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National Grid

Investor Seminar - 6th August 2013

National Grid - Investor Seminar - 6th August 2013

NATIONAL GRID

John Dawson, Head of Investor Relations

Steve Holliday, Chief Executive Officer

Nick Winser, Executive Director, UK

John Pettigrew, Chief Operating Officer, UK

Andy Agg, UK Chief Financial Officer

Andrew Bonfield, Finance Director

QUESTIONS FROM

Fraser McLaren, Bank of America Merrill Lynch

Mark Freshney, Credit Suisse

Andrew Mead, Goldman Sachs

Bobby Chada, Morgan Stanley

Peter Bisztyga, Barclays

Dominic Nash, Macquarie

Edmund Reid, JP Morgan

Martin Brough, Deutsche Bank

Mathias Meitner, Allianz

Verity Mitchell, HSBC


Introduction

John Dawson, Head of Investor Relations Good morning ladies and gentlemen and welcome to National Grid's Investor Seminar. Today is designed to be an opportunity to meet the UK team responsible for delivering RIIO over the next eight years; hopefully a period of further good outperformance, as we've delivered in the past. And you'll hear a lot more about the different initiatives that we're undertaking to deliver that.

We'll start with a few seasons altogether here in this room until around 10.45 and then we'll have a break for coffee. After that we'll split you up into five groups and take you to meet some of our operational managers from the UK. They are going to talk about their work to drive efficiencies and outperformance in our UK business and you'll get a chance to ask them questions as you go.

For those of you watching online we've prepared some videos of the breakout sessions which will provide you with some of the insights into what they're going to be hearing today. We've encouraged our people to be as open as possible on what they're doing and I know you'll find them a very engaging and thoughtful group.

As always people are experts in their own field and dig into what they know and what they are going to want to tell you and you'll learn an awful lot about RIIO, but at the same time be mindful of the fact that they're experts in their field and if you've got big group picture questions please don't hesitate to raise those with Steve, Andrew or the members of the IR team. It's our job to ensure that you have the right context for those sorts of remarks.

After the breakouts we'll come back to this room where we'll have lunch and then Steve will host a Q&A session to round off the day. And we're looking to finish around 2.30.

As I said this day is very much focused on RIIO and our people, we're not aiming for a PowerPoint heavy presentation, however there are slides for some of the sessions and of course you've got a pack on the table in front of you, all of the materials of which are available online.

That pack also contains our cautionary statement, which I would ask you to review, particularly as we may be making a number of forward looking statements today. And while you're doing that I'll hand you over to Steve Holliday our Chief Executive.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Steve Holliday, Chief Executive Officer Thank you John, good morning everybody. As John says today's very much a focus on the UK, UK Operations and RIIO.

Three things I hope you're going to get out of today, back to many of the comments that we've made since we accepted RIIO in our full year results. Exactly what have we been doing and what will we be doing to make sure that we perform and perform well under


RIIO. As John said, so who's the team, who are the real team in the UK that are going to be the key players in delivery?

And a real better understanding I hope about the key of RIIO, which is that outputs matter under RIIO and if you can deliver those outputs at a lower cost there's a huge opportunity to generate very attractive returns. And we're also going to try and give you an insight into how does that flow into our accounts, not just for the UK, but also for the Plc. what does that do to earnings and growth in the future.

If I just go back to the remarks that we made with our full year results, we talked about, in the course of the last 12 months, just how much regulatory certainty we've achieved, with obviously RIIO covering all of our regulated businesses here in the UK. And of course we reset 55% of our regulatory arrangements in the US last year, so for the Plc. we've got 85% of our business under new contracts.

Of course that gives us an amazing amount of clarity and here unprecedented clarity, with an eight year period to really drive performance and returns. Financing, an enormous concern over recent years with the financing we've put in place, with the outcomes of RIIO, the hybrid we issued. Clarity around how we can finance the huge investments that we'll be making in the next eight years. And beginning to set, rightly, expectations and an understanding, in my words, that really for myself and my team, many of whom you'll meet here today, it's about execution, a real laser focus on execution, what we call inside National Grid, performance excellence, a real drive around that performance.

But I'm often caused to reflect on RIIO, it seems to have been going on a long time, some faces around here I know have been talking about it with us for a long time. It's over three years ago that I had the pleasure of sitting in a steering group with Alistair and many others at Ofgem that was in those days actually titled RPI -X at 20 and raising the question about is that form of regulation fit for the future, fit for the challenges that we know that the energy scene and the networks in particular are going to be facing from 2013 onwards. And we were very supportive all the way through that that the answer to that question was no. But that didn't need wholesale change either, it just needed some adjustments.

I also remember two and a half years ago when Ofgem issued their first strategy document. And I remember the sense of blood draining out of my face at that moment too when, as many around this room will remember, a range for returns on equity that started at the bottom end with the number four and being pretty horrified about that.

But even at that stage, two and a half years ago, some of the things that are just so important to us and our investors, number one; the linkage to RPI, number two; the sense of a regulated asset value that is secure for the future, and number three; what's been so important in the UK, world leading, I'd argue in the UK, the sense of incentives that match what customers value in these businesses with what investors can then actually benefit from. And a sense under RIIO - a desire to want to increase overall the impact of those incentives.


It was a strange process at times; it felt a little bit in the middle if you remember, like in our old price control. And yet ultimately after some initial proposals in July, that in one of or two of the businesses we were concerned about, there were adequate changes between those and the final proposals and with our own internal work, for the Board of National Grid to be very comfortable in accepting the proposals, the electricity transmission business, the gas transmission business and all four of our gas distribution networks.

We've ended up with a position, the deal I've talked about before, we were we believe we can invest in essential infrastructure, we can deliver attractive returns for investors, we've got the cost allowances that we needed to do that and particularly with some of the new opportunities that we'll talk about today, a real opportunity to deliver very attractive returns.

So we've got a lot of certainty. That's with all the cash coming into the business, because of the way the deal has been structured by Ofgem allowed us to talk about a dividend for investors for a long time to come, and the linkage of that dividend to UK RPI.

What today is not going to be about, just to be clear, is anything other than the UK businesses. We're not intending to talk about the US today. We've clearly made a lot of progress in the US in the last four years, but we're not done yet either, there's still more to do to deliver our allowed returns and we'll, I'm sure, come back to that in an Investor Day towards the end of this year.

And of course we'll talk again about financing, there's always more financing to do for our business. We've attractively financed today the assets we have and the assets we're talking about building. But we know with the new trailing index of debt there are many questions around how we continue to outperform. We'll touch on that a little bit today but not in great detail, again, we'll come back and talk about the financing future for the Plc. at a different time.

It's really about UK, the value proposition here and how we're going to drive these returns. And that's why you're going to be spending the day with the UK team.

John Pettigrew who is the Chief Operating Officer in the UK is responsible for driving all of those assets, the gas distribution and the transmission assets. John's been with National Grid almost all of his career, he made a slight mistake going somewhere else for a short period of time, but then saw the light and joined National Grid and has spent time across many parts of our business actually; in our system operations, he ran the control centre for electricity some years ago, he ran the operations of transmission, he was the COO in the US for our distribution businesses in the US, before going to Harvard and then coming back into the UK to run the gas distribution businesses and is now responsible for the operations of the UK.

So John will lead today and through today will introduce you to a number of his team, not all of whom are long standing National Grid. I'm very pleased that we've hired in, during the course of today you'll meet three people who've come in from the outside; where we've identified we needed to bring in some real world class special talent to help drive this business. And you'll get the chance to meet some of those individuals today, as well


as a number people who have spent their career with National Grid and a great stalwarts as well.

So a really high quality team, I always think one of the things on the Investor Days that should be so important to you all is to get a real sense of the strength and depth. I know many chief executives talk about that, I know when I do that though I can do it with huge amounts of credibility. This is a quality team. And I hope by 2.30 you'll completely agree with me.

But before I hand over to John to lead today first of all Nick Winser is just going to talk a little bit about the energy markets. It's not an EMR big session today, I'm sure that just, Nick senses he's so close to - so what's going on with the electricity market reform here in the UK and in particular, just again to reemphasise the very special role that National Grid is playing in that. So Nick.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Nick Winser, Executive Director, UK Thank you Steve, good morning everybody, very nice to see you all. My job is to spend just about 15 minutes talking through, if you like the broad context for our operational management of the transmission systems really, it relates to distribution a little bit. But the broad context is of course energy policy.

The transmission networks are in many senses an instrument of UK energy policy and certainly the actual structure of energy policy is a major driver in terms of the investment that will go into those transmission systems. It's also fair to say that this is a moment where National Grid is increasingly providing input to the formulation of energy policy, but of course carefully standing back from determining the direction of energy policy itself.

So let's have a look at the drivers of investment. There are five I think to put it simply. First of all the carbon emission targets and legislation, so emission targets to reduce CO₂ by 20%, to get 15% of our energy - of our total energy from renewables by 2020. Large Combustion Plant Directive, IED, the Integrated Emissions Directive, which will drive the closure of a substantial amount of the oil and coal fired generation.

Secondly the decline of UK Continental Shelf gas, which is unremarked quite often, but is nevertheless certainly remarkable to see us move from self-sufficiency for this gas hungry nation in 2003, through to only 40% of our gas coming from the North Sea today, or this year, through to probably that declining to 20% by 2020. That's driven major changes to the gas transmission system, particularly around 2007 and will continue to drive changes to the structure of the gas transmission system.

Aging plant on the system, aging generating plant, we're starting to see the closure of gas fired plant that was not subject to either of the environmental directives and that's plant that was built around the beginning of the '90s, so we're starting to see age come into play there.

And fourthly the transmission system itself, the electricity transmission and the above ground installations on the gas transmission system are starting to reach the end of their


lives, peak year for construction of the 400KV was I think 1967, so as a measure of that that system is well over 40 years old and really well into an asset replacement cycle.

And finally, Europe, development of a single European energy market, particularly thinking about interconnection; you know when you think about the difference between gas and electricity this immediately pops out. If you regard the North Sea as sort of indigenous then you could say on gas we're able to import you know more than 75% of our needs. On electricity on a peak day that's 5%. So this is an amazingly low level of interconnection for a single market and I'll come back to that.

So energy policy and regulation is all about addressing those issues, so energy policy is quite often described in terms of the trilema and you're very well aware of that I know, affordability, security of supply and environmental targets. And the IR team thought you'd be very keen to see a worked example of the trilema. I can't say it's a particularly likely one in my mind, but we can discuss some variances to it. So this worked example talks about those three things in the context of us getting a substantial amount of US shale gas come in this direction at broadly the prices that it's available in the US, or perhaps a bit higher.

So what does that do in terms of the trilema? Well first of all in terms of affordability it's going to drive down prices. In terms of security of supply it would result in not only the very substantial amount of our energy system that now rests on gas for space heating, but also a lot more electricity generation being on world gas markets and dependent on the proper functioning of those markets. So the UK becomes heavily reliant, even more heavily reliant on gas, probably in excess of 50% of our total energy needs would come from gas in that scenario.

And of course in terms of decarbonisation, it's positive. As we've seen in the US decarbonisation can be driven by the replacement of burning coal with burning gas and in this case it would drive down our emission profile. It would not however get the profile down to the 100 grams per kilowatt hour or below that most observers say is necessary for the post 2030 transition of heat and transport onto a decarbonised electricity system. It would probably get us no lower than about 300 or so.

Of course an interesting variant on that which the politicians would be very keen on today would be to talk about a lot of shale gas in the UK and how would that change this picture. Of course it would help the security of supply corner by giving us more of our energy resources met from indigenous sources. So that's to show you how the trilema works through.

Of course the strongest sign of the development of energy policy is currently the Energy Bill which is going through Parliament and having a reasonably sensible progress through Parliament. That means three things for us in National Grid; it means a responsibility to provide advice and analysis to the Secretary of State, primarily on strike prices for CfDs. And that absolutely relates to the trilema, that analysis will talk about the cost of providing in different scenarios different strike prices, their impact on security of supply and their impact on hitting those environmental targets.


So we do that, we then stand back and let the Secretary of State make the decisions on the strike prices against those scenarios, advise us back. There will also be in there an assessment of security of supply, but that assessment will be against a clear, predetermined security of supply standard which DECC has already consulted on.

On the basis of the feedback on what strike prices the Secretary of States thinks are appropriate and the comparison with that scenario and the predetermined security of supply measure we will then advise the government owned counterparty body on the eligibility of generators to enter into CfDs. And we will run capacity auctions if there is volume of what will essentially be mid carbon intensity generation required to make up the difference to keep the lights on.

And you can think about that analysis very much by thinking about our work over the last few years. For about four of five years we've published future energy scenarios, and the analysis in EMR very much builds on those future energy scenarios. So on the screen now are two pictures showing the two scenarios that we focused in on this year in the future energy scenarios; coming down from three. Not a great surprise to anybody that we dropped the accelerated scenario, so we've now focused in on Gone Green and Slow Progression.

You can see on the basis here of installed capacity the difference between them is clear. For a start the one on the left has a much taller block of stuff, providing energy to keep the lights on. That's because in the purple and blue there's lots more onshore and offshore wind, which because of its low utilisation factor means that the whole stack has to grow and be higher.

Of course on the left you've had lower carbon intensity, because on the right the gap is filled by greater utilisation of gas.

So the EMR scenarios are much more numerous than this, but play out the same sort of investment.

And of course those two pictures give an insight into our needs to invest in the system, depending on exactly which path will determine the investment in the system, both in terms of its nature and its timing. So on the left you would expect to see, as well as significant connections to nuclear, you would expect to see a significant expansion of the electricity transmission system to connect up offshore wind, wind in potentially Ireland which has been talked about a lot, wind in Scotland, wind in Wales, these are all as you can hear remote from the demand centres.

On the right you get a different sort of investment and a different timing. You get potentially a lot more spent on connecting up new gas fired generation; but most likely then some significant extra investment on the gas transmission system because you're using a lot more gas.

And of course just looking at the next slide you can see sort of as a sign of this the very significant development of the gas system over the last 13 years in this case. From on the left a picture of self-sufficiency with all the gas landing at St Fergus and Bacton and being shipped in a pretty predictable way down through the country to the load centres.


By today a much more complex position with variable utilisation on a day by day basis of LNG, in particular is the swing resource, but obviously a lot of gas coming from Norway and through the interconnectors as well as the North Sea gas. So very different usage of the system and we would expect to see as both the generation side changes and the dependency of how much gas is used there and the further decline of the UK CS gas we'd expect to see further significant changes.

And then finally just to touch on Europe. Most observers believe that a single market, even if it was based on the use of predominately fossil fuels would merit a much greater level of interconnection between member states. It is, I think, immediately apparent, that once you start to have significant deployment of renewables across many member states, renewables that are intermittent, renewables that are intermittent against different factors, in particular solar and wind. You could think about wind in Northern Europe, perhaps solar in Southern Europe. You can see that the need, the benefits to have greater interconnection are much greater and that benefit of sharing back up against those renewable resources.

So we take part very strongly in this Europe network of system operator organisations both on electricity and gas and promote National Grid's interest, both from the point of view of talking about the need for more interconnection, but also providing analysis and insight to form European policy.

So that's an overview of the drivers for investment. Just to conclude then, our role is in some senses the same as it always has been, to facilitate the markets and to drive through that vital investment that's needed for that. I guess the subtlety of this is that our role of facilitating the markets has become more than just building the infrastructure, particularly under the Energy Bill and some of the reforms that Ofgem are thinking about to create a more integrated planning organisation.

And of course you can think back, actually it's interesting in this building to think back to the transitions in the rail networks around 2004 as the SRA was taken out and Network Rail got some big integrated planning responsibilities. So facilitating the energy market has just become more about providing analysis and insight, but then very much driving through to the delivery of the transmission infrastructure and making sure that energy policy and regulation come together very strongly to give a sensible proposition for customers and a sensible proposition for investors. Thank you I'll now hand over to John.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

John Pettigrew, Chief Operating Officer, UK So thank you Nick good morning everybody, so as you heard from Steve I'm the Chief Operating Officer for our UK business. So it's my role to drive the performance of the UK business, and ensure that we're delivering for both our customers and our investors over the next eight years.

My objective today is to give you an insight into how we're doing that and to show you some of the benefits we can expect to deliver over those eight years. You'll also get a chance to meet some of the members of my team and it will be their task to put the


meat on the bones of the plans that I'll share with you now. And after that there will be plenty of time to ask questions.

So over the next three hours or so I hope you'll gain a detailed insight into what we're doing, and go away with the confidence that we're well positioned to outperform over the next eight years.

So let me start by spending the next 40 minutes, together with Andy Agg, our UK Financial Officer covering some of the key actions we've already undertaken to build the foundations to deliver under RIIO.

We'll cover some of the new concepts under RIIO and the opportunities that they present. We'll look at the three areas that we believe provide the largest potential for sustained outperformance. And finally we're look at what we see as the critical success factors during this first RIIO period.

But let me begin by saying that we've already been on this journey for over 12 months now. In July last year we announced changes to our UK organisation and made some key appointments to the senior management team to really drive this agenda. By September we started to put in place the broader leadership team to give a number of management cost savings. Through the autumn and the winter we concluded a number of really important contract renegotiations and started discussions with the wider workforce.

So as a result of that when it came to the time to accept RIIO we really had a clear idea of what we could achieve under the new regime and we were well prepared to start delivering from April this year.

So this thorough process has made me confident that we've taken the new regulatory arrangements into the heart of the business. As you know RIIO is very different from the previous price controls. And it has a profound impact and consequence on our business. So just as the new arrangements have redefined the outputs and redefined the incentives for our business so we've thought again about our approach to operations to really drive our performance.

So in a way you could say that we've redefined Ofgem's definition of RIIO, from revenues equals' innovation, plus incentives, plus outputs to rethinking our operations, leveraging innovation and maximising incentives to deliver out performance.

And this process of rethinking our business embraces many of the areas of our work, from field force operations, to system support, to construction and asset management. And through to the processes that support these critical functions; all to ensure that we deliver the maximum value for our shareholders.

So let me spend a few minutes on some of the most significant actions that we've already undertaken, which we've captured under three themes and they're under our heading of rethinking.

So the first theme is reorganising, so two years ago I started a process in gas distribution, so we reshaped the organisation to drive customer service and better field


force efficiency. As a result our gas distribution performance in the last two years, against a wide range of metrics, including returns, customer service and unit cost efficiencies now benchmarks really well. So that's a turnaround we're very pleased with; and having done that we start the RIIO period for gas distribution in a very good position.

To get the same position for our transmission business we needed to go through a similar process. So as a result we introduced a new UK operating model for transmission. A simplified structure organised along process lines. We've completed the transition for our management layers, which has enabled us to remove around 20% of our core positions. We've just completed a consultation with the unions which will result in a reduction of around 10% in our staffing levels this year. And since around half of our controllable costs are made up of salaries and wages then this streamlining should help us to meet the challenge that Ofgem has set us.

Now a key feature of this new operating model is the creation of a new team called RIIO Delivery and that team is led by Chris Bennett who you'll meet later this morning. Now the reason for creating that team is that under the enhanced incentives in RIIO when you combine them with the significant investment plan that we have, then it will create many opportunities to outperform. So some of these we know today and some of them will emerge as we make progress on our improvement agenda over the next few years. So it's Chris's team that will have the role of constantly turning over stones and looking for those opportunities.

So the second theme relates to the work we've been doing around renegotiating, renegotiating our key contracts and our internal working arrangements. In our gas distribution business we've contracted for a significant proportion of our total expenditure and in doing that have reduced the cost by 20% compared to previous levels.

In our transmission business through a revised strategy we've changed the way that we contract for our capital delivery programme, again, to deliver lower unit costs. And at the same time as renegotiating these external arrangements we've been reviewing our internal working arrangements. So in particular we've reviewed our terms and conditions, including our pension plans to ensure that our total reward package is both competitive in the market, but sustainable under the new regulatory regime. So taken together these represent significant changes in value for National Grid.

And the final theme is around reengineering, so reengineering our delivery processes and reengineering our delivery plans in the light of the new RIIO outputs and the new incentives. We've reviewed the plans that we submitted to Ofgem two years ago now and we've also reviewed the allowances that Ofgem have given us related to those plans. And we've looked at how we can still deliver those outputs by spending less and how we can maximise the incentive performance by delivering in a more innovative way.

And in particular we've focused our efforts on asset management and on capital delivery processes, which are critical for finding no build solutions or where we need to build, doing that more efficiently. So by rethinking our organisation, our contractual relationships and our delivery processes I believe we're well placed to find innovative


solutions to deliver under the new incentives and achieve our ultimate goal of outperformance.

But in order to do that and in order to understand why this rethinking was necessary it's really important to understand what's changed in the regulatory regime, and in particular some of the new concepts under RIIO.

So the first concept is that many of the cost allowances will be directly linked to the outputs we deliver. So we have some fixed operating cost allowances, for example elements of our supporting system costs, so they remain, they're fixed. In addition we've got our non-load related allowances which are set and are linked effectively to delivering the level of network reliability and performance.

And remember, we're committed to delivering the outputs required by Ofgem, how we do this in vast majority of cases is actually determined by us. So if we can find innovative ways and lower costs of delivering those outputs we can share the benefits with customers and with our shareholders.

So on top of that many of our load related allowances will be a function of the outputs that we deliver and the associated unit costs. Once again, if we've got specific outputs we want to deliver and can do this at a lower cost then we share the benefits. So it's a mechanism that should really drive benefits for both customers and shareholders, which is one of the reasons why we've been supporters of these types of incentives right through the RIIO process.

So turning to load related allowances, well in particular these are going to flex up and they're going to flex down on the outputs that we deliver. But we'll not know exactly what the final allowances are for any particular year until a few years later, when all the outputs have been delivered and have been fully measured. So this is not quite as scary as it sounds. In reality when it comes to the point that we spend any more we'll need a clear view - we'll have a clear view on the outputs that we're going to be delivering and we'll have a clear view on the allowances those outputs will generate. And we'll also have an agreed mechanism in place to determine what the load related outputs that are required are.

So let me take an example, so if we take electricity transmission. So each year we'll produce a network development plan, which will be agreed through consultation and will include how much network reinforcement we need to undertake. So for example how much additional capacity we need to create between two different transmission zones.

So this industry consultation and with the Ofgem signing off process it means that we can go ahead and start spending to deliver new capacity, with the clarity about the funding, but also clarity about the recovery of that spend.

So what does this new output driven approach mean for our business? Well first it requires us to be a flexible organisation, to be able to continually adapt our operations to address new challenges, and the outputs as they arise.


Secondly, to outperform our true performance, so really understand our true performance, we need to measure both the outputs we've delivered but in addition we also need to be very clear about how much we've spent in delivering those outputs and finally and critically although we'll know what we have to deliver in terms of outputs it's up to us to decide how we deliver it.

So it's true that there are some areas where our totex allowances are linked to more defined asset deliverables. But there are more interesting areas where the outputs do not suggest a particular solution, so for outputs such as overall network asset health, or incremental megawatts of generation to be connected, the total allowances associated with delivering these outputs are a significant part of the regulatory outcome.

So that brings me onto the second concept, which is how the business is rewarded for outperforming. So in particular it's important to understand that we're now equally incentivised to reduce both our operating and our capital expenditure costs. So this is the new concept of totex incentive and the associated sharing mechanisms.

So as a result of this change there's no longer any incentive on our business to prefer a capex solution rather than opex solution and there's a much greater benefit associated with delivering a capital expenditure project more efficiently.

So this obviously is a significant change from the framework that's been applied over the last 20 years. So before I talk about the opportunities that we have to deliver sustained outperformance, what I'm going to do is I'm going to ask Andy Agg, our UK CFO to take you through some of the more interesting financial aspects of RIIO. So I'll hand over to Andy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Andy Agg, UK Chief Financial Officer Thank you, John. Good Morning, everyone.

So, as the UK’s CFO, it’s my role to lead the UK Finance Team to help drive performance under this new price control, as well as capturing the right performance data and reporting this in a clear and concise way.

So, I’m delighted to have the opportunity this morning to share with you some of RIIO’s key financial aspects: the new Totex incentive mechanism and how it will drive value for the group; some of the new language which will become part of our reporting, and how this relates to our existing financial reporting; a focus on key value drivers of RIIO; and, in particular, the delivery of outputs for lowest sustainable cash cost.

So, let me start by setting some background on the financial challenge presented by RIIO.

The regulated asset base across our UK operations was around £24bn at the start of this year; assuming a growth rate similar to last year, that would deliver around £25.5bn by March 2014. Based on regulatory gearing assumptions, this means that we would expect to have around £10bn of notional regulated equity in the UK at the end of this year. To


deliver an extra 100 basis points of return on equity, we, therefore, have to deliver £100m of additional value on a post-tax basis.

Now, this can come, in part, from the traditional revenue incentives like BSIS, or the new incentives such as stakeholder engagement. For these incentives, we earn additional revenue and profits which are then taxable. So, we would need to deliver an extra £130m under these mechanisms for 100 basis points of extra return.

But, in addition we now have a much bigger opportunity to enhance returns via the new totex incentive mechanism. Under our last price control, the business had different incentives around making opex savings compared to making capex savings. Put simply, saving £100 of opex created a little under £70 of value after tax, saving £100 of capex created just under £20 of value. This was due to the different sharing mechanisms under the old control.

The new totex incentive mechanism sweeps all this away and replaces it with something very simple. For every £100 the company saves now, whether it’s opex or a capex saving, it will create around £50 of value for the company.

Now, the actual range varies between about £44 and £63, depending on which business. But, broadly, around half of everything we save we keep as post-tax value. And that’s it, simple and powerful.

The reason that it’s so powerful is that it has now more than doubled the opportunity on the largest part of our spend programme - our capital investment.

To give an idea of the scale of this, the final proposals best view for UK regulated controllable operating costs was around £1bn each year, and this compares to an annual capital investment programme of over £3.25bn on average. In total, that gives a controllable expenditure base of around £4bn each year.

Delivering this at 5% less costs would save £200m. Based on a, roughly, 50% sharing factor, this would also add £100m of post-tax value each year. This equates to 100 basis points of extra UK equity return, again based on the RAV numbers I mentioned earlier. A 10% totex outperformance would be 200 basis points, and so on.

Now, linking to the discussion of outputs that John described earlier, our target is to maximise value under the totex incentive regime. And the way we can do this is to deliver those outputs at the lowest sustainable cash cost. Not necessarily worrying whether that is an opex or a capital cost.

Now, how this added value presents itself over time in our financial statements does get a bit more complicated, and that’s what I will be covering through the rest of the session.

But, as we go into the details of some of the mechanisms, I don’t want to lose sight of this clear and unambiguous point: that as long as we continue to deliver the outputs, then for every £100 we save compared to our allowances we will add around £50 of post-tax value.


Now, how does this all work in practice? Let’s begin with a reminder of the way the regulator sets are allowed revenues. The revenues that we are allowed to collect are set using the building blocks of fast money, return on RAV, RAV depreciation and cash tax.

Now, to understand how these building blocks are calculated, we need to go back and remind ourselves of the concept of the capitalisation ratio.

This ratio has been fixed for each of our businesses as part of the price control process. It sets how much of any pound we spend is added to the RAV for future recovery - which is known as slow money - and how much is added to revenue for immediate recovery this year or today - known as fast money.

In our electricity transmission owner activities, the capitalisation ratio is 85%. And I will use that to go forward with my example.

So, let’s go with an example where the outputs that we deliver in the first year of RIIO, of the new price control, drive £3bn of totex allowances. Our actual spend, assume, is £2.7bn - i.e. 10% less than the totex allowances, due to the efficiencies.

In this example, we will have made £300m, therefore, of totex efficiencies and, under the sharing mechanisms, we get to keep half of this.

So how does the £150m of outperformance value appear? Well, initially it will appear in line with the building blocks I mentioned. So, to recover the £150m of value, we get an amount added to our RAV as slow money, and this is calculated according to that capitalisation ratio of 85%.

In this example, therefore, we get an extra £127m of RAV - that we will be calling performance RAV - and this will drive additional revenues in future years through RAV depreciation and return.

We also get an additional revenue allowance in the current year. And this is based on the 15% of the total - which is fast money - and, again, according to that capitalisation ratio - so, around £23m. We add on a little bit of return associated with performance RAV, and then gross up for cash tax. So, this gives a year 1 revenue benefit of around £32m. And I’ll come back to that number again later.

The performance RAV - the £127m - plus the £32m of extra allowed revenue in year 1, less the extra cash tax we have to pay on that revenue, deliver the added value through our numbers. And both, together, contribute towards the increased return on equity.

Now the full £150m will result in the higher reported regulatory return in the year the efficiencies are achieved, in this case, in year 1.

And these new concepts - the capitalisation ratio, performance RAV - change the way that our RAV roll-forward will work compared it the way it did under the last price control. We move from adding Capex to adding slow money and performance RAV.

And then you can see on this slide a reminder of how these new elements are calculated.


So, I’ve described how the regulatory calculation works to reward companies for efficiencies. The next step is then to describe how that flows into our reported financial results. In order to do that, I will go back to the example that we have been using to describe the impacts of the totex incentive mechanism on our reported revenues.

When Ofgem were setting the price control, in our example, they assumed that our efficient level of spend would be the same £3bn in the first year of the control - so, effectively assuming no outperformance. Based on this forecast they would then set a revenue allowance based on the same building blocks.

So, in our example, based on £3bn of totex, allowed revenue would be set in year 1 to recover 15% of that - or £450m as the fast money - and to add the other 85% - £2.5bn - to the RAV, and to recover that over time.

Now, this recovery starts in year 1, relating to half a year’s return on that RAV, and increases in year 2, as depreciation is added, and we get a full year’s return. I’ve used 4.5% vanilla real return for the example.

We then add an allowance for taxation – and, to be clear here, I’ve just used an indicative number for tax that gives nice round revenue numbers – and this gives me a revenue profile that is associated with that £3bn of totex.

Since this revenue stream is based on the regulators’ forecast - before we actually know what outputs we’ve delivered, or what we have actually spent to deliver them - we term it the ex-ante allowance.

This ex-ante revenue, shown as the black line on the slide, with around £550m of revenue in total in year 1 and then £180m each year after that.

Now, remember that in our example I have delivered outputs associated with £3bn of totex allowances, but my actual spend to deliver those outputs has been £2.7bn - with a £300m less than those allowances because I’ve been more efficient than the regulator expected. In other words, I’ve outperformed.

Now, I’ve assumed here that I deliver exactly the outputs that the regulator expected when they set that ex-ante revenue allowance. Now, that will not always be the case, as we’ve heard, and the difference will also affect revenues - as things move in and out of the year - but I’m using a simple example for ease in this case, just focussing on outperformance.

To show how this flows through our financial accounts, we first need to calculate a revenue stream taking into account, now, exactly what we have delivered, the actual totex allowances we’ve therefore generated, and what we’ve actually spent to deliver.

We term this an ex-post revenue allowance, and there are four steps for calculating it.

Calculating allowed revenue stream based on what we have actually spent, our £2.7bn actual totex, according to the standard building blocks calculation - this is the blue line


on the chart. Then we calculate a totex allowance based on the actual outputs we’ve delivered, and this is still our £3bn.

We compare the actual spend, the 2.7, to this totex allowance and calculate how much of the difference we get to keep as added value under the sharing mechanism and, therefore, how much we share back with customers - 50% of the £300m or the £150m, in our example.

Finally, we add on some extra allowed revenue to the amount first calculated to reflect that £150m that we’ve earned. This is the £32m of year 1 revenue that I described earlier. And we also add the £127m of performance RAV. And that extra performance RAV drives extra allowed revenues of around about £11m each year from year 2 onwards.

All this together gives the dotted red line that you can now see on the chart. And this represents the allowed revenue stream which has effectively been calculated with the full benefit of hindsight - with full knowledge of actual spend, actual outputs delivered and, therefore, the final totex allowances. And, again, that’s why we term it the ex-post allowed revenue.

And you can see here how the benefits of the efficiencies flow through our revenues – the extra £32m in year 1, £11m per annum after that. Combined, these, on a post-tax basis over the next 45 years of our asset lives, have an NPV of the £150m. And this is our share, obviously, of the £300m total efficiencies. And this is the value that we have locked in by our totex outperformance in year 1.

The final step in understanding the impact of totex efficiencies on our financial results is how all of these calculations combine to affect the timing and amount of revenue recoveries. And this is driven by the fact that neither Ofgem, nor ourselves, have the benefit of perfect foresight when setting allowances. As a result the ex-ante revenue that is set when we are going into any year may well be different from the ex-post level that we can only calculate once we know our outputs and spend.

If we follow through our example, you can see that the ex-post calculation gives us a lower revenue stream than the ex-ante one. Now, this is because we have outperformed and we are giving back to the customer their share of that outperformance. As a result, in this example, we will have to return some of the revenue we’ve collected.

Clearly, we can’t know what we’ve spent until after we’ve spent it. So, we measure our actual spend and our actual outputs during the second year. So, for the first two years, our collected revenues - or our build revenues - follow the original Ofgem number, the black line. The shaded area is the difference between the ex-ante line and the ex-post line for those two years. And this represents revenue that we will have to give back. This is what we will term a regulatory revenue IOU.

In this example, by the end of year 2 we’ve built up a regulatory revenue IOU of around £30m. What happens is that our actual revenue allowances for year 3 onwards then follow the ex-post dotted red line, but on top of that we will true-up for the regulatory IOU at the start of that third year.


Our actual revenue related to our performance in year 1 now looks a little bit like this - which is rather different from the traditional profile we started with. And this is the profile that will flow through into our reported IFRS financial statements.

But, remember, despite these fluctuations, or potential fluctuations, in when amounts flow through to reported IFRS revenues, the full value from those efficiencies delivered in the first year will be recognised in our return earned in that first year.

Now, single adjustments of this scale are not particularly large in the context of the total regulated UK revenue streams. However, by the time we get to year 3, we will have another year of performance - year 2’s performance - and so on, and this will accumulate throughout the control. So, as a result, these adjustments could gradually grow in impact and will affect year-on-year comparisons.

On top of the normal timing, that we are all familiar with and we’ve seen under previous controls, we will also see the regulatory revenue IOUs I’ve mentioned being created and then being returned.

But, remember, this is not representative of value - this is simply a timing point on revenues. If we have collected too much revenue in year 1 and then return it in year 3 this will affect our reported revenues but will not impact our calculation of regulator return. We will adjust that calculation year 1 to ignore the revenue that we have collected but not earned.

We will have to monitor these regulatory IOUs to help us explain elements of our year-on-year IFRS revenue and operating profit profile.

To stress again, despite any short term revenue timing impacts, outperformance is always good for both value and for overall earnings in the long term.

Now, the example I just went through shows that there may well be occasions where we will return revenue in one year that we’ve recovered in a previous year. In our example, this was because we had outperformed. As I said earlier, we are also working under the new totex incentive regime that equalises the incentives between opex and capex. So, there may now be more occasions where we decided to spend opex in order to save more capex.

Now both of these are value adding actions but would potentially tend to reduce reported IFRS operating profits in a single year compared to the previous year.

So there could be mismatches between the performance indicated in any single year under our reported IFRS financials and the way we’ve created value, as I’ve outlined.

Under existing accounting rules we don’t currently expect to adjust our headline reported IFRS financials to take account of the creation of performance RAV, the creation and return of regulatory IOUs, or the mismatch between fast money and operating costs. But, clearly, it will be important that we explain these effects when we are reporting our external IFRS metrics.


It would be equally important that we produce clear non-IFRS performance metrics to help you judge our delivery against expectations.

As a result, we expect to report regulatory metrics based much more on value earned and incentive performance than pure IFRS measures.

We will also look to reflect some these in our internal targets going forward.

Some of our headline performance measures going forward are likely to be operational return on equity, spend against totex allowances, and incentive revenues and profits earned.

The first two of these measures require an estimate of the totex allowance in the year. And this is a new aspect to the calculation methodology, but not a new principle to us. We are very used to making estimates of in-year incentive performance, as we have been doing that for many years.

We will, going forward, ensure that we have a strong, consistent and transparent basis to support the amount of totex allowance that should be assigned to any single year.

So, in summary, the key messages I’d like you to take away from the session today are - the incentives on our business to drive efficiencies have been materially increased under RIIO, particularly in relation to our large capital investment programme. We have some new language and, as a result of the new regulatory arrangements, fast and slow money, capitalisation ratio, regulatory IOUs and performance RAV.

We are reflecting the new regulatory arrangements in our performance measures, internal and external, to ensure that we are making the right decisions to deliver outperformance under the new RIIO regime. And I expect that these measures, and the new language, will form part of the ongoing performance discussions that we will have with all of you over the coming years.

Finally, and most importantly, our largest opportunity to add value and to deliver outperformance is by delivering the outputs at the lowest sustainable cash cost, and not worrying whether that is an opex or a capex cost.

Now, by sustainable I simply mean that we are supporting the long term health of our operations, as well as a driving for financial benefits. These are long term assets, and we want to be able to deliver attractive returns into the next RIIO control and beyond. So, in order to do this, we will make decisions based on creating long term value.

Thank you, and I will now hand you back to John.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

John Pettigrew, Chief Operating Officer, UKOkay, thank you, Andy.


So, as Andy has said, the new totex incentive, the way the new totex incentive works, it redefines the way that we need to deliver our workload with the focus being on delivery of the lowest sustainable cash cost.

So, when we look across the three businesses, we can broadly classify the opportunities into three very simple buckets and the first we entitled scope - what I mean by this, is where we deliver an output in a very different way, at a lower cost compared to what was set on the allowances.

So, in the deep dives that we will do later this morning, you will meet with David Wright and Pauline McCracken, and they will talk through some of our approaches that we are taking to exploit that opportunity.

And the potential here is significant. So, as Andy has shared with you, if we can avoid spending money - whether it’s operating costs or capital costs - then we generate significant savings.

So with over £20bn of potential spend on capex over the next eight years, even modest savings will generate significant returns.

Our solutions when you see them will sound simple, but it’s the processes behind the decision making that will make the key difference.

So if I take a specific example. So, we are currently evaluating an option for using gas recovery and repair techniques to reduce sulphur hexafluoride leakage at one of our gas insulated substations. So, as you all know this is a powerful greenhouse gas.

So originally we expected to replace all the switchgear at an estimated cost of around about £70m. So, the alternative techniques we are currently evaluating could be as low as 10% of that cost. It will still deliver the environmental benefits that we were expecting - most importantly it will also still deliver the regulatory outputs.

So when you meet with David and Pauline they’ll talk more about that example and other examples like that under the opportunity of scope.

The second bucket, is simply delivering a more efficient unit cost compared to the allowances. So, Ian Galloway and Rob Douglas will set out the types of opportunities we have in transmission in this area.

For example, the work that Ian’s been doing to redefine our alliance contracts in transmission, has already built a platform for significant savings. And you should explore this with him in more detail later this morning.

In addition, you will meet with Emma Fitzgerald and Ed Syson, who will talk about the work that we have been doing in gas distribution particularly around Repex programme.

As I mentioned earlier, the changes we’ve made here - focussing on two partners rather than six, providing a platform to improve the commitment and flexibility to drive down costs - will save around 20% against our original target prices.


And from these sessions, you will come to realise that managing our contractors is a major opportunity for us here.

Ofgem have made it clear that total totex outperformance is one of the key drivers in return under RIIO.

And if you remember back to the return charts that Ofgem published as part of the final proposals, they assume that a well performing company could deliver strong returns based on around 10% cost outperformance.

So these sessions on scope, and capex, and Repex delivery are particularly important in understanding how we are going to drive returns in our business. And that’s precisely what the regulators incentivised us to do.

So the final bucket is the classic incentive regimes - these are incentives that we are all familiar with, where we can earn additional returns by targeting our performance.

RIIO introduced a number of new incentives for us - such as customer satisfaction, and stakeholder engagement - in addition to the existing regimes that have continued. And together these incentives give us the potential for improved returns.

So Chris Bennett and Paul Whittaker will take you through some of these incentives and do a deep dive later on this morning on them.

But, even the simple incentives, like customer satisfaction and stakeholder engagement - if you add it up across distribution and transmission - represents about £40m per annum.

So overall, even if we can achieve half of what we consider to be the maximum potential opportunity under these incentives, then it will add over 60 basis points to our UK return on equity.

And underpinning these three value opportunities, is the way that we are structuring our business to reduce our own cost base, and to deliver a performance driven organisation that’s able to innovate and really unlock the value in all of these three buckets.

So Nikki Spaul and Dan Davies will talk in more detail to you about this, but they will also talk about the organisational changes I have already mentioned.

From a personal point of view, I am really pleased with the way that the UK team has adapted to these new changes. Some of these developments are significant and require significant change.

We know we have to invest and develop three critical capabilities to be successful - our contractor and stakeholder management, our contract management, our stakeholder management, our customer service, and also our process and performance excellence. And in all these areas, we have made a really good start.


So, in summary, we have agreed a major change to the operation of our UK regulatory arrangements, and this has had a material impact on the way that we look to drive value through our business over the next eight years - both for the benefit of customers in terms of lower bills, but also our shareholders in terms of stronger returns.

We’ve been on the real journey at National grid, now, for over a year to ensure that we are well positioned to outperform under the new regime. And four months in, we are already making good progress.

And, as we go forward, the biggest challenge for us now is execution.

We’re already working hard to deliver performance excellence and drive continuous improvement right through all levels of our organisation. We are equipping our people with skills to challenge and innovate and look for ways to improve our processes. And we are actively managing our contracts through efficiency initiatives to deliver real value from them. And underpinning this, we will continue to strengthen our focus on customers.

RIIO brings real clarity to National Grid about what our customers expect of us, and we are firmly embedding that into all of our processes.

Good customer service is absolutely the right thing to do, but if we get it right it also creates value.

So I’ve talked this morning about the importance of really driving our business forward under the RIIO period and hopefully start to bring to life how we believe we can do that - and actually how we are already doing that. We have a significant opportunity to drive returns and value over the next eight years, and over the last three years we’ve delivered average returns on equity in excess of 13%.

So with an opportunity to invest well over £20bn in capital, adding significant value and scale to our UK businesses in the process - if we can deliver further good outperformance under RIIO, then we will deliver excellent shareholder value.

So, thank you, and I am now going to hand back to John Dawson, who’s going to explain what will happen at the deep dive sessions after coffee.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

John Dawson, Head of Investor Relations Thank you, John.

We have the luxury of running a little bit ahead of time which is a very unusual thing for National Grid. So, thank you very much for listening to the presentations.

What we are going to do after coffee is to break you up into five different groups and to take you through what we call these deep dive sessions with different members of the management team, as John has outlined. For this to work most effectively as a session, and to provide the best possible insights, we would like you to stick to these groups and


we will run you round and move you through in about 25 minute intervals. This will give you the best opportunity to meet and hear from the different subject matter experts.

On your badges, you are going to find a letter. The letter corresponds to your host and group, as shown here. They are also in your packs. The first room is also shown here on the board. So, if you have an ‘A’ on your badge, your host will be Andy Agg, who you met a minute ago, and your first deep dive session will be in the Limehouse Room, downstairs.

So, we have a bit of time for coffee. We are going to start the deep dive sessions a little earlier than planned. So we are going to go downstairs - there is an escalator outside which will take you down to the base. There you will find coffee, some displays - take 15 minutes, have a break, walk around. And, then, at half past, if we can all meet in our relevant deep dive rooms to start the deep dive session, that would be greatly appreciated.

So, at 10:30 promptly in your deep dive rooms.

Thank you very much.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Coffee break and deep dive sessions

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Question and Answer Session

Steve Holliday, Chief ExecutiveDon’t stop eating but I thought in the interests of time we’d start our Q&A session. We’re just going to continue to have lunch while we’re here. John rather politely referred to me as a compere actually, that's the nicest you've ever said to me John actually. I was intending to answer one or two questions possibly. But today has been about the UK team so a lot of your questions I will try and pass onto John and his team as well. But who’d like to kick us off. We’ve got a mic that's coming round just so it can be picked up for the webcast. Fraser, I will pay you afterwards.

Laughter

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Fraser McLaren, Bank of America Merrill LynchThank you. I guess you've intentionally stayed away from speaking about return targets today, but in this morning’s release there was a number of historic performance of 13% nominal ROE. Is that intended to be a sort of target, or is that intended to outline your credentials?

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Steve Holliday, Chief Executive


I think if you go back to the full year results I think we were quite clear there weren’t we, and that number is an average of the last six years actually. So we have generated 13% returns on equity across the UK businesses over the last set of price controls. The message when we accepted RIIO was, with the incentives that are baked into the formula, we absolutely expect to deliver the same sort of outperformance again in this period. So the 200 to 300 basis points is the guidance and remains the guidance going forwards.

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Mark Freshney, Credit SuisseSteve it seems that the, certainly if you get the efficiencies and if some of the investments are pushed to the right, it seems as if the asset bases might not grow quite as quickly as you think. And they’ve already had - the growth has had a bit of a downgrade if you like over the RIIO process. Does that mean that you'll look more actively at non-regulated investments, things like the Grain expansion? Is that the thing that's going to come onto the agenda next?

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Steve Holliday, Chief ExecutiveWell let’s just go back round the growth chart. I do think it’s an important point and when Andy was talking about what gets into the RAV of course, still within the capitalisation ratio, when you’re looking at UK growth going forwards we’re still looking at very high single digits growth in the UK. Couple that together with 5% asset growth in the US for the company overall, 6% growth in regulated asset value is what looks like the next five or six years. There is a bit of dilution though because of that saving, you’re right. Still attractive growth though, especially if we can deliver the sort of returns that we’re talking about this morning.

Unregulated are opportunities. There are - if you go back three years we thought we’d have invested a bit more in that business in that last three years than we actually have. Why haven’t we? It’s just been a function of discipline. We’ve not been able to find opportunities there that generate as attractive returns as our regulated entities. If you add up all the things we’re looking at at the moment, the interconnectors, businesses in the UK, potential for carbon capture and storage here, fourth phase expansion of the Isle of Grain, still pretty small in the context of the group overall. So I wouldn’t advise you to look hugely at that.

The core business itself has very healthy growth. Those are opportunities if we can generate extra returns on there that will take, but they’re not huge in the context of the group.

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Andrew Mead, Goldman SachsI know today is focused on the UK and it kind of highlights a bit, I suppose, the structure of changes gone in terms of splitting a bit the UK and the US apart. But on the point you highlighted at the beginning there, you know the capex is much more to go for now under the new regulation. Does RIIO mean that your global model has more advantage


from your global synergies than you had before? In terms of that capex saving it’s more important? And global procurement is more of a global…?

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Steve Holliday, Chief ExecutiveIt’s nice of you to be so positive about that Andrew. But I don’t think so in reality. You've heard a bit from Rob in the construction piece this morning about the opportunities we’ve got in procurement where unquestionably, and I'm acutely aware actually myself, I've been talking about that for an awful long time, you can see hopefully this morning that some of that is finally beginning to come through. We are producing more globally and globally means two things, procuring both the UK and the US collectively, as well as stretching deeper into international markets to source equipment of the quality that we require at a price that's more attractive. So I do expect that to come forward a little bit more.

Outside of that the other thing that you might have picked up this morning is a lot of the work that John started in gas distribution in the UK on process alignment, how we get our focus on the end to end process and driving efficiencies through that, and customer outputs through that, is absolutely the same journey in the US. That's a common approach across the UK and the US.

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Bobby Chada, Morgan StanleyTwo sort of different questions. First is I think in the breakout sessions there were very compelling arguments and examples for changing the business model, working through to drive better performance. But I guess one thing that I thought was missing slightly is how long do you think it takes you to hit full stride in delivering these things? Maybe you can talk a little bit about that.

And then secondly you talked this morning, John I think it was, about different language and different performance metrics to let us track this slightly more complex reporting. Do you know how you’re going to do that yet or are you going to talk to return on regulatory equity, or will you keep the same metrics and just give us kind of help on the regulatory true ups?

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Steve Holliday, Chief ExecutiveJohn can come in on the metrics. On timing Bobby I hope we’ve given you a bit of sense this morning. As John said in his remarks, this isn’t started on April 1st this year; we’ve been planning for RIIO for over a year now. So a lot of the groundwork was done way back pre summer 2012. Admittedly you've got a sense as well there's still some things in train and in progress. So yes, I would expect - you know when are we at full steam? Through the course of this year. We’re not expecting to and have not signalled any way please give us a break on the first year. It’s not as though we expect to earn and generate attractive returns in the first year, absolutely. But you’re quite right as well, there's an implicit here. We’d expect to continue to get better at this as well, therefore drive further performance in future years. John?


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John Pettigrew, Chief Operating Officer UKThe only thing I’d add to that is, as I said this morning Bobby, we started this process back in July 2012 and started a lot of the internal changes then, and we’re through a large chunk of them already. And at the same time we also put major contractual relationships in place for 1st April. And of course we’re still going through a bit of learning with our partners on that but, you know, we’re well on our way with that. So as Steve said, you know, we’re up and running already.

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Steve Holliday, Chief ExecutiveAnd metrics? Metrics, the new metrics. Where’s Andy? Come up Andy.

Because you touched a bit on the new metrics and Bobby is right to refer to return on equity, the regulated equity.

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Andy Agg, UK Chief Financial OfficerI think just sort of back to some of the comments I made this morning. We’ll definitely look at the right return on equity, and I'm deliberately not calling it return on regulated equity, because I think what’s important is we can explain what the elements of performance within that. So rather than just going with a headline number, why it is what it is. And then, as I said this morning, the bridge between the return, the reported return, and the underlying results from our own accounting perspective, and then as you said the return or the IOU process. So it’s about that transparency year on year of what the movements are. The exact definition of return on equity is very much something we’re still working through to land. Does that …?

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Peter Bisztyga, BarclaysIt’s I guess another sort of finance related question. But you've sort of indicated today that IFRS earnings aren’t necessarily going to be the best indicator of a performance of a business. What does that mean for dividends because a lot of investors care about sort of dividend payout ratio and stuff?

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Steve Holliday, Chief ExecutiveYeah, I'm schizophrenic about this because I do think, and John and Andrew know this, about Andy’s chart that showed you a very simple example of an outperformance on totex on year one, and how that flows through into year three. What we didn’t show you today of course was a multi-layered chart that says, well let’s assume the same outperformance in year two that’s in year four, and how does it all interplay.

And when you look at our expectations of how it interplays, I think we’ve probably over communicated the lumpiness that you'll see on earnings here. And of course a lot of


those things don’t kick in till year three anyway, the first three years are prescribed. So as you look at the earnings growth of this company, under IFRS it will continue to be there. And of course when the board looked at the dividend commitment, growing in real terms for the foreseeable future, as we said with that announcement we stress tested that against some downside scenarios so that's robust. And that's robust against a coverage of earnings as well of course cash. It’s not a commitment to actual coverage on earnings exactly each year, but the sort of levels of 1.2 plus that we’ve seen is a level through the course of the planned period.

I don’t want to sort of overplay this isn’t it going to show through in IFRS very differently. What we will do though is not rely on just the IFRS headlines, as Andy said. We just need to break down for investors the transparency of so what’s the gain, what’s the IOU year on year on year, and show those underlying corrections. But they’ll obviously be offsetting each other year on year as well. We don’t expect a business that is going to outperform in one year and then not outperform in future years, which would give you clearly a huge piece of lumpiness.

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Dominic Nash, MacquarieTwo questions please. Today’s presentation has focused very much on totex outperformance but have you got a view yet on financing outperformance against the cost of debt and tracker? And secondly, on the totex outperformance, the amount that you share between customers and yourself, is that a pre-tax or a post-tax number please?

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Steve Holliday, Chief ExecutiveThe second one is post-tax. It is post-tax.

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Dominic Nash, MacquarieSo it’s 50% to your shareholders and about say 45% to customers and 5% to the taxman then?

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Steve Holliday, Chief ExecutiveYeah, you showed a post-tax number on your chart Andy didn’t you?

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Andy Agg, Chief Financial OfficerI think it was - you’re referring back the 300 million, the 150, the 50% sharing. I think the mechanics of how the second or our piece of that flows through means we do then have to pay tax on that extra amount of revenue. But remember we’re talking about sharing the performance or the value. So effectively over time we will pay corporation tax on the extra revenue and we get a cash tax allowance on top, but that's after - so that effectively means on a post-tax basis we’re getting 50% of the upside.


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Steve Holliday, Chief Executive85% is going into the RAV don’t forget which is not taxed, it’s taxed at the revenue that comes associated with that. The piece that goes in as fast money is post-tax in the year.

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Dominic Nash, MacquarieSo consumers get less than 50% of the outperformance?

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Steve Holliday, Chief ExecutiveYeah in a net sense they do, yeah, absolutely.

Now financing outperformance. We’ve not talked about that today and back to Fraser’s question. When we talk about the returns on equity in our regulated businesses in the past that is before any financing outperformance. I hope we’ve been crystal clear over the last few years as well about our view of the ten year lagging index. I think it would have been a very difficult control for the board to accept on behalf of investors with a flat assumption for interest going through an eight year period. I think where Ofgem has landed is very sensible.

And as you've seen in the last 18 months to two years we’ve been raising spot well over 100 bps below the spot of that index. So we’ve hopefully given you a sense of confidence about the potential to outperform through the course of the eight year period. Clearly as interest rates continue to go up you might see that narrow down in the middle, and then widen out. But I'm sure Andrew you might like to add a couple of remarks to that.

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Andrew Bonfield, Finance DirectorYeah as you know when we spoke to you at the half year and the year end, the Canadian dollar bond was an example we gave actually where we were able to shorten the tenure actually with the current rates probably outperformed by about 250 basis points against the allowance. So that is an example of one deal, but that was a relatively short deal. Obviously if you go longer dated, as you did with the hybrid and also with the premium you pay for a hybrid, that was slight above the allowance. Overall historically in the UK we’ve outperformed quite significantly against the allowance. We still expect some outperformance but probably not as great as it has been historically. But that's because of the lagging indicator.

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Edmund Reid, JP MorganIn terms of how the credit rating agencies look at the business, am I right in assuming that these changes don’t really impact the way the credit rating agencies look at it because they generally look at it on a cash basis? And then going forward, in terms of


dividend sustainability, will you communicate more in terms of credit metrics, things like RCF to net debt when you report?

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Steve Holliday, Chief ExecutiveWhen we report on an annual basis?

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Edmund Reid, JP MorganOn annual basis, yeah.

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Steve Holliday, Chief ExecutiveYeah, absolutely. It is a very good question. If you go back and recall the publications that the three major agencies did during RIIO, it’s a bit like my remarks I think up front wasn’t it, about early on there was sort of some, oh this might look - 4% return on equity, that might look a bit challenging. As they came through they got more comfortable. We clearly spent a lot of time with the agencies as we always do and I think Andrew it’s fair to say they don’t see the risk, any implicit risk, in RIIO in terms of the risk profile of National Grid, or the regulated entities changed at all from the past. And if you looked at our metrics at the end of fiscal year ‘12/‘13, on all of the key metrics our RCF to net debt, FFO etc. we’re very strong. But we will publish those; we do so on an annual basis.

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Andrew Bonfield, Finance DirectorYeah I mean Ed if you look through the back of the presentation pack we always do have them, or the key ones anyway, RCF to debt, which is probably the most critical measure. As we know that's the one that we’re most constrained on.

As far as actually the rating agencies, the rating agencies actually reviewed the RIIO outcomes and have been quite positive on them from an overall credit metrics perspective, partly because obviously they see the opportunity for outperformance on the new TOTEX mechanisms. So Ofgem has spent a fair amount of time in consultation with the rating agencies to get their views on the likely outcome of RIIO.

Remember also from a rating agency’s perspective, one of the most important things, and this is a thing that we always need to keep in mind, is actually about the stability of the regulatory regime. And one of the advantages obviously we always have in the UK, is that stability, and that actually is a huge driver of their rating metrics. Actually the metrics themselves are a relatively small proportion of their overall rating. It’s more about the regulatory outcomes and the overall environmental concerns that they see, and also the willingness of the management and the management team to do the right things from a bond holder perspective as well as an equity holder perspective. Hence when we did the hybrid that is seen as a credit positive event because that actually did sustain and actually help support the balance sheet and the debt metrics.

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Steve Holliday, Chief ExecutiveAnd one of the things that was hugely important on the outcome for RIIO was the ability to think about these businesses as single A. You know we talked a lot with Ofgem about that actually during our presentations that Nick and Andrew and John and I spent some time with, because our ability to access international debt markets was critical by maintaining that single A. So ending up with a business that's financed and assumed to be single A for us was a hugely important final result.

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Martin Brough, Deutsche BankYou set out plans to meet your output targets at lease cost, but do you think on a broader sense the UK and DECC are on track to meet their output targets at lease cost, because some pretty ambitious targets in terms of renewables and then further out in terms of carbon? And part of the reason that maybe you can make CAPEX savings is the UK isn’t delivering renewables at the required rate?

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Steve Holliday, Chief ExecutiveNick can probably comment a little bit on that.

Laughter

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Steve Holliday, Chief ExecutiveI'm not passing the difficult question to Nick but - because I am quite keen actually to get this word in people’s minds about sustainable decisions that we’ve talked about here. So I know you’re talking about the generation mix to a certain extent Martin, but I'm also very keen, and we’re keen with Ofgem I think to understand some of the opportunities we see to enhance returns are not by us taking on enhanced risk. We don’t run this business that way, it’s not the way the output measures of Ofgem work either, so doing things if you will on the cheap in order to generate short term returns is not what our plans are all about. We’re still very focused, and the outputs are, on safety and reliability of our networks.

There's a huge flexibility here on load related, there's no question. And we’ve got a little bit of a pause of course understandably until electricity market reform is in place and is fully understood. But the scenarios that we’re talking about here are about outperforming against a baseline, there's still some uncertainty, particularly in the back period, about where some of those big investments would be.

Nick, the mix?

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Nick Winser, Executive Director, UK


So I think that the construction of EMR has our support. The CFD is the right instrument in my view. I mean we debated a bit, you know FITs and ROCs and why is the CFD the best compromise, you know, and I think it is. It retains the right risks on developers but doesn’t put the wrong risks on them. So winds doesn’t get exposed to the price of gas, that in my mind is a good thing.

As day follows night, if you’re going to have big low carbon contracts in a market you’re going to be forced to a capacity mechanism. Everybody is going to find that out, they’re finding it out right across Europe at the moment. I think that is driving towards the UK’s commitments most efficiently. So I think it’s the right set of stuff in that area. I think there's a lot of other things we could debate about, you know are all the energy efficiency initiatives coming from government, are they well designed? I would probably, personally, you know think there was more to debate there but I think the design of EMR is very good actually, and I think it will serve us very well.

Of course there will always be a debate around how much should be in the levy control framework, and of course there will always be a debate about whether the levy control framework measures the right thing, because actually you should be measuring customers’ bills, not levy control framework. And finally there will always be a question to be debated about are they the right outputs? But if you take the commitments we’ve got this is a good package in my view.

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Martin Brough, Deutsche BankSo does that mean you think that the government will meet its renewables directive targets and that you’re planning on that basis?

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Steve Holliday, Chief ExecutiveAnd I think that's a view that most people would share Martin. Actually of all the targets the total percentage of renewable energy has always been the really stretching and challenging one, and nothing has changed in 2013.

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Mathias Meitner, Allianz


From today’s discussions I understood that [gap in audio] outperformed and also from your historical performance that you are confident to outperform, but what I would need is just some signal, some data points. When will we get clear information that you’re on a good way? Will it be over the next month when we see the first results of your outperformance or will it take longer?

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Steve Holliday, Chief ExecutiveI'm kind of concerned if you’re getting a view of over confidence and complacency there Mathias actually. I mean what today has been all about is to give you a little sense of what’s been going on behind the scenes and therefore a degree of confidence when we talk about our ability to outperform. But ultimately you need to judge on results. So the first time you will see some of these results will be in the full year results in May 2014. At the half year we can give updates on where we are on some of the incentives, but they’re pretty meaningless frankly. You know the real judgement has always been on returns on our businesses to look at the full year results.

John is standing up here waiting for a really difficult, challenging question, come on. Verity, that was a challenge you couldn’t resist.

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Verity Mitchell, HSBCI just wanted to ask about SAP. Clearly it’s going on in the US at the moment. So there's no plans for transmission front office SAP. Do you think you don’t need it or is that something you’re just deferring while you’re handling a lot of other things?

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John Pettigrew, Chief Operating Officer UKSo in terms of IS systems to enable delivery of the processes we completed successfully the front office implementation for gas distribution last year which was an SAP implementation. We’ve already got SAP back office throughout the whole of the UK and have had it now for five years I think.

We are going to be looking at our investment in our systems in transmission front office. We currently use Ellipse which is a sort of MIMS product. We haven’t got to the point yet where we need to do the asset replacement, that's probably in 2015 and we’ll look at what the best solution is to fit our needs in 2015 to do that.

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Verity Mitchell, HSBCAnd was that part of the RIIO, did you discus that when you were thinking about RIIO?

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John Pettigrew, Chief Operating Officer UKYeah so as part of the negotiations with the regulator we have to set out our plans for IS investments. So as part of those plans we set out there was a need for some asset


replacement, particularly with our field force tools and our asset management tools within Transmission. So that was part of the discussions and are included in the allowances.

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Steve Holliday, Chief ExecutiveBut they were replacements of systems that have passed their life as opposed to a system that we must have in order to deliver some of the outputs, so asset replacement.

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Verity Mitchell, HSBCQuestion about the incentives under financing, I mean with a rolling index isn’t it a temptation to fund on a shorter term basis? I mean I know the Canadian was very attractive but it was also short term, rather than actually matching asset lives to the longest financing possible?

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Andrew Bonfield, Finance DirectorWell historically I think we’ve - our current sort of tenure date is about 12 years. Obviously in the US that's different because obviously US we tend to go as long as possible, because it’s complete pass through. In the UK we’ve actually just had a discussion last week with the finance committee of the board about our tenure of debt and the length, and it will probably stay broadly about the same, we don’t expect it to change that much under RIIO.

And part of the reason why you wouldn’t go longer is because if you actually did, potentially with changes in regulation being a new rate filing every eight years, you wouldn’t want to go too long. So you would never go and issue everything at 30 years obviously, but we don’t want to make sure that we mismatch between the asset length of asset lives and also the tenure of our debt. So it’s about maintaining that balance. So probably don’t expect it to change that much to be honest.

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Steve Holliday, Chief ExecutiveThat's great, thank you Andrew. Of course your question I think was going short term as well, actually shorter. When the curve is the way it is the incentive looks to go short. And if I may, you know I think that's one of the strength of governance in the UK. And we have an independent finance committee of the board, so it’s a key committee of our board. And as Andrew is saying, exactly one of the questions they were asking is how do we make sure that the temptation to go short for short term benefits doesn’t cause National Grid a real financing issue five years down the road, when all of a sudden renewals are a huge amount in a particular year. So they will help us actually monitor the average tenure of our debt overall, and ensure that we stay pretty much where we are 12, 13 years, and don’t just issue lots of short term money in order to outperform the index. It’s a good control mechanism.


That was supposed to be a question for John. That didn’t work at all actually. So has anyone got a question on the UK or have the team done such a great job this morning?

Nope, okay, well thank you.

So let me close with a couple of thanks. Thanks to John and the IR team for organising today. Thanks to colleagues from the UK for giving up their time to be here. But most of all to our guests, thank you. It’s always a big ask actually to ask you to give up over half a day and come and spend some time with us, particularly in August. So hugely grateful for you spending your time. I really do hope that it’s been insightful though. I hope you know you've got some deeper insights than the messages we’ve talked about over the last few years, a real taster I think of what has been going on in the UK and what continues to go on in our business here, because there’s a lot going on.

And it’s pretty clear; I trust through the course of this morning, that this message about execution is what lies at the heart of so much of what is going on. It’s about doing so much of the things behind the scenes, driving value. The point I made to Martin just now though, and a key point I think, the high level responsibilities that we and our board hold us to, safety, reliability and sustainability of our business, have not changed because of RIIO. And our decision making process is about how we use the cash that customers provide us, still go back to making sure that we deliver those outputs that are not just short term outputs but they’re long term outputs.

I hope you believe what I said earlier actually about the quality of people we’ve got in our business. I always think that's one of the great opportunities of a day like this, and I recognise and Andrew recognises, and we often talk about it with analysts and investors, and sometimes you just wonder, you know, what makes businesses successful ultimately are people. And I'm really proud, we have assembled a real quality team here and I trust you've got a sense of that through the course of this morning. And it’s because of that team, despite my remark on confidence; you know we are confident actually. We’ve been confident since the day we accepted the RIIO proposals that we will be able to invest enormously in the UK and deliver the appropriate attractive returns as well. So that's why we’ve been proud to talk about outperformance to an extent. Without complacency we’ve got a quality team in place.

We have a huge opportunity here though as you can tell. John talked this morning about the incentives, the old incentives that we used to talk about, and the fact that, you know, there could be 60 million a year under the old incentives. Of course you’d have seen when you were with our team that actually over the five year period we probably delivered about £100m a year incentive performance, but totex just changes the whole shape of that and the size of that. It’s created a very different opportunity.

And credit has to go to Ofgem. I've complained about how long it’s been, how difficult it’s been at times as well, but ultimately and back to this issue on the rating agencies and the risk that people put into the UK, the regime did need changing. We were not going to be incentivised to make the huge investments that we need to make for security of energy in the UK without a shift in that regime. To change it, to put in place the right incentives, to get the financeability of this business maintained and incentivise us to do


things that directly relate to the benefits that customers would see, and maintain an international view of stable regulation, is something they should be pretty proud of actually, because certainly in my travels it is still very true today, the number one regime for infrastructure and dividend hungry investors remains the UK. They’ve done a really good job to get us through those changes.

I think I’ll close by just reflecting on something that John said right earlier actually. He said the business genuinely feels very different today than three years ago. I think that's a nice summary. It’s always so hard in businesses to impart so much of what’s going on behind the scenes, so much activity to restructure our business, restructure our approach. Huge amounts changed, it’s a very different business than it was three years ago. We’ve got unprecedented clarity in the UK, an eight year opportunity. We’ve got a fantastic team in place. Behind that team we have thousands of really committed quality people in this business. But ultimately you will judge us on our results, and rightly so. And we’ll come back and look forward to actually presenting those results and giving you the flesh and the details of just how well we’ve done. So thank you very much for joining us today, hugely appreciated.

Applause

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END

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