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Gas Distribution

Performance during the year

Performance during the year

In the UK, actual gas consumption fell to 303 TWh in 2006/07, compared with 347 TWh in 2005/06 mainly due to very mild weather in 2006/07. Underlying levels of gas demand, excluding the effects of weather, also fell from 347 TWh in 2005/06 to 331 TWh in 2006/07, thought to be mainly due to the high levels of gas supply prices during 2006/07 affecting usage. The reduction was particularly noticeable for larger users.

In the US, gas consumption in upstate New York was 39.9 TWh (136 million dekatherms) for 2006/07 and 10.9 TWh (37 million dekatherms) in Rhode Island. This was slightly above the previous year due to colder temperatures and a lower average price.

Descriptions of our progress against our overall objectives in the areas of performance, growth, talent, relationships (including customer service) and responsibility are set out in Key performance indicators and Performance during the year. We include below further information specific to Gas Distribution with respect to our performance, growth and customer service objectives.

Performance

Progress against our performance objectives during the year included the following:

Safety	There were no employee related fatalities during 2006/07 compared with one in 2005/06. In the UK, lost time injuries for the retained networks fell 12% in 2006/07 to 21, compared with 24 in 2005/06 and 20 in 2004/05. The lost time injury frequency rate fell to 0.16 in 2006/07 from 0.17 in 2005/06 and 0.35 in 2004/05 (2004/05 includes sold networks).
	In both the UK and US, we again exceeded our regulatory agreed targets on safety-related standards. In the UK, more than 98% of ‘uncontrolled’ gas escapes (where the gas leak cannot be controlled by turning the gas supply off at the meter) were attended within one hour, and more than 99% of ‘controlled’ gas escapes (where the gas leak can be controlled at the meter) were attended within two hours. In New York, we responded to 80% of gas escapes within 30 minutes (75% target), 93% within 45 minutes (target of 90%), and 97% within 60 minutes (target of 95%). In Rhode Island, we responded to 96% within 30 minutes (target of 91%), and 97% within 45 minutes (target of 93%).
	We have decommissioned approximately 1,850 km of gas pipes in 2006/07 exceeding the HSE target this year, compared with 1,724 km in 2005/06 and 1,458 km in 2004/05.
Reliability	Over the year we have achieved all our standards of service set by Ofgem that relate to our gas transportation services in the UK and similarly in the US we have continuously improved the integrity of our gas distribution system by actively managing our critical leak backlogs and completing repairs. In the US we were ranked in the top three major gas utilities in all three metrics collected by the New York Department of Public Service as one means in the industry to assess system integrity, gas leaks discovered, main leaks/service leaks repaired.
Efficiency	We have continued to drive operational efficiency through the streamlining of processes and best practice sharing between our UK and US operations.
Financial performance	The adjusted operating profit of Gas Distribution in the UK and the US combined was £480 million in 2006/07 compared with £530 million in 2005/06 and £457 million in 2004/05. Further information on the financial results of Gas Distribution – UK and Gas Distribution – US is provided under Financial results - UK and Financial results - US below.

Our performance in the UK during 2006/07 under the current distribution network exit incentive scheme and the mains replacement incentive scheme was broadly neutral.

A series of strategic development initiatives have been delivered in support of our aim to be the most efficient gas distribution network in the UK. Centralisation of many key processes has enabled us to place increased emphasis on safety and efficiency while sharing best practice across the organisation and delivering our office rationalisation programme. Centralising our asset management, job scheduling and dispatch processes has exploited our economies of scale while also maintaining alignment of our operational workforce across the network to satisfy consumer requirements.

Having completed our Way Ahead transformation in the UK, we are now concentrating on driving further process alignment across our UK business and bringing the US business in line with the operating model, that is the centralisation of indirect activities into hubs organised by common competencies or functions with direct activities remaining in the field local to the assets and customers. This common operating model will enable us to run our businesses more efficiently, driving continuous improvement and allowing the quick roll out of best practice sharing.

Our US operations have been active in sharing new technology (such as key hole excavation utilising core boring) with counterparts in the UK, as well as evaluating UK techniques (such as sealant for joint repair) for adaptation in the US. The use of new technology and materials is being evaluated to identify opportunities to increase worker productivity and great effort is being made to share these opportunities between the US and the UK. In Gas Distribution in the US, enhanced productivity and efficiency initiatives have been identified that incorporate best practices discovered by members of the National Grid and KeySpan integration teams. These initiatives are being implemented now, where possible, or will be implemented immediately after the approval of the proposed acquisition of KeySpan.

Growth

Investment - UK

Gross investment in the reinforcement, extension and replacement of the UK gas distribution network was £490 million in 2006/07 compared with £444 million in 2005/06 and £359 million in 2004/05. This excludes investment in the four regional gas distribution networks that were sold on 1 June 2005.

Years ended 31 March	2007 £m	2006 £m	2005 £m
Capital expenditure	157	149	120
Replacement expenditure	333	295	239
Gross investment in the continuing operations	490	444	359

The increase in capital expenditure in 2006/07 compared with 2005/06 and in 2005/06 compared with 2004/05 was because of a higher level of investment in the reinforcement of high pressure pipelines, such projects being dependent on forecasts of future demand, as well as higher expenditure on new connections and the replacement of commercial vehicles. The level of investment in high pressure pipelines and reinforcement mains continued during 2006/07 together with higher information technology expenditure to replace obsolete equipment in system control, operational and support activities.

Replacement expenditure has increased by 39% since 2004/05, reflecting the substantial increase in planned workload under the long-term mains replacement programme agreed with the Health and Safety Executive. During the second year of our alliance partnerships for Gas Distribution, we have laid approximately 1,850 km of gas mains with an increasing proportion of our workload comprising complex replacement of large diameter mains.

Performance under the mains replacement incentive scheme has been held broadly neutral in 2006/07.

Investment - US

Capital expenditure in the replacement, reinforcement and extension of our US gas distribution networks was £36 million in 2006/07, £25 million in 2005/06 and £30 million in 2004/05.

After excluding the effect of exchange movements of £2 million in 2006/07 compared with 2005/06, capital expenditure increased by £13 million due to increased spending of £6 million in Rhode Island. After excluding the effect of exchange movements of £1 million in 2005/06 compared with 2004/05, capital expenditure decreased by £6 million due to the completion of the automatic meter reading project in New York.

Acquisition of Rhode Island gas operations

On 24 August 2006, we acquired from Southern Union Company its Rhode Island gas distribution network for approximately £269 million, including acquisition costs of £3 million, plus the assumption of £41 million of debt. The acquisition expanded our gas distribution business by 245,000 customers and added 3,000 miles of pipeline. We agreed to carry out the existing rate plan and have committed to file a new rate plan within one year of the acquisition date. Under a regulatory agreement, rates will be frozen for at least 12 months after completion of the transaction, and we may file a rate case within those 12 months that will address future rates. The Rhode Island gas operations have largely been assimilated into Gas Distribution in the US. Our asset management practices have been adopted which will lead to more effective use of financial resources, as well as greater utilisation of existing infrastructure.

Customer service

In the UK, we have achieved all our connections standards of service over the year, along with all other standards of service set by Ofgem that relate to our gas transportation services. During the year ended 31 March 2007, we made around 40,000 new connections to our network (2005/06: 50,000). The proportion of planned service interruptions in 2006/07 was 98.92% compared with a target of 95%, while the proportion of customer complaints responded to within five working days was 94.71% in 2006/07 compared with a target of 90%.

Our gas operations in the US met all customer service standards over the past year. We installed around 5,000 new services and 277,000 feet of new gas main connections to the network.

Financial results - UK

The results for the Gas Distribution - UK segment for the years ended 31 March 2007, 2006 and 2005 were as follows:


Years ended 31 March	2007 £m	2006 £m	2005 £m
Revenue	1.193	1,222	1,113
Other operating income	6	4	-
Operating costs excluding exceptional items	(790)	(743)	(689)
Adjusted operating profit	409	483	424
Exceptional items	3	(51)	(91)
Operating profit	412	432	333

2006/07 results compared with 2005/06

The principal movements between 2005/06 and 2006/07 can be summarised as follows:

	Revenue and other operating income £m	Operating costs £m	Operating profit £m
2005/06 results	1,226	(794)	432
Add back 2005/06 exceptional items	-	51	51
2005/06 adjusted results	1,226	(743)	483
Price changes	73	-	73
Weather and volumes	(69)	-	(69)
Timing on recoveries	(32)	-	(32)
Depreciation and amortisation	-	(9)	(9)
Business rates	-	(23)	(23)
Other revenues and costs	1	(15)	(14)
2006/07 adjusted results	1,199	(790)	409
2006/07 exceptional items	-	3	3
2006/07 results	1,199	(787)	412

Revenue and other operating income in Gas Distribution - UK fell by £27 million in 2006/07 compared with 2005/06. Net formula income was up by £4 million with the benefit of an average price increase of 8.8% implemented on 1 October 2006 giving rise to a £73 million increase in revenue, but largely offset by delivery volumes being significantly lower than the prior year reducing revenue by £69 million.

The weather in 2006/07 was significantly warmer than 2005/06 lowering consumption by 28 TWh which, combined with the impact of underlying volumes being lower by 16 TWh (caused principally by the continuing effect of high wholesale gas prices), led to an under-recovery of income of £42 million in 2006/07. Together with a £10 million under-recovery in 2005/06, this resulted in a net year-on-year timing impact on the recovery of income of £32 million.

Operating costs were £47 million higher in 2006/07 compared with 2005/06. Depreciation and amortisation costs were £9 million higher reflecting the increased capital investment in the distribution network. As in 2005/06 (see below) there was a £23 million increase in business rates following the changes in rateable values introduced from 1 April 2005. The remaining increase in operating costs of £15 million was mainly driven by workload including significant investment in maintenance and other safety-related activities.

Adjusted operating profit was £74 million lower in 2006/07 than 2005/06, a reduction of 15%. An exceptional credit of £3 million in 2006/07 related to pension elements of restructuring programmes offsetting costs associated with the creation of the new shared services organisation in the UK. Operating profit was £20 million lower in 2006/07 than 2005/06, a reduction of 5%. In summary, revenue and other operating income were £27 million lower, operating costs were £47 million higher and exceptional charges were £54 million lower.

2005/06 results compared with 2004/05

The principal movements between 2004/05 and 2005/06 can be summarised as follows:

	Revenue and other operating income £m	Operating costs £m	Operating profit £m
2004/05 results	1,113	(780)	333
Add back 2004/05 exceptional items	-	91	91
2004/05 adjusted results	1,113	(689)	424
Business rates pass-through	23	(23)	-
Weather and volumes	12	-	12
Other price changes	10	-	10
Way Ahead operating costs	-	52	52
Gas commodity costs	-	(17)	(17)
Other revenues and costs	68	(66)	2
2005/06 adjusted results	1,226	(743)	483
2005/06 exceptional items	-	(51)	(51)
2005/06 results	1,226	(794)	432

In 2005/06, revenues in Gas Distribution - UK increased by £109 million compared with 2004/05, including a £45 million increase in revenue recovered under the distribution price control formula. The weather in 2005/06 was colder than 2004/05 and that contributed £29 million of the increase, and an average price rise of 4.6% was implemented on 1 October 2005, which resulted in a further £33 million increase. That was partially offset by a £17 million reduction in underlying volumes. Other revenues increased by £64 million in 2005/06 compared with 2004/05 primarily because of the provision of services to the four regional gas distribution networks following their sales on 1 June 2005. Significant cost efficiencies were achieved as a result of the Way Ahead restructuring programme. Controllable costs, which exclude increases in ongoing pension costs and gas commodity prices, as well as the costs of providing services to the sold networks and to other National Grid businesses, decreased by 19% in real terms during the year ended 31 March 2006. Total operating costs excluding exceptional items increased by £54 million in 2005/06 compared with 2004/05. Business rates increased by £23 million following changes to rateable values from 1 April 2005, but these have been recovered through the price increases under the distribution price control, as referred to above. The remaining increases in operating costs of £31 million were primarily because of the effects of higher gas commodity prices and increases in the costs of providing services to the sold networks and to other National Grid businesses, partially offset by the savings made in controllable operating costs.

In 2005/06 adjusted operating profit was £59 million higher than 2004/05, an increase of 14%. Exceptional charges of £51 million in 2005/06 related to restructuring costs under the Way Ahead programme. Exceptional charges of £91 million in 2004/05 also related primarily to other reorganisation initiatives aimed at delivering cost reductions. Operating profit in 2005/06 was £99 million higher in 2005/06 than 2004/05, an increase of 30% as a consequence of the above changes.

Financial results - US

The results for the Gas Distribution - US segment for the years ended 31 March 2007, 2006 and 2005 were as follows:


Years ended 31 March	2007 £m	2006 £m	2005 £m
Revenue	638	571	427
Operating costs excluding exceptional items	(567)	(524)	(394)
Adjusted operating profit	71	47	33
Exceptional items	(4)	-	(16)
Operating profit	67	47	17

The average exchange rates used to translate the results of US operations during 2006/07, 2005/06 and 2004/05 were $1.91: £1, $1.79: £1 and $1.87: £1 respectively.

2006/07 results compared with 2005/06

The principal movements between 2005/06 and 2006/07 can be summarised as follows:

	Revenue £m	Operating costs £m	Operating profit £m
2005/06 results and adjusted results	571	(524)	47
Exchange rate movements	(36)	33	(3)
2005/06 constant currency basis	535	(491)	44
Purchased gas	(77)	79	2
Rhode Island gas operations	176	(159)	17
Bad debts	-	(3)	(3)
Pension and benefit costs	-	5	5
Other	4	2	6
2006/07 adjusted results	638	(567)	71
2006/07 exceptional items	-	(4)	(4)
2006/07 results	638	(571)	67

Revenue increased by £103 million in 2006/07 compared with 2005/06 on a constant currency basis, an increase of 19%. The rise in revenue was primarily due to seven months of additional revenue from the gas distribution network in Rhode Island we acquired from Southern Union Company in August 2006. This increase was partially offset by a reduction of purchase gas recovery due to lower purchased gas costs.

Operating costs increased by £76 million in 2006/07 compared with 2005/06 on a constant currency basis, an increase of 15%. This rise is largely due to £159 million of costs incurred in the gas distribution network in Rhode Island in the seven months since its acquisition in August 2006. This increase was partially offset by lower purchased gas costs of £79 million due to lower gas prices and lower sales volumes.

Adjusted operating profit was £27 million higher in 2006/07 than 2005/06 on a constant currency basis, an increase of 61%. Exceptional charges of £4 million in 2006/07 related to merger integration initiatives.

Operating profit was £20 million higher in 2006/07 than 2005/06, an increase of 43%. In summary, revenue was £67 million higher, operating costs were £43 million higher and exceptional charges were £4 million higher.

2005/06 compared with 2004/05

The principal movements between 2004/05 and 2005/06 can be summarised as follows:

	Revenue £m	Operating costs £m	Operating profit £m
2004/05 results	427	(410)	17
Add back 2004/05 exceptional items	-	16	16
2004/05 adjusted results	427	(394)	33
Exchange rate movements	19	(18)	1
2004/05 constant currency basis	446	(412)	34
Purchased gas	128	(130)	(2)
Environmental	-	26	26
Pension	-	(2)	(2)
Other revenues and costs	(3)	(6)	(9)
2005/06 results and adjusted results	571	(524)	47

In 2005/06, revenues in Gas Distribution - US increased by £125 million compared with 2004/05 on a constant currency basis, primarily due to increased recovery of purchased gas by £128 million as a result of higher purchased gas costs.

Operating costs for 2005/06 increased by £112 million compared with 2004/05 on a constant currency basis. This increase was primarily due to higher purchased gas costs of £130 million, of which £94 million related to higher prices and £36 million to increases in volumes.

In 2005/06 adjusted operating profit was £13 million higher than 2004/05 on a constant currency basis, an increase of 38%. Operating profit in 2005/06 was £30 million higher than 2004/05, an increase of 176% as a consequence of the above changes.

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