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National Grid (NYSE:NGG)

H1 2013 Earnings Call

November 15, 2012 4:15 am ET

Executives

John Dawson

Steven John Holliday - Group Chief Executive Officer, Group Director of Uk Gas Distribution & Business Services, Director, Chairman of Executive Committee, Member of Finance Committee, Chief Executive of National Grid Transco and Director of National Grid Transco

Andrew R. J. Bonfield - Finance Director, Executive Director, Chairman of Disclosure Committee, Member of Executive Committee and Member of Finance Committee

Analysts

Mark Freshney - Crédit Suisse AG, Research Division

Jonathan Constable - Nomura Securities Co. Ltd., Research Division

Bobby Chada - Morgan Stanley, Research Division

Dominic Nash - Liberum Capital Limited, Research Division

Jamie Tunnicliffe - Redburn Partners LLP, Research Division

Iain Turner - Exane BNP Paribas, Research Division

John Musk - RBC Capital Markets, LLC, Research Division

Peter Bisztyga - Barclays Capital, Research Division

John Dawson

Okay. Good morning, ladies and gentlemen. I am John Dawson, Head of Investor Relations at National Grid, and it's my pleasure to welcome you here today to National Grid's first half results presentation for 2012-'13. Shortly, I'll hand you over to Steve Holliday who will kick off the presentation. But before I do, a few notices. Before we start, can I please ask you, as usual, to turn off your mobile phones, and as usual, we will have a question-and-answer session at the end, could I ask you to you to use some microphones, and please state your name and organization.

In today's presentation, Andrew and Steve will refer to various profit and other measures, unless otherwise stated, these will be adjusted for timing of storms and all operating profit and interest costs are at constant currency.

Finally, our presentation today may contain forward-looking statements. I need to draw your attention to the cautionary statements in the presentation and in your pack and at the start of the online presentation for those dialing in. Please refer to these when you consider our comments today.

Just a reminder, you will find all of the materials for today's presentation and additional fact sheets on our website and on our Investor Relations app. Without further ado, let me hand you over to Steve.

Steven John Holliday

Thank you, John, and good morning, everybody. The running order for today begins with a few comments from me, on the highlights from the first half, and Andrew will take you through the details, details of our financial performance for the first 6 months. I will share a few thoughts about the general progress that we've made and the development of our longer-term financing strategy. I'll then return to talk about our progress against this year's priorities and the outlook for the rest of this financial year. Nick Winser is with us today, as usual, but Tom King is not, for a change, and I'm sure you all understand that Tom rightly has stayed in the U.S. this week.

We delivered a good financial performance over the first 6 months, excluding last year's impact from Hurricane Irene in the U.S. and the normal swing in timing. Profits before tax is up 15%. On a similar basis, operating profit from the first 6 months are up 7%. As a result, after interest and tax, overall earnings increased by 14%. These are pleasing results, and while there's more we can do in the second have to build on this progress, they clearly provide a strong platform for good full year.

I'm pleased to announce that the board has approved a 4% increase in the dividend to 14.49p per share, in line with our policy for this year. As we previously said, we expect to announce a long-term dividend policy at the latest with our full year results in May, of course, subject to the U.K. RIIO process having concluded. This is an important year for our businesses in both the U.K. and the U.S. Securing appropriate regulatory arrangements, embedding down significant organizational changes, are key actions on both sides of the Atlantic. These are very -- ensuring that we deliver the needs of our customers, as well as delivering our targeted returns and securing long-term financing the important investment programs.

Here in the U.K., we continue to work with Ofgem on the RIIO price controls. While it's fair to say we've been surprised over the last 5 months by some of the aspects of the process, we've been working hard and constructively with the Ofgem team to bottom out the differences and important gaps in understanding before we can finalize a new long-term price control. Nevertheless, RIIO sets out some major changes to incentives and the sharing mechanisms in particular. As a consequence, we've already been making changes to our U.K. businesses to ensure we're well positioned to deliver the maximum benefits of RIIO, both for U.K. consumers and for other stakeholders. And I'll share some more details on those changes later.

In the U.S., we continue to make substantial progress. Building on last year's restructuring and the cost reduction program, the businesses continue to embed important organizational and process changes. One key recommendation from the 2011 Liberty audit was the need to integrate our IT infrastructure and financial systems, whilst at the same time improving and simplifying many of our accounting processes. And Andrew will talk about some of our progress in this area.

Tom's leadership team have also made significant progress both across the business, but critically in our focus, jurisdiction-by-jurisdiction. The evidence of which is now starting to be seen in both our regulatory and broader stakeholder engagement, particularly in moments of crisis, as we've seen recently with Hurricane Sandy. Although Hurricane Sandy rightly termed Superstorm Sandy has clearly occurred after the first half of the year, it will be totally inappropriate of me not to mention such a monumental event.

I am immensely proud of what's been achieved and so quickly. I cannot express to you how fortunate we are to have such an amazing team with people, a dedicated people, despite enormous damage, unprecedented damage, particularly on Long Island. The strength of our team and its combined resources, those that came to help has worked very effectively. In Massachusetts, Rhode Island and upstate New York, we connected 98% of those disrupted electricity customers within 4 days. That quickly enabled us to dispatch more teams down to Long Island. But for Long Island electricity customers, it's been a very different story. At its peak, over 1.1 million customers of LIPA were without power. Superstorm Sandy followed up 7 days later by the snow blizzard impacted just about their entire network, where we, as you know, are the contractors of LIPA. And over the past 2 weeks, we've mobilized 15,000 people, National Grid people, for all of our territories, contractors from across the U.S. and from Canada on the ground helping with the restoration. But the challenge, the combination of storm damage and flooding has made restoration efforts very challenging. While service was restored to nearly 900,000 customers in the first week, it's taken a lot longer to restore services in those areas with heavy flooding and the most significant tree damage.

As of last night, the LIPA distribution system was ready to supply energy to all but 8,000 homes and businesses which are in the very worst affected areas. But that only tells part of the story, because there are another 30,000 homes and businesses that still don't have power, but it is not yet safe to turn that power on because of the flood damage and the severe damage to those properties. And we have to work with local officials and other services to make sure those customers can receive power as soon as possible but critically safely.

Our downstate gas business also sustained unprecedented damage from flooding. [indiscernible] our employees who worked for us for 45 years, some of them have never seen flood damage in Brooklyn and Long Island before, on the south shores of Long Island, Staten Island and Queens and Rockaway. While all those networks are restored faster, it will help the customers whose properties are severely damaged, and in some cases, lost forever.

Clearly, any service interruption's not good for customers, but our teams have made an enormous contribution to limiting and mitigating the impact of this terrible disaster. And we'll continue to work with all the services to help so many people who are in desperate need.

Turning to safety, as always, a high priority for us at National Grid, and very much at the forefront during an event like Superstorm Sandy. The safety, as I've said before, isn't just about keeping our employees and contractors safe, we must also do the utmost to ensure that no members of the public are impacted by our operations. After a challenging 2011/'12, where we had a number of unacceptable safety incidents, we redoubled our efforts. And in this respect, I'm pleased with our progress. In particular, 47% reduction in the severity of injuries to our employees in the first half of this year. But as always, there is more to do to delivering a best-in-class safety performance.

So overall, a really good start to the year, solid performance and good progress towards our strategic goals. Let me hand over to Andrew to talk you through the financial results in more detail.

Andrew R. J. Bonfield

Thank you, Steve, and good morning, everybody. I'm going to cover 3 areas today. I, first, will look back at our results for the first half of the year then I'll look -- give you a brief update on our technical guidance for the year before finally giving you my perspectives on some of our key finance priorities over the past couple of years.

First, the results. We saw consistently strong performance from all of our main businesses. Operating profit in our U.K. Transmission business was up GBP 75 million or 12%. This reflects increased revenue due to RPI and investment, partially offset by higher depreciation and controllable costs.

Gas Distribution profits were up 6%, again reflecting RPI. Profitability in our U.S. operations grew by GBP 79 million or 19%. This was largely driven by higher revenue, mostly including the deferral recoveries in Niagara Mohawk and lower bad debts. These were partially offset by increases in controllable and other costs lines.

Other activities saw profits reduced by GBP 63 million as a result of the sale of OnStream and costs related to our U.S. systems and finance process changes, which I'll talk about a little bit more later on.

At a group level, operating profit increased to GBP 1.6 billion, which if you exclude health -- timing and the impacts of last year's storms, saw a healthy increase of around 7%. So we've had another good 6 months of operating performance. We've grown revenues, maintained really good controls over controllable costs and made selective investments for the long-term growth of the business.

Minimizing controllable costs remains a priority. In the first half, the absolute increase was GBP 33 million or 1% in real terms. This movement is mostly due to increased support needed to support the capital investment program here in the U.K. Depreciation was up as expected, given the level of investment. Bad debts were down, in line with improved economic conditions in the U.S. and lower commodity prices, whilst pensions cost increased ever so slightly. Other costs increased by GBP 34 million, and profit in our other businesses declined as I mentioned earlier.

Financing costs were down 6%. This improvement was down to continued low interest rates, which enabled us to finance at attractive coupons and lower interest accretions on our RPI index debt. In the period, we've raised about GBP 1.2 billion of new debt, taking advantage of the competitive bond yields to pre-fund our investment program. Optimizing our funding costs depends to a large degree on maintaining stable A- credit ratings. This not only underpins our historic debt, but also improves our ability to raise new debt needed to fund the investment program. It is essential we retain access to a variety of international debt markets for funding. An example of this is the $750 million Canadian bond issue issued in September, the largest corporate Maple bond issued to-date.

Our effective tax rate for the first half of the year increased by 80 basis points to 27.5% due to the mix of profits between the U.K. and the U.S. We would expect as per normal that the full RIIO rate will be slightly higher, reflecting a higher mix of U.S. profits in the second half. However, our guidance for the full year is a slight reduction in the tax rate to around 29%. All this meant the reported earnings were up GBP 139 million to GBP 836 million. After removing the impacts of timings of storms, earnings were up by 14%.

Investment was up 23% than the same -- versus the same period last year. Nearly 95% of that investment occurred within our regulator operations, growing our asset base on which our allowed regulator returns will be applied. This fuels the engine that drives our future growth. We've invested over GBP 800 million in the first 6 months in U.K. Transmission, a 34% increase over the prior year.

[Audio Gap]

Net debt was up to GBP 20.4 billion, reflecting the increased investment I spoke about earlier, but partially offset by lower cash dividend. In August, we saw a 48% uptake in the scrip dividend. This is more than double the 21% average over the prior 3 years.

So overall, in summary, this represents a strong start to the year and a solid base for another good year of financial and operating performance.

Now to our guidance for the year, which is mostly unchanged aside from some updates regarding storm -- timing and storms. We returned about 90 million of timing balances, mostly in the U.S. in the first half, which is driven by weather and commodity pricing. We do expect a partial recovery of this in the second half of the year.

Obviously, Hurricane Sandy will have an impact on our IFRS earnings on EPS. Costs associated with customer restorations in our own service territories are not expected to exceed GBP 100 million on operating profit.

Finally, on guidance, I'd like to look forward to you the impact of IAS 19 on pensions accounting which will impact from 2013 and '14. This revision essentially equalizes the return on plant assets and the interest rate on plant liabilities that flowed through the financing charge in the income statement. The impact of applying the standard in the current year would be to increase interest charge by a roundabout GBP 180 million or decrease earnings by about GBP 130 million. It's important to remember this is a noncash item and has no economic impact on the group. We will restate our results when we introduce the change, but it will not change any of our guidance on the financing capacity of the group nor will it change any of our credit metrics.

I would now like to spend a few -- a couple of minutes on our key finance priorities. When I joined Grid, which is some -- now 2 years ago, Steve and I agreed a number of key priorities for me, around communication, the finance function effectiveness and long-term financial strategy. Since May 2011, I think we have made significant progress as a team, providing better disclosure around our regulatory assets and returns, about the portfolio and the benefits we get from each of our businesses and the relative performance of our operations in the U.K. and the U.S., particularly in terms of comparative returns on capital employed. We do need to use these measures consistently and for a number of years, but based on the feedback I have received, I think we've made a good start.

In terms of moving out or improving the finance function effectiveness, I'm pleased with our achievements despite the significant external pressures on our workload. For example, in 2010 and 2011, our U.S. finance team struggled with the request for information required to support the needs of the business. The resulting rate case outcomes and the Liberty audit set out some clear opportunities for improvement. Since then, we've made some significant investments to support our people and processes.

And earlier this month, we actually went live with a new SAP system, which is the latest milestone in that journey. At the same time, we continue to enhance our underlying finance processes in part to meet the outcomes of Liberty. Strong evidence of that progress has been the ability to support the rate filings in both Rhode Island and New York this year, responding effectively to the myriad number of information requests we have received. I'm really pleased with the progress the team has made, and though we have not completed our journey, I'm confident that we have a thriving finance team in the U.S. which will be a better place to drive the business forward.

In the U.K., the finance function has been heavily involved in supporting the RIIO business plan process. As we move forward, they will also have a very important role to play in helping the business deliver the efficiencies required under RIIO. The third, and probably the most important for you, priority was our longer-term financing strategy, which will be occupying a lot of mine and Steve's time and others on the exec committee over the next few months. Particularly, as we continue to work through the final stages of RIIO, we evaluate our investment opportunities and make appropriate decisions around financing and dividend policy. As before, we expect to provide a full update on this by the -- at the latest, our full year results in May next year.

We still have a lot of work to do, not least finalizing RIIO, but our overall position is unchanged. It will be key to sustain the right balance between financing at the single A rating I mentioned earlier, maintaining an appropriate dividend policy and delivering growth in the equity value of our shares. All 3 are critical to supporting our regulatory commitments and to delivering long-term shareholder value. With that, I'll hand back to Steve.

Steven John Holliday

Thanks, Andrew. During the first half of this year, our focus has been centered around, as you'd expect, the main priorities that I laid out in May. Each of which have important implications, not only on the next 6 months, but on creating the platform for the future. I just want to take you through each of those in turn.

On the U.K. regulatory process, I've already shared a few thoughts about the process and our progress to date and the approach we've been taking as we work towards an appropriate conclusion early next year.

The next key date is the publication of Ofgem's final proposals on Monday, the 17th of December. Given the complexity of these, covering 6 large regulated businesses with current assets in excess of GBP 20 billion, we will need to study these very carefully, particularly against the context of our extensive and thorough response in early October. And you shouldn't expect to hear our conclusions until we've not only fully assessed all of those details, but we've also made ourselves comfortable with the significant amendments that are being made to the licenses. This will take some time.

In the U.S., our focus in the last 6 months has been to take on Niagara Mohawk and Narragansett businesses through the rate filings, with the objective of securing outcomes with a suitable focus on efficiency and customer service and allowing us to deliver market-tested returns. If we achieve this, we'll be able to make further good progress towards raising the overall returns across our U.S. business.

With the Narragansett's gas and electric case, I'm pleased that we've reached a settlement agreement. In fact, hearings start today with the Commission and our scheduled hearings today and tomorrow. Assuming a smooth process, this will result in a decision in January, with the new terms coming into effect on February 1, 2013. The agreement proposes a 9.5% return on a 49% equity portion with the necessary increases in cost allowances. The agreement provides the scope for us to invest. Invest at improving infrastructure and service levels for the benefits of our customers on Rhode Island while permitting us to earn an allowed return, providing we manage that operation efficiently, clearly getting that fairness, that balance right between consumers and investments.

Turning to New York. Niagara Mohawk's electric and gas businesses constitute the largest portion of our U.S.-regulated activities. Together, they make up almost 1/3 of our revenues, a very important building block to delivering on our commitment to improve overall U.S. returns. Similar to Rhode Island, we reached an important milestone with a tentative agreement with the Commission staff on a settlement. A joint proposal from the staff and ourselves will be filed early in December. There'll be hearing scheduled in January, and the final order we expect in time put into effect the new rates from the 1st of April 2013.

The agreement includes a 9.3% return on equity on a 48% equity portion. Various inflation adjustments in property taxes have facilitated a 3-year deal. The deal also allows for $1.6 billion of important capital investment, investment in new infrastructure, again, improving reliability and customer service. The impact of this structure, I'm pleased to say, will keep the customer bills broadly unchanged throughout the 3 years of the plan. If we perform well -- what do I mean by that? We deliver the right customer services and we do it efficiently. We have a good opportunity to earn those targeted returns that are set out in the settlement. So overall, those 4 settlements proposed would bring out allowed average return in the U.S. to around 9.8%. But critically, it should enable us to make further improvements on the actual returns we achieved.

Turning now to investment and efficiency. As Andrew have said, we have just invested a record amount in the first 6 months of this year, GBP 1.825 billion, reflecting the expected increase in our U.K. electricity transmission program. Now as a result, very much on track to deliver an expected investment of GBP 3.5 billion to GBP 3.8 billion this year. But in the U.K., the RIIO outcome will have a significant impact on our longer-term capital investment program. And our focus will increasingly be on delivering the required outputs at the lowest cash cost, that is, capital and operating cost together, TOTEX. This enhanced focus, rightly enhanced focus on TOTEX, the financial the drivers in the U.K. business are dramatically changing. Our focus needs to be on ensuring that those outputs, connections, where liability and service standards are delivered at the lowest cash cost. If we achieve that and we reduce our CapEx, it benefits customers, but ultimately, it will benefit investors for the achievement of higher returns.

One thing in this process is certain. By April next year, we need to have an organization that's well positioned to deliver a good performance under RIIO, whatever the ultimate deal is. And this will have to be achieved through a combination of financial discipline, as Andrew has just described, and efficient execution. In order to drive that focus on execution in the U.K., we've asked John Pettigrew rather to take on role of U.K. Chief Operating Officer. John reports to Nick Winser in this role. John has a record of leadership in National Grid and has joined my executive team. That reflects the importance on this role.

Our investments in the U.S. are expected, as Andrew mentioned, to remain at a reasonably steady level that aimed at replacing aging assets and growing our transmission activities where appropriate. We continue to look for opportunities where we can leverage those skills and capabilities.

Our U.S. business continues to benefit from the annualized effect of the 2011 reductions in costs, and as I mentioned earlier, the new model focused on jurisdictions. The new systems investments and process changes that Andrew has talked about will cement these benefits in future periods and importantly, help us to identify more opportunities.

Turning to the outlook for the full year. As Andrew said, notwithstanding the impacts of Superstorm Sandy, our expectations for the full year are unchanged from those we shared in May. We have made a good start to the year, and combined with the benefits of further revenue growth and the efficiency incentives and initiatives, we're well positioned to deliver a year of good operational and good financial performance. Now with that, Andrew and I will be very happy to take any questions you may have.

Question-and-Answer Session

Mark Freshney - Crédit Suisse AG, Research Division

Mark Freshney from Crédit Suisse. I just have 2 questions. Firstly, I have a question on -- within the other activities line. There seems to be a lot of spend on IT systems. Could you please talk through the process of actually recovering those costs from the individual regulated businesses or is it a group cost? And secondly, when you talk about the long-term financing strategy, would that also include looking at ownership of the businesses or potentially new ownership structures?

Steven John Holliday

Okay. I'll take a piece of that and then pass this on to Andrew. This is a good question around these costs. The capital costs of the SAP system are in the U.S., and indeed, are apportioned across rate base by rate base and the ongoing operating costs of that system are in those entities as well and are part of our filings that we've been going through during the course of this year. Somewhat exceptional one-off cost associated with all the training activities is the cost that Andrew referred to that we've kept out. That is a one-off cost to put in place the processes that we, as a company, have decided we want in place. Your second question on financing, you can pick it up, Andrew. But there isn't anything that's changed here, Mark, about the various different opportunities we have to think about and consider on how we can finance the combination of continuing to deliver yield for investors and grow the business. We've been pretty clear about it, and we really need to understand RIIO, have been through that, and all the rate processes before we can be crystal clear about that strategy in May next year.

Andrew R. J. Bonfield

Yes. I mean, just on the IT systems costs. That's about 1/2 of the GBP 63 million reduction in other, that is, principally, training costs. There are about 20,000 employees we're training. Under the accounting rules, that is an expense rather than can be capitalized. And the reason why we put it in the corporate center charge is because that won't be recoverable from regulators as we move forward. The regulator element, as Steve said, or the recoverable element is in the regulator business. So these are one-off charges. You should expect the costs to be lower in the second half and actually not to recur in future years, so that will almost disappear. And second item -- other items there, obviously, is OnStream. It's about GBP 12 million. It was there last year and not there this year. It's a small reduction in metering and property, which is lumpy as you can expect because it's dependent on transactions was down year-over-year. As regards to the financing strategy, as I said, I mean, I think the thing we have to maintain is the balance between the ratings, dividend policy and knowing how important the dividend is to shareholders. Obviously, that is critical from a shareholder value perspective and growth. We will look at that in the context of options around value and way -- best way we can actually finance it, be it from the debt markets, be it other financial instruments, be it from ownership of entities and so forth. So that is all part of that review. At this point in time, the portfolio has been -- actually benefits us by actually having the right mix between cash -- consuming assets, such as our U.K. Transmission business and cash generating businesses like our distribution businesses in the U.K. and the U.S. That balance is important if we are going to maintain the right level of yield going forward. So that's all part of the mix, but we'll update you again, as we said, probably no later than May next year.

Jonathan Constable - Nomura Securities Co. Ltd., Research Division

Jonny Constable from Nomura. Two questions. Firstly, on the storm costs relating to Long Island. Please can you give us a bit more of a steer on how we should think about the scale of these costs? And what would the process look like to recover those costs? What kind of time scales might we be talking about? If you could give us any insight into how that maybe breaks down into the different ways that you recover those costs or expect to recover the costs. Secondly, just coming back onto the financing policy and just zooming in on the bit of your statement about an appropriate dividend policy. I was just wondering if you -- I know we're going to have to wait for the financial strategy, but it'd be great if you could give us a bit more of, I don't know, maybe your guiding principles and how you think about what an appropriate dividend would look like.

Steven John Holliday

No, Johnny. I'm not being facetious here. I think we've given more than enough guidance. And Andrew just reiterated in terms of -- we know who our investor base is. We understand how important the dividend is for an equity investor in this business. This is about getting the balance right between how much that dividend should move in the future and how much opportunity we've got to invest in very attractive businesses, of course, to grow the equity value of the business and how those things are financed. That's all in a post RIIO. We'll come back and make that very, very clear in May, at the latest, as I said. That's providing that the RIIO process, of course, is complete by then. In terms of the storm, and I am very clear this morning, what we've been worried about, and the reason why Tom is not here with us today, is making sure that we are helping people. And we are going way beyond helping people get the electric system up. We have employees of ours whose homes are destroyed. We have over 40 of our employees whose homes are destroyed, and they're coming to work. They've been working 16-, 18-hour days helping with the storm response. So the absolute focus has been rightly, and continues to be, on restoration. Now actually, we're moving from restoration into repair now. Because you restore power, some of those restorations are temporary, so now under LIPA's guidance, we will go back and put repairs in place. And there's a difference that Andrew was talking about earlier, of course, we own -- our investors own the assets in Massachusetts, Rhode Island, Upstate New York and those gas businesses downstate. There are businesses and there are costs, and they get actually recovered through regulation as you know. We're a contractor on Long Island. The assets are owned by the Long Island Power Authority, LIPA, and we're contracted to provide a service to LIPA, and of course, we lost that contract. So our focus is very much on a couple of things right now. First of all, getting from restoration to repair, and doing more than our job, helping people who are in serious trouble, who've lost all their possessions, all their homes, and that's working with lots of other authorities, and then we've got to get back to the day job as well of helping transfer that contract during the course of 2013, because it actually ends as far as we are concerned at the end of next year. And we've got to do a really good job in the course of next year in transferring that contract, so the ball is not dropped between us and PSEG, who picked up the contract. Even your people, Andrew, have been involved.

Andrew R. J. Bonfield

Yes. I mean, at this stage, it is far too early for us to put an estimate together, we are still actually working out and through the process of restoration. We have people out in the field, even the finance staff, so it's hard for us to do an estimate. We are -- I don't have enough clarity around that to be able to give you a number today or any confidence that, that number will be right. We've given you an indication in the release, the number of crews on site and the length of time which indicates it will be a multiple of what we incurred as a result of the Hurricane Irene last year. As far as recovery is concerned, those are mechanisms which we have in place of LIPA, and we don't expect any difference from prior periods relating to those.

Steven John Holliday

Which is not the focus. The focus just has to be right now in doing everything we can. It's very hard. We're in London right now. This is a war zone almost on the south coast of Long Island. Out on the Jersey Shore as well, people's homes are gone. There are stories that are going to come out over the coming weeks, I think, just going to be heroic stories, actually, of what many of our employees have been involved in, many of the contractors who have been working for us. People came down from Nova Scotia and have been sleeping in tents on Long Island for 2 weeks and working 18-hour days. It's just an incredible event, it really is. I'm very proud of what -- all people who have been helping us have been doing -- 15,000 people on the island that's where the focus is, at least, to be at the moment. Bobby?

Bobby Chada - Morgan Stanley, Research Division

I have a couple of questions. The first one, I appreciate you don't want to get into this cost issue in Long Island, but just so I understand the mechanism clearly, it's a -- you have a contract with LIPA, and therefore, there are clear contractual closes and mechanisms to pass costs onto the owner of LIPA. Is that the right way we should understand it?

Steven John Holliday

We are the contractor for LIPA, very clear. Hurricane Irene last year, you can see how those -- how those mechanisms work, but just shouldn't be talking about this right now frankly. I'm not trying to be awkward. I think it's important -- when people have lost their homes and we still got today -- we still got 8,000 people who haven't got power back. We've got 30,000 homes and businesses that power is there, and we've got to work with lots of authorities, something that would dry their homes out, and dry their businesses out, so they can get back to normal. And that's what we really need to think about today, Bobby, I think.

Bobby Chada - Morgan Stanley, Research Division

Okay. So swapping back to the U.K. then. Can you talk us through in a bit more detail the operational changes, the reorganization is seeking to put in place and some of the benefits that we should expect from that?

Steven John Holliday

I'm looking forward enormously to doing that, and I think that, that is going to be the subject of a seminar next year. What I wanted to do today was flag 2 things, I think. One, it's clearly this RIIO process is not finished. Until we have the final proposals, there is still a lot of uncertainty. But the structure of RIIO, the incentives and the way that TOTEX is treated is very clear. And that has been -- that principle is laid down and is clear. So we've already began to make some adjustments about how we think about that in the future, how the alignment of the organization is on the future. There's another piece in here, of course, is that our role as a system operator has been evolving over recent years considerably. We no longer just operate the system in England, Wales and Scotland, we operate the offshore as well, and we have a design authority role in terms of thinking about long-term transmission strategy. So we've got to think about how we get our focus organizationally on that, and then of course, those EMR and how we ensure that all the separation is appropriate in EMR. So there are lots of threads that have come together that cause us to adjust the U.K. organization, and we will come back, I assure you, during the course of early 2013 and run people through a lot of detail about that.

Bobby Chada - Morgan Stanley, Research Division

So maybe I can try for the third time if I'm lucky then. If you get the settlements that you're discussing in Rhode Island and New York, the difference between your position and the staff's position in all of these cases does not appear to be anything like the difference that we've seen in prior rate cases, when we were talking about hundreds of millions of dollars of difference on OpEx, for example. Does that mean that if these settlements were agreed, and I appreciate that they haven't been agreed yet, you're more confident that -- or you are either confident or more confident that you can deliver those allowed returns?

Steven John Holliday

I think that's what I said in my remarks. This is a settlement agreement that I believe and Tom and the team believe has got the balance right between what we need to invest for customers, the cost of running those businesses for customers and our ability to deliver those allowed returns. If we do all those things well, you're exactly right, those are what we expect. But they are settlement agreements at this stage, they still have to go through the process of getting final approvals. Dominic?

Dominic Nash - Liberum Capital Limited, Research Division

Dominic Nash, Liberum Capital. Two questions, please. Firstly, on RIIO, what would you like to see changed from the interim proposals to the final proposals? And second, on the debt rate on the EUR 1.2 billion this year, what was the marginal cost of debt? And is that a trend that we could succeed -- see continuing in the medium term as you refinance your existing debt and add new debt in?

Steven John Holliday

Obviously, I'll let Andrew pick up the second part of that, although, there's a very important part of that because that feeds into your first question. RIIO is 8 years. There's a huge implicit risk in 8 years clearly about the ability anyone has to have a crystal ball. So I'm not going to go through our October 1 submission to the consultation of the initial proposals, that would keep us here for the bulk of today, because there's an enormous amount of detail in there, frankly, because there were a -- number of areas that we felt very strongly we needed to ensure that Ofgem -- we think they misinterpreted or perhaps, we haven't done as clear a job, we drew out our -- these were big complex plans. We're on the huge complexity on a number of areas yet again on the 1st of October. But there are kind of 3 big headings really. The first of those is financeability. So that’s the linkage in here. We need to finance these businesses so they can deliver for customers and we can invest for customers. Andrew's remark on the Maple bond was very important. That bond could not be issued if those businesses weren't single A. So the financial strength of these businesses through this 8-year period is a huge part of our consultation response on the 1st of October. So a lot around the financing. Second area is around some cost allowances. As we said in July and we said in our response, we found very hard to understand. We have been building gas transmission pipe in the U.K., we've built the Milford Haven pipeline, we've built the pipeline across the Pennines. We know what it costs to build pipe in the U.K. We know where steel prices are, we know labor costs and actually, et cetera, et cetera, and the complexity of some of the planning requirements in the U.K. as well that are very stringent. The allowance that Ofgem came back within those -- in those initial proposals was 47% below our experience. So there's a lot in the consultation therefore about evidence around the world about the cost of building pipe. And there's a similar story actually around compressor cost to replace gas compressors on the system. So there's some -- a particular area around the cost allowances and then there are a whole bunch of things around efficiency. In our original plans, we proposed a series of initiatives and delivering efficiency for customers taking costs out of our businesses, and we believe we've had some gaps in understanding, I think, of what was embedded in the base plan. So those are the 3 major areas. I'm sure you've read our consultation. It was very fulsome. There's a lot in there. We've been engaged with Ofgem. We now need to wait for the final proposals. Finance, Andrew?

Andrew R. J. Bonfield

Financing. I mean, obviously, financing. I mean, the index that will be -- going to be given under RIIO is broadly a 10-year index, so it depends where you are on the curb against that. So if you're issuing short-term money today, and you look at the spot on that index, you should do slightly better. But obviously, you are then taking the risk that over the 10-year period or 12-year period, you're going to have some catch-up later on, and it's going to hurt you in the longer end. We do a mix of financing, so it's not comparable, but we do measure ourselves against the spot. And that's the focus for Malcolm and the treasury team, to make sure that we're not in a situation, as we balance out the financing, where we're above the spot on the index, because that's obviously the critical strike point against the allowance. So that's the focus we do.

Dominic Nash - Liberum Capital Limited, Research Division

And the absolute rate?

Andrew R. J. Bonfield

The absolute rates -- the Canadian bond was unattractive and at the lower end of the scale, but that's a 5-year-money, so therefore, it's not directly comparable. So we're not comparing like-for-like.

Steven John Holliday

Jamie first, then Iain.

Jamie Tunnicliffe - Redburn Partners LLP, Research Division

Jamie Tunnicliffe from Redburn. I was interested in the comment about the surprises that you'd seen during the RIIO process. I think you said that, Steve. Is that mainly related to those sort of cost allowances where you're just saying it doesn't match up with your experience on the gas pipeline costs and compressor costs and on efficiency? I'm just interested in sort of what those surprises during the RIIO experience have been for you.

Steven John Holliday

Yes, we -- I think, we were quite clear weren't we, at the end of July. We were surprised the initial proposals. We recognized they were initial proposals. But there's been a dialogue, and we've -- we were challenged by Ofgem, but this expression well justified business plan, which I think is a great expression actually. And that required us to consult extensively with consumers about what they wanted from the networks, as well as the customers who directly pay the bills to us, all the other energy companies. And we built our plan around their requirements and around a scenario of investment in the U.K., and often very early on said they were very good plans. So there was a mismatch in some ways than with some of the differences in the initial proposal, so that's where we were surprised. I've touched on a couple of those areas, and there are good examples there, appear to be quite a gap there. That's clearly why we responded in the consultation in the way that we did. And we've been working with Ofgem over recent months to try and bridge those understandings and make sure we get to an answer that works. This is about both of us getting to an answer that works, isn't it? It's a long time, 8 years. Investments we need to make are very important investments for all of us in the U.K. We have to finance this big investment program, as well. We've got to get the balance right, and that's, I think, a duty that Ofgem and us share and take very seriously. Iain?

Iain Turner - Exane BNP Paribas, Research Division

Yes. Iain Turner from Exane. You've more or less broken the back of the regulatory process, I guess. It is much -- but I mean, you nearly finished it in New York and Rhode Island. I just wondered what's on the regulatory agenda in the U.S. after those 2 deals are concluded.

Steven John Holliday

It's a lovely expression, because I don't think we'll ever broke in the back, actually. And rightly so, we've got 14 entities in the U.S., and I think we've talked before, haven't we, about getting ourselves on to a drumbeat, almost, where there will inevitably be filings year on year on year on year. We had a -- clearly, a lot of filings at the same time because we'd enter into 10-year plans that all ended up ending around the same 18-month period. As Andrew says, the challenge on his team, the challenge on the organization to go through those filings is just enormous. So we want to get ourselves into position where we do have a couple each year when you've got 14. Exactly, what we do next? It's subject to our thinking during the course of the next 6 months, and subject to some pressures from the outside, as well as some challenges from the outside. Where do we feel people want to invest more? Particularly in the gas businesses. We have clearly got with low gas prices, a lot of people who want to burn natural gas in their boilers at home today. So one of the things that was announced yesterday, actually, was permission to build an interconnector between Brooklyn and Queens, which had to get federal authority. That actually went through the Senate yesterday, pursued by Senator Schumer, get its final approval. That's a big investment to increase the capacity of gas to get into Brooklyn and Queens. So when do we need to think about upping the investment level in those businesses. It's those sort of things that will drive the priorities on filing in.

Unknown Analyst

[indiscernible] from CF Partners. Part of the drive of the CapEx in the U.K. is renewables build out and also no nuclear, I believe. At the moment, it looks like renewables build out is a bit of a question mark because of planning permission I've heard on some comments recently. Also, no nuclear is not really sure if it comes because there's a big discussion about the prices the companies get. Could that influence CapEx? And how do you look at it and how do you deal with this uncertainty?

Steven John Holliday

Yes, you're absolutely right in your comments, and of course, it influences our CapEx. But this is something that we've known about from the very beginning of RIIO, which is what the principles of RIIO. Principles, when they are originally set out, were and remain very good principles because it creates a base scenario around investment and then the mechanisms to flex capital up and down, why customers don't pay for things that they don't need. Likewise, if more capital is required to connect more in a short time, then investors also have the opportunity to make sure that they collect returns and revenue to that. So those mechanisms that are part of RIIO, which will be detailed in the licenses, actually, so that's one of the things, although, we've looked at the principles of those and agree with them, the detail will be in the licenses will work. It is very clear, if you sit here today and look at the scenario that we submitted in our original plan, that some of the investment in the early years has gone back a couple of years, exactly right, but it will move again probably as well. This is a very moving feast around when -- because it goes back to EMI, when do people have the incentives and build the nuclears, how much wind is onshore, how much wind is offshore. What we do know is the government targets are very, very clear. We know that's shutting in this timeframe, so we know there will be an enormous investment in generation. We know we have to connect to all of those, and we're very clear through the big transmission planning where the big pieces of reinforcement are required. And as Andrew mentioned in his remarks, the Western Link is one of those, the offshore Western Link already. There's an Eastern Link in our plan as well and there are other reinforcements that we will have to do in this timeframe, but RIIO does have the mechanism there to protect everyone in terms of the flexibility.

Unknown Analyst

Is there something like a minimum or maximum CapEx per annum that you can envisage under different scenarios, like if everything comes OnStream that needs a lot of investments and if a lot of the staff is coming very late or is not coming in at all? What's the range of CapEx [indiscernible]?

Steven John Holliday

That's actually on our website. We have the base scenario and we have a very slow scenario and we had an accelerated scenario. I think the accelerated scenario looks unlikely today, but somewhere between our base and the slow is where we will be. And we need to flex our CapEx on things like replacement as well. You can't work in a business like this, with the supply chain in particular, by taking it up and then up and down. That will increase prices for customers over time. So we need to make sure that we manage a program here and we're not smoothing things literally, we're trying to make sure that we don't get huge jumps ups and jumps down. That's the job that we already do. We will continue to do that in the future.

John? And back down to Jamie.

John Musk - RBC Capital Markets, LLC, Research Division

It's John Musk from RBC. It's just a very simple one. Can -- you signaled you want to take the time on the RIIO response. Can you just let me know the timetable and what the deadlines are for when you have to respond?

Steven John Holliday

Sure, yes. Would you repeat the question? I'm not sure everyone might be aware. I mean, we tend to think don't we? I put myself as I'm saying that in that bracket as well about the old process. RPI minus x, the way the price control process works, because RIIO is very different, the process is fundamentally different. One of the differences is actually is at the end of the process, both the time and also the appeal of mechanisms have changed as well. So in the old world, 30 days. In the new world, it's 75 days. That's the precise answer to your question. And there's a reason for that quite clearly, and I think I've outlined why. There's a lot for us to look at. We're confident about the thought that board can be happy with those proposals. One in the back row, please. I can't see who it is. It's Martin, is it?

Peter Bisztyga - Barclays Capital, Research Division

No, it's Peter Bisztyga from Barclays. There's going to be a lot of new incentive mechanisms on the RIIO for you to sort of over outperform or underperform on. Can you give us some indication of how different layers of management within your business will be themselves incentivized to make sure they hit each of those metrics as best you can?

Steven John Holliday

You are getting way ahead of yourself here. But you're right in terms of the things that we will be thinking about and putting in place. And as we think about how we reward people inside the organization, like any business, those rewards need to be totally aligned to things that are valued by the businesses' customers, and indeed, its investors. And there will be some tweaks around those things. There are more incentives in here but the incentives around outputs, that's one of the good things about this process. There are issues around the financings as I said. There are issues around some details and some efficiencies, but the philosophy of rewarding outputs that customers value, reliability, connection service and so on and so forth, are crystal clear. And so they are already aligned in many of our plans, but there is no question that it will be even more crystal clear in the future. Jamie?

Jamie Tunnicliffe - Redburn Partners LLP, Research Division

Just a question -- sorry, Jamie Tunnicliffe from Redburn. Just a question on U.S. CapEx. You mentioned how your -- you sort of repeated the GBP 1.1 billion to GBP 1.2 billion per annum, but when I hear the comments about the impact of the lower gas prices and what that does for demand, and also, there's clearly a debate about serviceability of these assets, given everything that's going on and the shocks, and what sort of level of, I suppose, endurance and stability in the system do you want. So I just -- is it right to still talk about EUR 1.1 billion to EUR 1.2 billion? Is it more likely that we're going to have a debate do you think in the U.S. where it sees that number going up from where we are? Is the risk more on the upside from here? Just any sort of thoughts on that are interesting.

Steven John Holliday

It is right to talk about EUR 1.1 billion to GBP 1.2 billion today. That's what we've signed up for, if you will, through our rate plan. So the number that Andrew was referring to encompasses the capital that's enshrined in the Narragansett agreement and the Niagara Mohawk agreement, which are -- which is a lot more capital than we used to invest in those businesses, by the way. That's a -- in the first half of this year, U.S. CapEx, as Andrew said, is up 24%. That's all part of the regulatory arrangements. We're placing more gas pipe investing in those assets. And there's nothing more than that today. You're sort of into do we believe that in the future there is a need to invest more in those assets. So I think Natural Grid's been saying ever since it's been in the U.S. that there is a need to step up investment and replacing assets. We have been doing that progressively, but if you look at the engineering sense of the lifecycle times and the investment, there is a period of investment in networks across a lot of the older U.S., not so much the south, but certainly in the northeast to replace assets. And that is a conversation we'll continue to have with our customers and our regulators, and when that becomes part of the plan, then that number will change, but until that's part of the plan, Jamie, then the GBP 1.1 billion to GBP 1.2 billion is what we can see for the next few years.

Andrew R. J. Bonfield

And just to add a comment, actually from financeability perspective. U.S. CapEx is more financeable than the U.K. CapEx today, because it's nominal, so therefore, and you get a higher return, cash return straightaway than you do in the U.K. So marginal investment in the U.S. actually will not be harmful to overall financeability and actually will be better than what we're currently seeing under the RIIO proposals.

John Dawson

Bobby?

Bobby Chada - Morgan Stanley, Research Division

Have you given any input either from a regulatory perspective or a financing or treasury perspective to the CPAC committee and your views on the change in formula for RPI and kind of try to narrow the RPI, CPI wedge? I'm just interested in generally how you approach it because it could affect you in so many different ways or.

Andrew R. J. Bonfield

Well, first of all, obviously, one of the good things that Ofgem are doing is they are consulting about the potential impact of any RPI in the exchange and the impact on revenues in particular. We obviously also have to put in about what implications are for our RPI index bonds. Because in the financeability metrics, they have used, obviously, the assumption around the bonds and how those -- obviously, the accretions on those, how that works, and if that changes as a result, how does that impact our overall financeability. So that's open. As far as consulting, I think obviously, we are a relatively small player in this area. We are considering a response. But to be honest with you, Bobby, I think there are other people like major holders of gilts who are far in advance in the queue than we are, but we will consider putting in something.

Steven John Holliday

Okay. Any remaining questions? Good. Okay. Thank you very much for joining us this morning. Appreciate your time.

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