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Electricity Distribution

Performance during the year

About the business

Our Electricity Distribution business operates in the US. For reporting purposes it is split into two segments: US Electricity Distribution and US stranded cost recoveries.

The external and regulatory environments in which our Electricity Distribution business operates are described in External market environment and Regulation, our business drivers are described in Business drivers and our objectives and strategy are set out in Objectives and strategy. Further information relevant to an understanding of our Electricity Distribution business is included below:

Electricity Distribution network

Electricity Distribution - US

We are one of the leading electricity distribution service providers in the northeastern US, as measured by energy delivered, and one of the largest utilities in the US, as measured by the number of electricity distribution customers. US Electricity Distribution serves approximately 3.4 million electricity customers over a network of 71,000 circuit miles in New England and New York.

In the US, our electricity distribution system spans upstate New York, Massachusetts, Rhode Island, and New Hampshire to customers that include homes, small and large commercial and industrial enterprises.

Our primary business drivers are the long-term rate plans with state regulators. These plans provide incentive returns and shared savings allowances, which allow us an opportunity to benefit from efficiency gains we may identify within our operations.

We recover our costs of providing electricity to customers through delivery rates approved by applicable regulators, which are set based on historical or forecasted costs, and which include a return on our assets. The cost of the electricity supplied is passed through to customers. We are also subject to service quality standards with respect to reliability and certain aspects of customer service and safety.

New York

Our electricity delivery rates are governed by a 10 year rate plan that began on 1 February 2002. Under the rate plan, after reflecting our share of savings related to the acquisition of our New York business, we may earn a threshold return on equity for our electricity distribution business of 10.6% or 12.0% if certain customer outreach, education, competition-related and low income incentive targets are met. In the event we earn more than 12%, varying percentages of the excess are shared with customers. The return on equity is measured on a US GAAP basis and calculated cumulatively from inception to 31 December 2005 and on a two year rolling basis thereafter. The earnings calculation used to determine the regulated returns excludes half of the synergy savings from the acquisition, net of the cost to achieve them, that were assumed in the rate plan.

The rate plan also allows for subsequent recovery of specified costs and revenue items that have occurred since the rate plan was established, once these amounts involved exceed $100 million (£51 million). These ‘deferral account’ items include changes from the levels of pension and post-retirement benefit expenses from levels specified in the rate plan, as well as various other items, including storms, environmental remediation costs, and certain rate discounts provided to customers, together with costs and revenues from changes in tax, accounting and regulatory requirements.

In 2006/07 a settlement was agreed with the New York Department of Public Service which reduced the projected deferral account balance at 31 December 2007 to a projected value of approximately £255 million excluding changes in actuals to that date and before reflecting the collection of £152 million in calendar year 2006 and 2007 already agreed.

Massachusetts

Under our long-term rate plan in Massachusetts, there is no cap on earnings and no earnings sharing rates mechanism until 2010. From May 2000 until February 2005, rates were frozen. In March 2005, a settlement credit in the company's rates expired, resulting in an increase of £6 million in income through to February 2006. From March 2006, rates are adjusted each 1 March until 2009 by the annual percentage change in average electricity distribution rates in the northeastern US. Regulators approved annual increases in the amount of £11 million, effective 1 March 2006 and £4 million effective 1March 2007. In 2009, actual earned savings will be determined and we will be allowed to retain 100% of annual earned savings up to £39 million and 50% of annual earned savings between £39 million and £81 million before tax. Earned savings represent the difference between a test year's distribution revenue and our cost of providing service during the same test year, including a regional average authorised return.

We will be allowed to include our share of earned savings, if any, in demonstrating our costs of providing service to customers from January 2010 until May 2020.

Rhode Island

Our distribution rates in Rhode Island are also governed by a long-term rate plan. Between May 2000 and the end of October 2004, rates were frozen, and we were permitted to retain 100% of our Rhode Island earnings up to an allowed return on equity of 12%. We can keep 50% of earnings between 12% and 13%, and 25% of earnings in excess of 13%. With effect from November 2004 until December 2009, we agreed to lower our rates by £6 million before tax per year.

From January 2005 onwards we are able to keep an amount equal to 100% of our earnings up to an allowed return on equity of 10.5%, plus £2.6 million before tax, which represents our share of demonstrated savings subsequent to the acquisition of Eastern Utilities Associates in 2000. Earnings above that amount up to an additional 1% return on equity are to be shared equally with our customers, while additional earnings will be allocated 75% to customers and 25% to us. We determine our earned return on equity based on a hypothetical capital structure of 50% common equity, 5% preferred equity and 45% debt.

New Hampshire

In New Hampshire, our electricity distribution network serves over 40,000 retail customers, while we also own transmission assets consisting of substations and interconnections with our other electricity operations in New England.

Distribution rates and terms of service are subject to regulatory approval. We have recently executed a settlement agreement with the staff of the New Hampshire Public Utilities Commission that would establish a five year rate plan for our electricity distribution network. The proposed rate plan includes a 9% reduction in distribution rates. Over the term of the rate plan, earnings in excess of an allowed return of 11% would be shared with customers. In addition, the plan allows for incremental increases in rates for capital expenditure incurred under our reliability enhancement program. The proposed rate plan is subject to approval by the New Hampshire Public Utilities Commission.

US stranded cost recoveries

The US stranded cost recoveries segment captures the recovery of some of our historical investments in generating plants that were divested as part of the restructuring process and wholesale power deregulation process in New England and New York. In addition, this segment includes the recovery of certain above market costs of commodity purchase contracts that we are committed to purchasing that were in place at the time of restructuring and deregulation.

We are able, with the approval of the utility commissions in the states in which we operate, to recover most of these costs through a special rate charged to electricity customers. Pursuant to the settlement and stranded cost recovery agreements in effect in each of the states in which National Grid operates, revenue from this segment will decline as the recovery of stranded costs is completed.