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Gas Distribution

• Introduction
• Highlights
• UK map
• US map
• About
  Gas Distribution
• Performance against
  our objectives
• Financial
  performance

Our Gas Distribution business operates in both the UK and the US. As a consequence of the differences in the respective economic and regulatory environments, we report the results of Gas Distribution as two segments: Gas Distribution UK and Gas Distribution US.

This section should be read in conjunction with the rest of the Operating and Financial Review, in particular our vision, strategy and objectives, business drivers and risks and external and regulatory environments.

Principal operations

Gas Distribution UK

Our Gas Distribution UK segment comprises four of the eight regional gas distribution networks in Great Britain.

Our networks comprise approximately 132,000 kilometres of gas distribution pipelines and we transport gas on behalf of approximately 33 active gas shippers from the gas national transmission system to around 10.8 million consumers.

We also manage the national emergency number (0800 111 999) for all of the gas distribution networks and for other transporters in the UK. During 2007/08 we handled approximately 3.5 million calls to the national emergency number.

Gas Distribution US

Our Gas Distribution US segment comprises gas distribution networks providing services to 3.5 million consumers across the northeastern US, located in service territories in upstate New York, New York City, Long Island, Massachusetts, New Hampshire and Rhode Island.

Our network of approximately 58,000 kilometres of gas pipelines covers an area of approximately 28,800 square kilometres.

In the US, our core services are the operation and emergency response for each of our gas distribution networks, in addition to billing, customer service and supply services.

Except for residential and small commercial consumers in Rhode Island, customers may purchase their supply from independent providers, with the option of billing for those purchases to be provided by National Grid. The gas industry is less deregulated in the US than in the UK, in that the majority of gas supplied is still sold by local regulated utilities such as National Grid, to customers. Regulated utilities purchase gas from gas producers, and gas transporters then transport this gas on the independent inter-state pipeline system and into regulated utilities’ gas distribution networks for delivery to customers. In our case, we receive gas from the inter-state pipeline system at 94 gate stations. The inter-state pipeline system and local gas distribution networks are also used to deliver gas on behalf of customers who have purchased gas from independent suppliers or direct from gas producers.

Regulation

Gas Distribution UK

We hold a single gas distribution transporter licence in the UK, which authorises us to operate the four gas distribution networks we own. Detailed arrangements for transporting gas are provided through the Uniform Network Code. This defines the obligations, responsibilities and roles of industry participants and is approved by Ofgem.

Our four regional gas distribution networks each have a separate price control which determines the prices we can charge to gas shippers for our gas delivery service. These maximum prices are based on Ofgem’s allowances for operating, capital and replacement expenditure, together with depreciation of, and a return on, Ofgem’s allowances for our regulatory asset value.

The price controls that applied to our UK gas distribution networks during the year ended 31 March 2008 were an extension of our previous price controls, based on an allowed rate of return at a real pre-tax rate of 6.25% on our regulatory asset value.

The next full price control period came into force on 1 April 2008 and covers the period up to 31 March 2013. This review allows for capital expenditure of £0.7 billion and mains replacement expenditure of £2.2 billion over that period, together with an allowed rate of return of 4.3% on a post-tax basis. These allowances are expected to grow our asset base by almost 25% over the next 5 years.

As at 31 March 2008, our regulatory asset value is estimated at approximately £6.5 billion.

In the UK, the price control formulae specify a maximum allowed revenue assigned to each network. Each formula consists of a fixed core revenue, cost pass-through items, a mains replacement adjustment mechanism and shrinkage and exit capacity incentive terms. Transportation charges are set broadly to recover allowed revenue but in any year collected revenue can be more or less than allowed. Any difference is carried forward and our charges are adjusted accordingly in future periods.

Replacement expenditure maintains the safety and reliability of the network, by replacing older gas pipes with modern pipes. Ofgem treats 50% of projected replacement expenditure as recoverable during the price control period and 50% as recoverable over future years. Each network is subject to its own mains replacement incentive mechanism and retains 33% of any outperformance against Ofgem’s annual cost targets as additional return or, alternatively, bears 50% of any overspend if it underperforms.

Ofgem has established standards of service we are required to meet that apply to our operations. These include: overall standards of service, for example answering 90% of all calls to the national gas emergency number within 30 seconds of the call being connected and attending 97% of reports of a gas escape or other gas emergency within the required timescale; connections standards of service that require us to provide connections to customers to agreed timescales after an unplanned interruption; and guaranteed standards of service for our other transportation services. Compensation is payable for any failures to meet both these and the connections standards of service.

Gas Distribution US

Gas Distribution US operates under franchise agreements that provide us with certain rights and obligations regarding gas facilities and the provision of gas service within each state in which we operate. In addition, there are federal and state laws and regulations covering both general business practices and the gas business in particular, especially with respect to safety, energy transactions, customer sales and service, levels of performance, rates, finances and environmental concerns. The jurisdictions include, but are not limited to: the US Department of Transportation, the US Environmental Protection Agency, the US Federal Energy Regulatory Commission (FERC), several state utility commissions, departments of transportation, and environmental agencies. Local building departments, fire departments and departments of transportation also impose regulations upon our operations. A number of these agencies issue licences and permits governing activities under their jurisdiction.

The prices we set in the US for our customers are based on a cost of service model, whereby the prices that we agree with our regulators are designed to recover the costs we incur in providing services to customers, together with a return on equity invested. Customer bills typically comprise a commodity rate to recover the cost of gas delivered and a delivery rate to cover our gas delivery service. Delivery rates comprise a combination of a per customer charge and an additional price per therm of gas delivered. The allocation between these components varies by jurisdiction, type of customer and size of customer.

Depending on the jurisdiction, prices are set either by actual sales volumes and costs incurred in a historical test year or by rate plans based on estimates of costs and our return and estimates of volumes expected to be delivered, which may differ from actual amounts. Gas purchases for supply to customers, which represent a substantial proportion of our costs, are pass-through costs, in that prices are adjusted on a regular basis to ensure that over- or under-recovery of these costs is returned to or recovered from customers with interest. As a consequence, we have no economic exposure to such costs assuming they were prudently incurred. However, as prices are typically established based on estimates of costs and volumes, there can be timing differences between the financial period when we incur such costs and the financial period when our prices are adjusted to return or charge for any over- or under-recovery.

Our rate plans include sharing arrangements, which allow us to retain some of the benefit of efficiency improvements in excess of those built into rate plan assumptions. Typically, we retain all the benefits up to a certain level of return on equity, after which we retain only a proportion of the benefits with the balance returned to customers.

Rate plan	Equity return	Equity to debt ratio		Sharing arrangements
New York City    and Long Island	9.8%	45/55		100% to 10.5%, 50% to 12.5%, 35% to 13.5%, nill above 13.5%
Upstate New York	10.6%	42/58		100% to 10.6%, 50% above 10.6%
Boston, MA	10.2%	50/50		100% up to 14.2%, 75% above 14.2%
Essex, MA	11.2%	55/45		None
Colonial, MA	11.2%	46/54		None
Rhode Island	11.3%	44/56		None
New Hampshire	10.4%	49/51		None

We also have a number of service standards for our operations. These vary between our rate plans but include such measures as: reliability levels; responsiveness to gas emergency calls; customer satisfaction levels; customer complaints; customer meter reading performance; customer call answering; enrolment of customers into the low income customer assistance programme; outstanding gas leaks requiring repair; and other measures. Many of these service standards have penalties if we do not achieve certain specified minimum standards.

Current and future developments

In addition to the current and future developments section, the following developments are relevant to the Gas Distribution business.

Acquisition of KeySpan

The most significant development for Gas Distribution during the year was the acquisition of KeySpan, which substantially expanded the size of our activities in the US, with the addition of gas distribution networks in New York City, Long Island, Massachusetts and New Hampshire to our existing upstate New York and Rhode Island operations.

UK regulatory price control reviews

Ofgem extended the previous five year gas distribution price controls for a further year to cover the year ending 31 March 2008. The principal impact of these one year price control extensions is to increase prices by approximately 11% and to reduce the seasonality of revenues. In addition, the balance between fixed and variable elements in our revenue changed, reducing the impact that volume changes, including weather, had on our revenue in 2007/08 compared with previous years.

On 18 December 2007 we accepted Ofgem’s final proposals for new price controls with respect to our role as owner and operator of four of the eight gas distribution networks in Great Britain, covering the period from 1 April 2008 to 31 March 2013. The key elements of these proposals are a 4.3% post-tax real rate of return on our regulatory asset value, a £2.9 billion baseline five year capital expenditure allowance and a £1.9 billion five year operating expenditure allowance.

Rhode Island gas rate plan filing

Following the acquisition of the Rhode Island gas distribution network from Southern Union Company on 24 August 2006 rates were frozen for one year. We filed a request on 1 April 2008 with the Rhode Island Public Utilities Commission for a $20.4 million (£10.3 million) rate increase, representing a 4.6% increase on a total bill basis. The filing includes a revenue decoupling proposal, a gas marketing programme, a discrete funding mechanism for an accelerated bare-steel and cast-iron mains replacement programme, a new rate for low-income customers, and full reconciliation of commodity related bad debt expense.

Upstate New York gas rate plan filing

We plan to file with the New York Public Service Commission on 23 May 2008 for an $84 million (£42 million) rate increase in natural gas delivery rates, representing a 9.6% increase on a total bill basis. The filing includes a revenue decoupling proposal, a gas marketing programme, a new rate for low-income customers, and full reconciliation of commodity related bad debt expense. The filing also seeks recovery of $11 million (£6 million) of costs associated with an energy efficiency programme proposal submitted to the Commission on 30 April 2008.

New Hampshire gas rate plan filing

On 25 February 2008, we filed a request with the New Hampshire Public Utilities Commission to increase distribution rates by approximately $9.9 million (£5 million). The filing marks the first request for an increase in distribution rates in 15 years and is necessary to fund ongoing operations and significant infrastructure improvements. If the request is approved, the typical residential heating customer will experience a 6.4% increase in total monthly bill. The average increase for all rate classifications and usage levels is 5.6%. We have requested that a portion of the increase be put into effect in August 2008, with the remainder implemented in February 2009. If approved, the provision for a temporary rate increase would result in an average initial increase of 3.75%. The filing also includes a commitment on the part of the Company to improve emergency response times and call answering times and reflects annual permanent savings to consumers of $619,000 (£313,000) realised as a result of National Grid’s acquisition of KeySpan.