• Home
• Highlights
• Messages to Shareholders
• Business Overview
• Operating and Financial Review
• Introduction
• About National Grid
• Performance summary and key performance indicators
• Performance against our objectives
• Transmission
• Gas Distribution
• Electricity Distribution & Generation
• Non-regulated businesses and other
• Discontinued operations
• Financial position and financial management
• Going concern
• Financial position
• Commodity contracts
• Commitments and contingencies
• Related party transactions
• Retirement arrangements
• Accounting policies
• Independent Corporate Responsibility Report
• Corporate Governance
• Directors’ Reports
• Consolidated financial statements
• Company financial statements
• General Information
• Shareholder Information

Commodity contracts

We purchase electricity and gas in order to supply our customers in the US and also to meet our own energy requirements. We purchased gas and oil for our discontinued Ravenswood generation station prior to 31 December 2007 when we entered into a tolling arrangement with a third party. We also sell gas produced by our West Virginia gas fields. Additionally, we buy back capacity rights already sold in accordance with our UK gas transporter licences and Uniform Network Code obligations as part of our management of the gas transmission and distribution networks in the UK.

In the US substantially all our costs of purchasing electricity and gas for supply to customers are typically recoverable at an amount equal to cost. The timing of recovery of these costs can vary between financial periods leading to an under- or over-recovery within any particular financial period.

The most significant gas purchases for our own use relate to the operation of our gas transmission and gas distribution networks, mainly in the UK, while we also purchase fuel for our vehicle fleets in the UK and the US.

Our Energy Procurement Risk Management Policy and Delegations of Authority govern our US commodity trading activities for energy transactions. The purpose of the policy is to ensure that our US operating companies participate in the physical and financial markets only for those commodities to which we or our customers have a physical market requirement, and will transact only within pre-defined risk parameters approved by the Energy Procurement Risk Management Committee.

In our UK gas transmission operation, we are obliged to offer for sale, through a series of auctions (both short- and long-term), a predetermined quantity of entry capacity for every day in the year at predefined locations. Where, on the day, the gas transmission system’s capability is constrained, such that gas is prevented from entering the system for which entry capacity rights have been sold, then UK gas transmission is required to buy back those entry capacity rights sold in excess of system capability. Forward and option contracts are used to reduce the risk and exposure to on-the-day entry capacity prices. Our UK electricity transmission operations have also entered into electricity options, pursuant to the requirement to stabilise the electricity market in Great Britain through the operation of the British Electricity Trading and Transmission Arrangements (BETTA). The options are for varying terms and have been entered into so that we have the ability to deliver electricity as required to meet our obligations under our UK electricity transmission licence. We have not and do not expect to enter into any significant derivatives in connection with our BETTA role.

In the US, we also have a management contract with Merrill Lynch Trading, under which we and Merrill Lynch Trading share the responsibilities for managing upstream gas distribution assets associated with our Massachusetts gas distribution operations, as well as providing city-gate delivered supply. This contract allows for both parties to employ derivative instruments to maximize the profitability of the portfolio of gas distribution assets. Profits associated with these activities are shared between us, Merrill Lynch Trading and our customers in Massachusetts.

Energy purchase contracts

The majority of our energy purchase contracts are entered into to meet our normal sale, purchase and usage requirements and so are accounted for as ordinary sales or purchase contracts. These included contractual commitments to purchase energy under long-term contracts amounting to £4,753 million as at 31 March 2008 (2007: £3,731 million) of which £1,790 million is due within one year (2007: £1,233 million). Further information is included in note 29 to the consolidated financial statements.

Commodity purchase contracts accounted for as derivative contracts

Certain of our forward purchases of electricity, gas and electricity capacity do not meet the normal purchase, sale or usage exemption for accounting purposes and hence are accounted for as derivatives. Mark-to-market changes in these value contracts are reflected through earnings under the heading of commodity remeasurements.

Commodity purchase contracts accounted for as derivatives include contracts for the forward purchase of electricity that reverted back to us as part of the settlement arising from USGen’s bankruptcy in 2005, which were originally entered into prior to the restructuring of the electricity industry in New England. The electricity purchased under these contracts is not required for our normal activities and is sold in the energy markets at prices which are currently significantly below the amount we are required to pay. The fair value of these contracts amounted to a £47 million liability at 31 March 2008 (2007: £132 million liability). We are also a party to several other power purchase arrangements entered into by the former generating business, the output of which is sold to third parties through back-to-back arrangements. We recover the costs incurred under the contracts, net of proceeds received on sales, from customers as part of our stranded cost recoveries

Certain contracts for the forward purchases of gas and forward purchases of electricity capacity are accounted for as derivatives as we trade these contracts as part of our energy management activities. The fair value of these contracts include contracts with a positive value of £116 million, recorded as assets in our balance sheet and contracts with a negative value of £39 million recorded as liabilities.

Derivative financial instruments linked to commodity prices

We also enter into derivative financial instruments linked to commodity prices, including index-linked swaps and futures contracts. These derivative financial instruments are used to reduce market price volatility and are principally used to manage commodity prices associated with our gas and electricity delivery operations in the US on behalf of our customers.

Derivative financial instruments are carried at fair value in the balance sheet and mark-to-market changes in the value of these contracts are reflected through earnings with the exception of electricity and gas futures contracts, and gas sales swaps which are designated as cash flow hedges.

In addition, a number of power purchase agreements were replaced in 1998 with index-linked swap contracts that expire in June 2008. These index-linked swap contracts are the subject of regulatory rulings that allow the gains and losses to be passed on to customers. At 31 March 2008, there were liabilities of £26 million (2007: £136 million) in respect of these contracts. The fair value of the index-linked swap contracts is based on the difference between projected future market prices and projected contract prices as applied to the notional quantities stated in the contracts and discounted using a US Treasury Bill rate curve to the current present value. Payments made under indexed swap contracts are affected by the price of natural gas and we use New York Mercantile Exchange (NYMEX) gas futures as hedges to mitigate this impact. The futures contracts are derivative commodity instruments with gains and losses deferred as an offset to the corresponding increases and decreases in the swap payments.

In addition we use NYMEX electricity and gas futures to reduce the cash flow variability associated with the purchase price for a portion of future electricity and natural gas purchases associated with our electricity and gas distribution operations in the US. These had a positive fair value of £19 million as at 31 March 2008 (2007: not material).

We also utilise over-the-counter natural gas swaps in the US to hedge the cash flow variability associated with forecasted sales of a portion of natural gas production from our West Virginia gas fields. We have hedge positions in place for approximately 70% of our estimated 2008 and 2009 gas production, net of gathering costs. We use forward prices from a third party vendor to value these swap positions and they are designated as cash flow hedges. We also use over-the-counter natural gas swaps to hedge the cash flow variability of gas purchases associated with certain large-volume gas sales customers. These gas swaps are carried at fair value on the balance sheet and their charges are reflected through earnings. We use market quoted forward prices to value these swap positions. The value of these contracts was not material at 31 March 2008 (2007: not applicable).

Sensitivity analysis

As described in note 34 to the consolidated financial statements, movements in commodity prices would have the following estimated impact on the financial statements as a consequence of changes in the value of commodities. This analysis does not take account of any change in our commodity portfolio.

		2007/08		2006/07
	Income statement	Other equity reserves	Income statement	Other equity reserves
	£m	£m	£m	£m
10% increase in commodity prices	25	(1)	10	–
10% decrease in commodity prices	(22)	1	(10)	–