhat more prudent approach than Venture did as far as what we recognize as a proven or probable reserve, a 2P reserve. As a result of that, there is a net reduction in overall reserves of some 60 million barrels of oil equivalent, and that gives us combined reserves, including the cushion gas in Rough, of some 400 million barrels. Coming back to the results, Storage had another good year, operating profit of GBP 168 million. That was down on 2008, which of course included some cushion gas sales, but average achieved SBU prices were actually slightly up, and operationally, the asset itself performed extremely well. In North America, Direct Energy had a challenging year, profit coming in at GBP 153 million, despite some help from FX rates. Here's the detail on that. You will recall that we had an additional bad debt charge of GBP 45 million in the first half. That did cause us to review the balance sheet very closely, and we have made some further adjustments to both revenue recognition and cost accruals totaling GBP 16 million. So a one-off hit in total of GBP 61 million this year, without which Direct Energy as a whole would have been flat year-on-year. Before those one-off charges, the residential energy business increased profit to GBP 155 million, benefiting from the low commodity prices and expanding margins to close to 6%. Business energy also performed strongly in what was the first full year after the acquisition integration with Strategic Energy. Services was also ahead, but as you'd expect, upstream and wholesale suffered from the low gas price, and gas production profits in particular were well down. In terms of cash flow, we had another strong year. EBITDA, we maintained at over GBP 2.5 billion. We also reduced the working capital requirements of the business, largely as a result of the reduction in retail prices. Interest costs were up, of course, but that was more than offset by a reduction in the cash tax that we paid. So overall, that produces a very strong operating cash inflow, which we invested together with the proceeds of the rights issue at the back end of '08, invested that in the business, and you can see the CapEx of over GBP 4 billion. That left us with closing net debt of GBP 3.1 billion, or GBP 2.5 billion if you adjust for the margin cash-out position that we had at the year-end. Coming back to the CapEx, obviously, in 2009, that's dominated by the acquisitions. You can see there at the bottom, the net of close to GBP 3.2 billion. That includes what we spent on Venture, what we spent on the 20% stake in British Energy, but it's net of the proceeds from the SPE disposal. Organic CapEx was around GBP 900 million, as you can see, the largest component of which was the spend on upstream gas in the U.K. That includes spend on the Grove, Chiswick, and Seven Seas projects. U.K. Power includes stage payments on Langage as the construction for that new CCGT continues, and also the initial costs for the Lincs wind farm. We've given some guidance there for 2010 CapEx. Again, we expect U.K. gas development to be the largest component. Projects for this year include York and Cygnus, as well as more on Chiswick. For U.K. Power, we have the final payments on Langage as that comes into service, and our 50% share of the spend on Lincs. Lincs is, of course, now in joint venture structure with DONG and Siemens, and that has reduced our capital commitment to that project. We are showing storage here at GBP 150 million, although that does very much depend on the timing of the investment decision for Bains in particular, so we might see some of that slip back into 2011. Overall, organic CapEx guidance we are giving at GBP 1.2 billion. That is down from our previous estimates because of the reduced commitments to Lincs. To that, you will, of course, need to add acquisitions, including the $380 million that we are spending in Trinidad on the LNG project there, which we announced just this morning. In terms of the balance sheet, we have a strong position. The business now has over GBP 9 billion of capital employed in it, but only around a third of that is funded by debt. That debt level of GBP 3.1 billion represents around one and a quarter times EBITDA. You do have to adjust for pensions and leases to get the full picture, but we do have headroom for further investment, given the cash generation in the business. The pension deficit, as you can see, as measured by IAS 19, is up quite significantly. That reflects the fall in corporate bond yields. Finished the year at GBP 565 million, and that is despite the fact we put in close to GBP 300 million of deficit payments during 2009. We have agreed a funding plan to address the deficit with the trustees based on the 31st March 2009 valuation, and that funding plan calls for another GBP 200 million of deficit payments in 2010 and GBP 100 million in 2011. As you might have seen from the results, we did have a fair number of exceptional items in 2009. Give you some detail on those. The first two you have seen before and included in the first half results, so let me just comment briefly on each of the others. The U.K. restructuring cost of GBP 75 million, of course, is mainly the integration cost for British Gas, something we flagged with the November IMS. It also includes GBP 20 million for the Venture Production integration. The GBP 49 million credit you see there is the profit we realized on the disposal of 50% of the Inner Dowsing, Lincs, and Glens of Foudland wind farms. You then have the onerous contract provision related to Shawn, which is GBP 199 million. We did take GBP 150 million or close to it of impairments in 2009, reflecting the low commodity prices and how they impacted on asset values. Number of items within that, including Canadian gas assets and some Norwegian gas assets, and also some write-downs on two of our older U.K. power stations. Finally, in exceptionals, you have got the GBP 273 million credit within discontinued. That is mainly, of course, the profit on disposal of SPE. All those, together with the IAS 39 mark-to-market movement, which actually was quite small this year at GBP 71 million, all those get added together and reported in the middle column. In summary then, 2009, a strong performance given the low commodity price environment. The U.K. downstream business was particularly strong, not just in residential energy, but in business energy and in services as well. Upstream, we did suffer from the low wholesale gas price, and North America was impacted by the one-off issues that I talked about. Nevertheless, overall earnings were up over 20%, and that did enable us to maintain EPS, as I said earlier. 2010 has started strongly. The cold weather in the U.K. has increased consumption levels in our residential business quite significantly, of course. We have passed back much of the benefit of that to consumers through the lower retail prices, the price reduction we announced a couple of weeks ago. That has put the business in a very strong position competitively, and we do continue to see good growth in the other parts of British Gas services and business energy. Based on the forward curve, we are expecting to see a continued low gas and power prices at least through to next winter. Unlike 2009, that does come off a period of low prices, so we will see the full effect of those flowing through. Less cushioning from hedging. That will, of course, impact our Upstream earnings both in the U.K. and North America, but we will benefit from reduced losses in the R&C business. Of course, this will be the first full year contributions from Venture and our share of British Energy. Overall, we are comfortable with where forecasts are right now, although it is early in the year, of course, so we will see how commodity prices and the weather turn out from here. With that, I will hand you over to Sam. Thank you very much, Nick. Well, good morning, everyone. 2009 was a big year for Centrica. As we have just heard from Nick, the financial results for the year were strong against the background of declining wholesale commodity prices and, of course, the continued weakness in the global economy. These market conditions did, however, allow us to address our Upstream hedge through the acquisitions of Venture and the stake in British Energy. Combined with our continued focus on efficiency and service across the group, we have now delivered on each of the strategic priorities that we set out three years ago. To transform British Gas, to sharpen the organization and reduce costs, to reduce risk through increased integration, and to build on our growth platforms. In British Gas, the first stage of the transformation is complete. Our service levels and operational efficiency have improved dramatically. This has been reflected in a number of recent surveys, which confirm that our service levels have improved considerably. From having the lowest customer satisfaction among the major suppliers just two years ago, we now have the most satisfied customers, a truly transformational achievement. The significant improvement in service is also clear in our own operating statistics. The number of calls received from customers has fallen by about 40%, and the average speed to answer is now consistently below 60 seconds. The overall number of complaints has fallen by 70% and is now well below our market share. The number of online transactions has also doubled in the last year alone, with increasing number of customers choosing to submit meter reads and book annual service visits online. Our first-time fix rate in services has also improved materially, and we have achieved higher levels of employee engagement. As a result, our net promoter score shows an encouraging upward trend in both energy and services. In addition, our new advertising campaign has successfully contributed to the strength of the brand. The combination of very competitive pricing demonstrated by our market-leading price reductions for both gas and electricity and higher service levels has led to customer account growth of some 550,000 customer accounts over 2009. We have reduced our cost base in residential energy by over GBP 200 million over the period, and we are on track to achieve further cost savings across British Gas in excess, as Nick mentioned, of the previously announced target of GBP 100 million. This will allow us to reinvest in the business, building on the strength of the British Gas brand and establish platforms for further growth. Under the leadership of Phil Bentley, we are now running British Gas as a single business, focused on meeting the current and future energy and service requirements of our customers. A combined management team is now in place, and support functions have been fully integrated. This enables the business to offer a wide range of low-carbon technologies and energy efficiency advice and expertise for our customers. We also now have FSA approval to offer insurance-based products to our customers, presenting greater flexibility in the range of energy-related products we can provide. The combined British Gas business is well-positioned for growth as a result of the increased competitiveness of our products, but also from cross-selling and bundling. During the year, we increased the number of joint product households, those customers that use both services and energy, by 164,000 to over 2 million, and helped by the launch of our first bundled energy and services product, Energy Extra. 58,000 customers have chosen to take this product by the end of the year. We will continue to target growth in joint product households, deepening the customer relationship and increasing retention. In summary, I am very pleased with the transformation of British Gas, leaving the business well-placed for continued growth. Now let us turn to the Upstream and our goal of reducing risk through greater integration. As this chart shows, three years ago, only 20% of the energy we supplied to our retail tariff book came from our own sources. Following the acquisitions of Venture and our stake in British Energy, we have dramatically improved the level of vertical integration in the U.K. business to over 60%. This makes our earnings less volatile and our energy hedge position more closely aligned with our competitors. Having addressed this, we now have a pipeline of opportunities in power and gas and the flexibility to target those projects with the highest return. The acquisition of Venture Production has materially increased the scale and capability of our upstream gas business. We are pleased we have retained the majority of the skilled Venture team, who will help to deliver the new strategic direction of the business. The integration of Venture with our own existing business provides us with sustainable and a flexible portfolio of assets with valuable development opportunities going forward. The combined business is now structured around five core regions to maximize the benefits of focus on asset and infrastructure performance, regional geology, and of course, business development opportunities. Our LNG business has also developed quickly. During 2009, we brought 15 LNG cargoes into the U.K., and already have a further seven contracted for 2010. We have utilized our capacity at the Isle of Grain and bought gas on both a delivered and an FOB basis. LNG will be an increasingly important source of gas for the U.K. as domestic production declines. In this respect, the announcement today regarding our acquisition of upstream LNG reserves in Trinidad, both current production and over one TCF of contingent resources, is significant. Turning to upstream power, our power generation segment has also made significant progress in 2009. The acquisition of a stake in British Energy from EDF establishes our position in nuclear power and the right to participate in EDF's new nuclear build program in the U.K. Considerable progress has been made across the power generation portfolio. Our new CCGT power station at Langage in Devon is now operational, and we have further strengthened our leadership position in offshore wind. in October, we gave final investment approval for our 270-megawatt Lincs offshore wind development, and we are pleased to have been awarded exclusive rights over the Irish Sea zone in the Crown Estate's Round 3 offshore wind process last month. We have also successfully developed new funding models for our offshore wind activities. Going forward, it will continue to be important to ensure that we put in place efficient financing structures for all our investments. In storage, the Rough facility once again demonstrated exceptional operating performance. In 2009, overall reliability was in excess of 98%. Storage utilization was very high during early 2009 as a result of the Ukrainian crisis, together with record rates of injection, which followed the successful completion of compression upgrades. The importance of gas storage, and Rough in particular, was demonstrated just last month, with the field supplying around 10% of the U.K.'s gas demand on each of the three days where National Grid issued gas balancing alerts. As the U.K.'s dependence on gas imports increases, storage will play an increasingly important role in maintaining the country's security of supply, and therefore, work continues on our three new potential storage projects, Caythorpe, Baird, and Bains, which together would add around 85 BCF of storage capacity. In North America, the economic climate and the low commodity price in 2009 remain challenging. This clearly impacted our upstream business. Whilst downstream, business energy performed well. The residential business, however, was severely impacted by some of the one-off accounting charges, which were clearly disappointing. However, towards the end of the year, the macroeconomic environment has begun to show signs of recovery, and the business is performing well. We have a strong downstream position in key deregulated markets. In Texas, a market larger than the U.K., we are the third-biggest residential power supplier, and we have grown our customer base in the U.S. Northeast by over 150,000 customers to over half a million customers. The scale and profitability of the business energies division has also grown following the acquisition of Strategic Energy in June 2008, with revenues and electricity volumes more than doubled. That makes us the third-largest C&I supplier of power in North America. Upstream, we have increased our gas and oil reserves through small-scale acquisitions to around 400 BCF equivalent. In power generation, we have improved the reliability of our CCGT fleet in Texas, resulting in increased availability and reduced outages. With the new management team appointed under Chris Weston, we will now look to further develop the integrated energy model by investing for incremental growth and value, as well as improving the returns from the existing business. We have made good progress across the group in the last three years through greatly improved operational performance, including particularly our safety performance, but also through significant changes in our business model. We are now ready to move on to the next stage. Our vision remains unchanged. It is to be the leading integrated energy company in our chosen markets. Building on the capabilities we have developed over the past three years, we have set out four new strategic priorities, which will enable the business to move forward and deliver growth. First, to grow British Gas, leading the transition to low-carbon homes and businesses. Second, to deliver value from our growing upstream business, securing sustainable energy for our customers. By sustainable here, we mean both a growth business in its own right, and a business with a low-carbon focus. Third, building an integrated North American business with leading positions in deregulated markets. Finally, and most importantly, driving superior financial returns through operating performance and our investment choices. We therefore have four new clear strategic priorities, and priorities for each of the business with a clear financial context to deliver growth across the group. Let us start with British Gas. Here you can see we have a number of distinctive capabilities. We serve 12 million homes, amounting to half the households in the U.K. We have an unmatched services business that has unmatched scale. We have a strong recognized brand, and our existing position as a leader in energy efficiency and green technologies. It is a business with low capital requirements. Our strategy for growth within British Gas builds on these capabilities. We identify three aspects within the strategy. First, to optimize the business, to drive further efficiencies, and continue to deliver best-in-class service. Second, to take the lead through innovation in existing growth areas, including enhanced service propositions. For example, through insulation, which we announced this morning, insurance-based offerings, and product bundling with energy. Third, to capture new markets by embracing new technologies. For example, smart metering and microgeneration. By entering new or adjacent markets, for example, the local authority sector. In this way, we will continue to grow the business, building on our existing capabilities and leading the transition to low-carbon homes and businesses of the future. Our second strategic priority is to deliver value from our growing upstream business to secure our customers' energy needs. Here we have a number of distinctive capabilities. We have transformed our scale and capability in upstream gas. We are the only U.K. supply business producing both gas and power, giving us a unique dual-fuel hedge. We have a low-carbon intensive generation fleet. We are leaders in U.K. offshore wind and gas storage. Given these distinctive capabilities, our strategy for the upstream U.K. business under the leadership of Mark Hanafin, has two key elements: delivering value from our existing investments, and developing our pipeline of low-carbon investment choices. With access to a strong range of investment opportunities, including offshore wind, new nuclear, gas development, and gas storage projects. We can target those opportunities with the strongest returns, with each project competing for capital across the group. While the prospects for growth from future investments are attractive, we will also remain very focused on optimizing the returns from our existing portfolio. This remains a vital component of our commitment to ensure sound financial stewardship. In North America, our objective is to build a more integrated business. The market continues to offer attractive opportunities in large profit pools as we look to grow our leadership positions in competitive, deregulated markets. We currently have strong downstream positions in multi-state deregulated markets for both residential and business customers. We have gas and power assets to support these positions and a unique services capability. Under Chris Weston's leadership, our strategy here is to improve the returns from our existing business, to grow our leadership positions to become the number one or two player in competitive, deregulated markets, to leverage our services capability with bundled offerings and low-carbon solutions, and to build on our upstream asset base to close the structural hedge. Our fourth priority provides the group-wide context of strong financial stewardship. Maintaining a strong balance sheet is a clear priority. We will target our investment to opportunities offering appropriate double-digit levels of return, taking into account the risks inherent in each project. We will also phase our investment to achieve consistent and superior earnings growth. Effective competition for capital therefore provides a healthy environment for challenge within the business, enabling us to make appropriate choices from the options available. Alongside financial discipline, a strong health and safety culture, best-in-class service levels, and leading technology systems and processes are also key enablers of performance, as of course is the continuous development of our people and organizational capability. Our focus on costs and efficiencies will remain relentless. In conclusion, 2009 marks the successful culmination of a three-year program during which we've made significant progress. We've now delivered against our existing strategic priorities, and Centrica is well-positioned to move forward to the next chapter in our development. Our new strategic priorities will enable the business to move forward and deliver growth for a low-carbon world with new propositions and services for our customers, backed up by new sources of energy in our integrated model. We will deliver value to shareholders both from our existing asset base and distinctive capabilities, as well as through carefully targeted investment. With that, I'll now like to turn it over to questions. Thank you very much. Very good. Thanks, Sam. Questions, please. As always, if you could say who you are, where you're from, and press the button in front so the mic becomes live. Who'd like to start? Right. Start with you. It's Mark Freshney from Credit Suisse. Just three quick questions. Firstly, you talk about leverage flexibility. Would you be potentially able to quantify what kind of leverage flexibility you have? Secondly, just a little bit more color, I guess, on the U.S. hedge ratios. I know in the past, in the U.K., you spoke about what your hedge ratio was and you had a target to get it to around 50%. Perhaps just giving a bit of color there and maybe also color as to whether that's hedges in gas or electricity upstream. I guess thirdly, just on the pensions, do you think that, given that pensions are things generally done in arrears, that potentially putting in an extra, I think it's GBP 300 million, into the pension plans is aggressive and risks stranding an asset in the event that we do see an upturn in asset valuations? Let me take the one on leverage flexibility in the U.S. hedge, and I'll have Nick take the one on pensions. Leverage flexibility here perhaps is an unfortunate terminology in that what we mean here is using the flexibility that we have in our investment portfolio. We have closed the structural hedge, so now we have multiple options in gas storage, in gas production, in wind, and in renewables, and we have the opportunity of making some choices. So it's really around taking advantage of the choices rather than implying leverage in the financial sense of the word. I think that's important. The second part of your question was around the structural hedge in North America. Currently, if we look at the equivalent retail and tariff book equivalent to the way we've looked at the U.K., our structural hedge position, again, is around the 20% level. Over time, over a period, and in the same way that this took us time in the U.K., we would aim to move that up to 35%-40%. This will be a gradual process of finding assets and opportunities that we think will clearly deliver high returns. They have to compete with the returns in the U.K. It will be blocks of generating assets or it could be gas production. Pensions, Nick. No, just on pensions, I look forward to the day when having a surplus in the pension scheme is a problem. But we have agreed with the trustees that if there is outperformance of the asset base, and we are a relatively high proportion of equity investment, that we would use that to effectively de-risk the scheme and to better match the assets and liabilities. So if there is a surplus asset performance that outperforms what our expectations are, we will use that to reduce risk rather than finding ourselves stranded with too much capital in the scheme. Okay. Right. Another question. Right. Far side. Sian Tanner from RBS. There is so much going on in the U.K. that is interesting and attractive. Why are you persisting with the U.S. when it is only 10% of your operating profit? Why are we persisting with the U.S.? We do think that the U.S. has got considerable growth potential. We do think that in the same way, 3 years ago, people would say, "Well, actually, it is very hard for us to build the integrated model in the U.K." I think we have demonstrated that can be done. I think, on a much smaller scale in terms of the relative sizes of the business, we have got the opportunity of reinforcing and building the business. We could see very considerable growth opportunity. Markets are deregulating. This is not just an acquisition-driven growth opportunity in the U.S. We are actually seeing growth opportunities as markets open up. If you look at something like the Pennsylvania market, which opened at the beginning of this year, we have already added 30,000 customers there organically. We can see a lot of opportunity there. Ultimately within the U.K., in the downstream, our business will clearly be constrained for growth. Having made the decision, I think quite correctly, not to continue to compete in Europe, we actually need the geographic growth beyond these shores. It's not an opportunity cost either. No. I mean, we are developing both and well. We will only do it if the returns are there. Be quite clear about that. Back in the middle. Good morning. It's John Musk from Nomura. A question on this year 2010 upstream oil and gas EBIT. I think you're guiding, my understanding is, to a lower number this year on last year. I just want to understand the mix in terms of price and volume in that. Also, on the volume side, what is going to be coming from the Venture assets versus your legacy assets, let's call them. Then secondly, you're relatively confident that you're going to be able to maintain margins in the downstream. Can you just talk a little bit about any political pressure you may face with that, certainly around elections as well? If you want, Nick, would you like to take the first one? I'll take the second. I think at the moment our guidance would be for upstream profits broadly in line with 2009. That really reflects the fact that although volumes should recover, and of course, as you say, we'll have a full year of Venture, and depending how much we run more, volumes could be up 40% or more. But the average selling price, of course, will be down quite significantly because we were benefiting from hedges that we had coming into 2009 this year. Sorry, in last year's results from the high prices in 2008. So you will see a much lower average selling price, which nets out to that broadly neutral year-on-year position. The offset, of course, comes in the I&C losses, which because of the low gas price, does mean we're looking at only around GBP 50 million of losses in I&C. When you flow all that through in the reduced tax, of course, because of the lower upstream profits and higher downstream earnings, which is why we're comfortable overall with the figures. I think just to supplementary on that, about 25%-30% of our production will come from Venture this year. In terms of the second part of your question, which was around, is there political pressure around margins? I think everybody understands that we need to make a return in this business. Actually, when you look at the 7.6%, last year was clearly a very low year because of the very volatile price and the rapidly rising commodity price. The previous year was actually higher than that, 8.6%. I think at this level, which is consistent with our long-term guidance for this business, I think that if you contrast that with other businesses, I would give you BT as an example at 15%, or I'd give you even a business that has very different working capital requirements to this business, Marks & Spencer are at 8.5%. Now, I think that's the sort of context that it has to be seen in. I think the Ofgem report, which came out on Monday indicated profitability per home. The number of GBP 105 was sort of seized on, but actually when you divide our actual results by the 10 and a quarter million homes that we supply, you'll see the number actually is before tax, GBP 58 a customer and GBP 38 after tax. So that's the GBP 3 a month per customer that we've been talking about. I've certainly talked to people in government about those numbers, and I think they are comfortable with those numbers. Fine. We'll go to the back, then I'll come across the back. Lakhi Sathanasu, Evolution. Just three or four questions. On your U.K. Gas CapEx guidance, can you give a very rough split between development expenditure and exploration and appraisal? On Lincs, when you did the joint venture announcement, you didn't say anything about debt. We have been hearing in the markets that you're out there looking for debt. Do you think you will be able to achieve non-recourse funding for the construction phase of Lincs? On British Energy, now that you've had some chance in the boardroom, do you have any concerns that EDF may not put in the kind of maintenance expenditure, the expenditure on lifetime extensions that you would want to see, and maybe because of pressures elsewhere in the organization, channel funds outside? Finally, if you can, any guidance on your hedge positions this year and next in residential acquisition costs and upstream gas and generation? Well, perhaps if I can deal with the last one first, and that's that we don't give guidance on our hedge position. I tried. But let me move on to the first one, which was how much of the 550 of upstream gas is going to be on exploration. I think approximately just over 20% will be on exploration and appraisal, 22%. Not all of that, of course, will hopefully be written off. We'll have some success and therefore the P&L charge will be lower than that. I think in terms. I'll let Nick speak to the financing of the Lincs project, and perhaps Mark, as he's on the board of British Energy, talk to your question around is there a risk that they're going to under-invest in these facilities? Yeah. On the Lincs, as you say, we have put that into joint venture with DONG and Siemens. We will at some stage put some gearing into that structure. We have some tentative feel to see whether that's sensible to do that now or whether to leave it. As you say, the issue is construction risk. Clearly, you can get project finance. We just did it for the existing wind farms, but we did that after they were built. You can cover off construction risk. The question is who's taking it, whether the banks are taking it or whether we as the developers are taking it. So it can be done. But we'll see what terms are available, and if they're sensible, we'll go ahead with it. Would that be so-called limited recourse if you're taking it on board? So there's all kinds of tunes you can play. Correct. I mean, so it's an allocation of risk. Yeah. Mark? Yes, on the EDF question, I mean, EDF are very focused on supporting British Energy with all of their resources, and you're seeing that coming through in the very healthy production figures and reliability figures. Absolutely no evidence of pressure to cut back. Good. Thank you. We'll go on this side. Please. Great. Gus Hoxha from Riverbay Securities. If I may, a rather anal question. With regard to the double ROC regime for your wind projects, I'm mindful of the, let's say, rather more nebulous government. Well, the Renewables Obligation amendment of this year, which appears to suggest that for a project to qualify, it hinges on whether a project is relevant, so whether the turbines, and I quote, "are relevant or not." Therefore, I'd be very grateful for some form of guidance from you and perhaps by way of example, some of your projects have indeed what makes a project relevant or indeed, unfortunately, irrelevant. Well, certainly, in terms of, and I will let Mark add to this or Nick add to this, but in terms of our Lincs project, there is no doubt that it qualifies. In terms of the next two projects that we have in Round 3, which is Docking Shoal and Race Bank, actually, they will qualify, Docking, if they are developed within the critical timeframe. It is actually more a question of whether they meet the timeframe. We expect that we are preparing, we are moving ahead with Docking Shoal, and we would expect that certainly that would conform with the timeframe if we can get all the engineering done in time. Do you want to attempt at that, Mark? Well, it is Race Bank that we are- Sorry. Race Bank. I beg your pardon. doing the technical work on. Yeah. I mean, Sam's absolutely right. It's not a question of the turbines that we're using not being appropriate. It's just a question of timing and the window that you need to have first power. Okay. Fine. Just for clarity, if I may. Sorry to take up time. I need to Okay. It has to be operational before Sorry. It has to be operational before March 2014 to qualify? Correct. Great. Correct. Thank you. Down this side. Nick Hilsop from RBC. I had a question. DECC are going to launch their feed-in tariff for sub 5 megawatt microgeneration. I think you mentioned 5 megawatt microgeneration as an opportunity for you. Some people think that might be quite significant on a one- or 2-year view. Are you gearing up for that? Well, the answer to your question is yes, we are. I think the microgeneration in the home, and I will let Phil build on this, but the arrangements that we have with Ceres, which is now in It has been through the sort of alpha testing, is now in the beta testing, and we are going to be installing some of those boilers this year. The arrangement we have with Baxi too, where we have a microgeneration facility, are both intended to capitalize on that. So Phil, is there anything you would like to add on microgeneration? Because I think it is a significant opportunity. Yeah. I mean, as you know, it does make the returns far more attractive now for investors, and on top of that, for a household to invest in it. On top of that, British Gas was the only company that has got what is called a pay-as-you-save funding from the government in the pilot, where you can recover that investment through the bill over an interest-free credit period. So we think we are in quite a good position. On top of that, as Sam said, we have been investing in some microgen technologies. For example, we are the largest installer of solar panels now through Solar Technologies. We have also got some pellet burners as well. So we think there is a big opportunity there. It's a point that Sam touched on around the community opportunity because hitherto, we focused on the householder and the homeowner, but actually, a lot of this money is being spent now through councils and local authorities, and teaming up with them, we think offers a big growth opportunity for British Gas. Okay. Thank you. I had one follow-up question. Given your current leadership position on pricing in residential gas and electricity, could you just give us perhaps an idea of how you're doing in terms of new customers at the moment? I mean, sales are very strong. I'll let Phil speak to that, but there's been very good response to the price reduction. Yeah. No, they're doing well. Could you give us any- I think I've given you the flavor- slightly more if not the number. Right. What I would say is, before the price reduction, in the month of January, we were growing customers. It's actually, we know sales are up very substantially. It will be a few months with the industry processes before we actually see what's happening to notifications and therefore, how this translates into additional growth, but we would expect it to. Thank you. Good. Middle. Morning. Ajay Patel from UBS. My question's around the upstream. I was kind of thinking, clearly we're in a weak gas price environment. To what extent has that maybe affected contractual sort of relationships with LNG providers? Has that improved for you? Does that look attractive relative to acquiring upstream assets? So just a bit of color there would be helpful. Yeah. I mean, it's a very good question. In a softer gas environment, are upstream gas producers more inclined to talk to us? I think the answer to that is yes, therefore, we continue the dialogue with a number of gas producers. Obviously, those who have LNG look at the relative attraction of the U.K. market relative to other markets around the world. One of the big phenomena is that with the advent of shale gas, the U.S. market, which had previously been seen to be quite a significant import sink for gas, clearly is self-sufficient now, therefore, in a relative sense, the U.K. market becomes more attractive. But equally, the Asian market is growing fast, prices in Asia are therefore still quite robust, so we have to offer a competitive proposition. As I mentioned, we bought a lot of spot LNG last year. We're building relationships, over time, we would hope that those relationships will turn into long-term contracts. It isn't really an either/or. We will have to have some contracted gas and some gas assets of our own. It will be a combination of the two. Okay. Please. Peter. It's Peter Houston from Citigroup. Couple of questions, please. Can I just pick up on the reserve adjustments, which is on slide 11. So if I got this right, you've reduced the estimates of reserve by 60 million barrels of oil equivalent. From memory, Venture had 244, so it's about 20- 200, yeah. 240 million barrels. Yeah. It's a 25% reduction in the estimate reserves. Yeah. Forgive my ignorance as a utilities analyst rather than an upstream analyst, but is that normal when you buy it? Yeah. It's not abnormal actually because there's a wide range of different classification possibilities for reserves. Unless you go to the one SEC definition internationally, the SPE tolerates a wide range of different interpretation. We have historically booked all our reserves on a much more conservative methodology. Essentially only booking reserves that we have a very high confidence are going to be developed in a very near-term timetable independent of volatility and the gas price. For a variety of fairly obvious reasons, they had a less conservative approach to booking their reserves. The critical point is, was that a surprise to us relative to our investment case? The answer to that is no. We actually haven't seen any downgrade relative to our investment case in their reserves. We were never assuming, if you like, that the 240 would be immediately developed. Okay, thanks. My second question, picking up actually on the chairman's opening remarks. He alluded to your view of the various reform proposals for the wider power market that is under discussion at the moment. You are clearly, I think, expecting some significant changes to the structure of the market from what the chairman said. Using the Project Discovery five options as a base, where is Centrica amongst those five options? Well, I think the first point to make is that actually the market is delivering and it is not broken at the moment. In the period, and this was I think illustrated by the Climate Change Committee's paper. In the period between 2020 and 2030, if we have a lot more intermittency on the grid, then a power market that was designed for low fixed cost, high variable cost generated power, is going to have to be redesigned for a market that will have more intermittency and low variable cost, high fixed cost. Our view is very clear, and that should be a gradual process. It is not an immediate problem. The only immediate problem, I think, is as we have consistently been saying along with EDF, that with the collapse of the carbon price, there is going to need to be some sort of support mechanism on carbon or carbon related, to get new nuclear going, which is important if we are going to have security of supply in the second part of the next decade. Every other form of low-carbon technology has got a support mechanism, so we need to level the playing field. So we would see that actually this is around a one-off intervention is the immediate issue to ensure that the full cost of pollution is actually paid by the emitters, rather than a root and branch review of the electricity market, which we don't think is necessary. Sorry, final question. Just on the dividend, I think there was some market speculation that around these results you might announce an enhanced dividend policy. Where are we on dividend? Well, we've maintained the dividend policy, which is to deliver real growth each year, and it's up again 5% this year. And we believe we've got room to continue to deliver that. Recognizing the stability and the earnings that's coming from becoming more integrated. Yes, over time you might be able to push the payout ratio, but equally, we've got a significant investment program where there's significant opportunities to invest in the business. And if they're offering good returns, then I think our shareholders will want us to invest in those. So we have to balance the two, and I think we're comfortable with where the policy is at the moment. And that's exactly where the board is. There is no view to change things. We're trying to build a business, use shareholder money effectively, return it when available, but move the movement on all the time in a positive way. And you will hear from us if we intend to change that. Please, middle. Hi. Peter Bisztyga from Liberum Capital. Two questions from me. First of all, acquisitions like the Trinidad assets, do you think of those counting towards your U.K. upstream hedge or your U.S. upstream hedge or both? And then secondly, could you just give us a flavor for how customer churn rates differ between energy-only customers and customers taking energy and services? Yeah. Let me perhaps take the first one, and Phil take the second one. In terms of the acquisitions at Trinidad, over time, that's going to contribute to We would see it contribute. It has the option to do both, but more likely the U.K. market, given where shale is at the moment. But it is well-positioned as an asset where if gas prices are higher in North America and North America is importing gas, then clearly we have the option of taking the gas there or taking it to the U.K. There are two pieces to this. There's the existing production where we participate in 50% of the diversion rights, but the gas is actually marketed to a third party. We can always then buy it back. The larger opportunity in terms of resource is actually the undeveloped gas field, which will take some time to develop, and it will depend on which market is more attractive at the time. It does give us that optionality, and we would see gas prices actually between the U.S. and the U.K. have been starting to converge. Phil? Phil? Well, I think it's a great question because it absolutely goes to the heart of the strategy, which is that the services piece, when bolted on with energy, makes a big difference to reducing churn. So we've seen churn generally in energy come down materially. If you take prepaid customers, they used to churn about 37%, and now we're churning at probably about 17%. Our premium customers are churning less than 10% for energy, and we'd expect with an overlay of services probably to see churn fall by another 40%. So it's absolutely critical to the strategy, and it's one where we think we have a real competitive advantage versus everyone else out there, because at the end of the day, you need a man with a van to get this stuff done and all these new opportunities, whether it's smart meters, microgen, it's all part of cementing that relationship, which we think we have a real opportunity to grab. Go to the back. Ed. Hi, it's Edmund Reid from Cazenove. Three questions. The first one was on smart metering. I was just wondering if you can give us some details on the timetable for smart metering. The second one was the margin in the services business. I think historically you've talked about a 15% margin, net operating margin, and it looks like you are doing 16.6% and you're obviously looking to grow that business. Are you still thinking 15% or could you do better? The third one's a bit dull. It was on the working capital movement in 2009. Would you expect that to reverse in 2010, or was it a reversal of a negative movement in 2008? Okay, well, why don't I take the first two and I'll let Nick deal with the dull one? The smart metering, we are actually I think making good progress in the rollout of smart meters. Last year we installed 50,000, which were really largely in our B2B market. This year we expect to install just under 150,000 in the residential market and a further 150,000 in the B2B market. So we'll have nearly 300,000 by the end of the year. Now, this is really a pilot, if you like, in that only when we have the central comm system up and running, which will be about two years away, will we have the full functionality on these smart meters that enables everybody to take advantage of time of use pricing in the residential market. So they won't have all the functionality this year that they will ultimately have because we have to build the central comm system, but the rollout has begun. Really, the critical thing is getting that central comm system up and running as quickly as possible, and we're engaged with Ofgem and DECC on that. The second piece was around margins on the services business. We've got a wide range of different product offerings in there. I think our historical guidance of 15% really sort of remains. Obviously, it will depend on the products that we offer. The insurance-based product is selling very well. We've now got quarter of a million customers on the insurance-based product, and we'll be switching more people over to that. So hopefully that will give us some margin expansion as well. Nick? That was a very exciting question on working capital. If you exclude margin cash, of course, which will always move about with commodity prices, the big driver of working capital is the debtors within the downstream residential and business energy supply, and that in turn is dictated by where the retail prices are. So you're absolutely right. The run-up in retail prices in 2008 caused a working capital outflow, which the fall in prices we've seen in 2009 has seen that reverse to a large extent. There's also an element of consumption in there, so falling consumption also helps working capital. As we sit here today, I would guide to working capital being flat in 2010, but it clearly will depend on what happens towards the end of the year in terms of retail price movements. So good. Go to this side. Yeah. Jamie Tunnicliffe from Redburn. You were pointing out that trade-off between some investment opportunities you see and the balance sheet having scope for that, and then payout. Would you just try to understand that trade-off and how you manage it through time? Would you want to see your leverage ratio decline much from here, or is it really you're happy with the net debt to EBITDA, the level type ratio, and you'll look to maintain that balance sheet efficiency through time? Thanks. Do you want to take that one? Yeah. As I said in the presentation, we're about 1.25x EBITDA at the moment for debt. There is some headroom in that, and although we've stabilized the cash flows and earnings of the business considerably with the vertical integration, we don't have a regulated asset base, so we couldn't push it necessarily to the 2x and beyond that some other big companies in the sector might be able to do. But certainly, pushing it up to 1.5x and perhaps further depending on the mix of profits is possible. We'll be able to do that if the right investments are there and the returns are there, and we'll use that headroom. The business is highly cash generative now, and so we do have a lot of cash to potentially deploy, a lot of opportunities we've talked about. But if the returns are not there, then the money goes back to shareholders. Maybe one more? Okay. Yeah. Hi, Andrew Moulder from CreditSights. Could I just follow up on Jamie's question? What would stop you pushing out that ratio to 2 times net debt to EBITDA? Are you worried about the A rating? Are you worried about access to the markets? What is the restraining factor here in the balance sheet strength? I think ultimately it comes down to do we want to keep the A rating? And the answer is yes, we do, because actually the sort of business that we are in, where we are entering into multi-year, in some cases 20-year gas contracts with producing countries, that is important. Not that we have any triggers if we have a lower rating, but actually it is just the ticket to the game. If you want to enter into a GBP 20 billion gas contract, you have to have that A credit. So that is helpful for us. I would add to that the debt to EBITDA ratio only tells half the story. You do have to add on the pension deficit. You have to adjust for operating leases, and we have assets in the business that are not on the balance sheet that we use, and so they get capitalized. So it is not the whole story, just looking at the debt to EBITDA ratio. Thank you. Well, we have got time for just one more. Hi, Teja Patel from UBS again. My question is around CapEx of the upstream. So when we were at the analyst day, it was a sizable amount for the upstream. I think it was GBP 2.1 billion if you took all the blocks in the chart that was in there. I am just wondering, if gas prices stay where they are at the moment, what proportion of that can actually be deployed, and actually will a lot of that not make sense given the environment actually will make sense later? Just kind of get a feel for where the trade-off is there. Well, the good news is that if you look at our portfolio, and I think you're really talking about upstream gas rather than upstream power. But if you look at upstream gas, both the organic portfolio that we had ourselves as Centrica and the portfolio that we acquired from Venture, a good chunk of that is reasonably robust at low gas prices, even if we don't have any contango in the forward curve. I'd give you the York field, which is in our plans for this year, is a good case in point with very low capital and cash costs. There will be some at the margin, and we are very focused on returns that clearly we will want to scrub and reduce the capital costs of. But I think the guidance that we're giving for this year, and we're going to take it one year at a time, of spending GBP 550 million on gas developments is all projects that actually don't require any escalation in gas prices beyond the current level to deliver well in excess of our targeted returns. Very good. Well, thank you all very much indeed for coming this morning. Thank you.