National Grid plc
Q2 2019 Earnings Call Transcript

Published: 10 Nov 2018

[Aarti Singhal:]

Good morning, everyone, and welcome to the National Grid half year results presentation. Warm welcome also to those of you who are watching this on the web. As usual, we will start with safety. No planned fire alarm tests this morning, so if you hear an alarm, you do need to leave this room and go towards reception downstairs. Also, the cautionary statement, which is here behind me, I draw your attention to that. And with that, I'd like to hand you over to John Pettigrew. Thank you.

[John Pettigrew:]

So thank you, Aarti, and good morning, everyone. I'm joined this morning by Andy Agg, our Interim CFO; and Nicola Shaw, our U.K. Executive Director, who will be on hand to assist with any questions at the end of the presentation. Unfortunately, Dean Seavers, our U.S. Executive Director, is not able to join us today. As usual, I'll start the review of our performance for the period and once Andy has been through the financials I'll come back and talk about second half priorities and outlook. So let me begin with our financial performance for the period. On an underlying basis, that is excluding the impact of timing and major storms, our operating profit was down £79 million at a constant currency to £1.3 billion. This mainly reflects the return of U.K. Gas Transmission allowances associated with Avonmouth, lower profits in the U.S. due to minor storm costs and the impact of U.S. tax reform. This was partly offset by increased revenue from our new U.S. rates and income from legal settlements. Underlying earnings per share was 19.7p for the period, up by 6% at constant currency. Benefiting from a lower tax rate in the U.S. and a reduced share count from the buyback program relating to the return of gas distribution proceeds last year. During the period, we invested over £2.1 billion in critical infrastructure, representing an increase of 7% at constant currency. And finally, as you know, our policy is to pay 35% of the prior year's total dividend at the half year, resulting in an interim dividend of 16.08p per share, an increase of 3.8% on 2017. So as you can see, it's been a solid first six months of financial performance with strong organic asset growth. I'll now turn to our safety and reliability performance. The last 6 months have seen continued strong levels of safety performance, with a combined loss time injury frequency rate of under 0.01, which is comparable to world-class safety performance. Our reliability has also remained excellent. We had near 100% reliability for our U.K. electric and gas networks and despite a number of storms in the U.S. during April and May, we maintained strong reliability across our U.S. networks during the period. Our system operator published its winter outlook in October with a forecast electricity capacity margin of 11.7%, which is up from 10.3% last winter. U.K. gas demand is forecast to be lower this winter at 46.6 billion cubic meters versus actual demand of over 54 billion cubic meters last winter. And bearing in mind the major storms we experienced in the U.S. last year and the extremely cold temperatures in the U.K., we have, as we always do, reviewed our procedures and are well-prepared for the coming period. Now before I turn to the detail, let me outline 4 strategic highlights for this half. Firstly, we've decided to exercise the options on our remaining share in Cadent. Second, we've completed the full refresh of rates for our U.S. distribution businesses. Third, we started a significant cost efficiency program in the U.K. to become a leaner, more agile business. And lastly, on the growth front, we've taken the final investment decision on our Viking interconnector to Denmark. All of these are significant milestones, and I'm really pleased with the progress that we've made. I'll provide you with more detail on each of these achievements over the course of this morning. On Cadent, this morning we announced that we decided to exercise our option on our remaining 39% share, which will be complete at the end of June 2019. This will complete the process of exiting gas distribution in the U.K. We've realized significant value for our shareholders with £4 billion returned last year and we shaped our portfolio towards higher growth. In May, we set out that the cash proceeds of £2 billion would be reinvested in the business to support the strong organic growth we expect over the medium term. As a result, the performance of Cadent has been classified as discontinued and is no longer included in our underlying numbers. Now to our operational performance and the significant investments we're making. In the U.S., we've invested $1.5 billion so far this year. Within the U.S., it's made of a large number of small projects. But we also continue to develop larger ones, such as the almost £80 million asset replacement substation in Providence Rhode Island. We're in the final month of this project, which involves transferring and energizing circuits from the old substation to the new one. The new substation is one of a number of works that we're extremely proud. Not only does this increase the reliability for our customers, but it also supports further economic development in Providence, it enhances safety and it helps to keep customer bills low. Moving to our regulatory progress in the U.S. As I've just mentioned, we've also completed the full refresh of rates for all of our distribution businesses, with Rhode Island Gas and Electric and Massachusetts Gas being agreed in the last 2 months and I'll expand on these shortly. This full refresh is a significant milestone and provides us with a solid foundation from which to deliver strong returns on earnings as well as funding increasing capital investment plans that we have. We've also progressed regulatory discussions on the phasing of bill reductions for the lower U.S. tax rate as well as for the return of the deferred tax credit. Andy will cover both of these in more detail in a moment. Looking at the new rates in Rhode Island. We agreed a 3-year rate plan from September 2018. This allowed a 9.3% return on equity, with an annual CapEx of $240 million. We also have near performance incentive mechanisms, which will provide the opportunity to earn between 7 and 20 basis points of additional returns. And for Massachusetts Gas, the order provides a base return on equity of 9.5% and annual CapEx of $413 million. This will be invested in modernizing our network to ensure the highest levels of safety and reliability on connecting the new gas customers. New rates were effective from the 1st of October. Now, let me update you on our union negotiations in Massachusetts. Many of you will be aware that we're currently in dispute with two of our gas unions over terms and conditions. These two unions represent 1,250 workers from our U.S. workforce of over 16,000. Particular issues are around employee healthcare contributions as well as proposals to bring future employees into a defined contribution pension scheme rather than the defined benefits plan. Over the last few years, we've agreed very similar terms with 16 other unions and therefore, we're hopeful that we can reach an agreement with these two unions very soon. The negotiations have been ongoing for several months and as no agreement was reached before the existing contracts expired, we implemented our contingency workforce plans from the end of June. This includes the employment of fully trained contractors. These are workers from other parts of our business, increased supervision to ensure safe operation and the establishment of temporary work sites. These activities are to ensure that during the work stoppage we've continued to successfully provide the service our customers expect, including completing almost 40,000 individual jobs. As a consequence of the work stoppage, we've incurred additional costs of £97 million, which are classified as exceptional. Now to the U.K. Operationally, both our electricity and gas transmission business has continued to deliver good levels of performance. For example, in our electricity transmission business, RIIO-T1 includes allowances and targets from obtaining the health of our assets. This involves the replacement and refurbishment of our primary assets to improve their condition and decrease the level of network risk. I'm pleased that we're forecast to meet all of our targets. We've done this at a cost below our allowances, which is delivering real value for our customers and our shareholders. And in gas transmission, we're making good progress on Feeder 9 with the tunneling under the Humber estuary. This is an important project to safeguard the security of the supply for a pipeline that transports 20% of the U.K.'s annual gas needs. To date, the tunnel boring machine has completed over 1,700 meters of the almost 5,000 metric tunnel and will remain on track for commissioning in the autumn of 2020. Now as many of you heard at our Investor Day in September, we're also responding to the rapid changes we're seeing in our industry, embracing new opportunities and technologies to better meet the needs of our customers and also create value for all of our stakeholders. In this context, we focus very hard on our cost base to ensure that our U.K. business is as efficient as possible and well positioned for the future. An extensive program is underway that is expected to deliver 4 key outcomes; a flatter, leaner organization, further economies of scale, simplified processes and ways of working and more efficient use of IT and back-office activities. It's these outcomes that will ensure that we become a more agile organization, equipped to be even more responsive to our customers. We expect to deliver £100 million of OpEx savings from 2021, and Andy will take us through the financial impact of this in more detail shortly. Now to the regulatory developments in the U.K. There have been three areas of focus in the period

[Andrew Agg:]

Thank you, John, and good morning, everybody. Before I start, I'd like to highlight that we're presenting this morning the underlying results for our continuing business, excluding timing and excluding also the results of Cadent in both 2017-'18 and 2018-'19. As John mentioned, underlying operating profits reduced by £79 million at constant currency to £1.3 billion. Operating profit benefited from additional revenue with new rates in our New York jurisdiction and from the settlement of legal proceedings in other activities. However, this was more than offset by the expected return of Avonmouth revenues in gas transmission, the impact of U.S. tax reform and higher storm costs. As you know, the impact of tax reform at the operating profit level is offset through a lower tax charge. This, together with a lower interest charge and a reduced share count due to return of the gas distribution proceeds last year, contributed to a 6% increase in earnings per share to 19.7p. This performance excludes 2 exceptional charges that we've taken during the first half related to the contingency workforce in Massachusetts and to the efficiency program in our U.K. business, which John has covered. Capital investment was £2.1 billion, 7% higher at constant currency. This reflects increased investments in our U.S. regulated business as well as the ramp-up of investments on our interconnector projects. Our balance sheet allows us to efficiently fund this growth and overall, we are on track to deliver good returns and value-added for the year with the interim dividend increased in line with our policy. Now let me walk you through the performance of each of our segments. Underlying operating profit for the electricity transmission business was £556 million, up 3% compared to the first six months of last year, reflecting higher regulator revenues. We invested £462 million on the reinforcement of our networks and on new connections. This was £53 million lower than last half year, reflecting the completion of a number of larger nonload related projects. Looking ahead, investment will increase next year as we begin work on undergrounding of overhead lines in Dorset and on delivering increased network output measures. For the full year, we expect to deliver stronger totex to our performance, in part due to the increased allowances available to us for data centers and for cyber security from the September reopener filings. The contribution from other incentives and legacy allowances will be broadly consistent with the prior year and as a result, we expect our performance above the 200 to 300 basis point range. In gas transmission, where operational performance remains on track, underlying operating profit was £91 million. This is £53 million lower, primarily reflecting the expected return of Avonmouth pipeline revenues. As a reminder, this is one of the vagaries of the way RIIO framework flows through our IFRS results. These adjustments will have no impact on our returns as the allowances have already been excluded from these calculations. Gas transmission capital investment is £153 million, broadly in line with the prior period. This includes an investment in Feeder 9, the Humber pipeline replacement project and continued investment in our asset health program. The September reopener filings resulted in reduced allowances for the upgrade of our compressor fleet and for Feeder 9. These lower allowances will be reflected in the current year return on equity, which we now expect to be slightly lower than the allowed level of 10%. The allowance updates will flow through next year's IFRS performance with a 2019-'20 full year negative MOD adjustment of approximately £80 million. Turning now to our U.K. cost efficiency program. We continued to look hard at our cost base to ensure it's appropriate for the remainder of RIIO-T1 and for the future. We've recognized exceptional costs of £127 million in the first half. Approximately half of this will be a cash outflow this year with the remainder over the next two years. This program is designed to generate OpEx savings of around £50 million next year and at least £100 million per year from fiscal '21 onwards, with cash flow benefits in each of the next 2 years. We continue to expect to deliver outperformance of 200 to 300 basis points this year and in each of the remaining years of RIIO-T1. In our U.S. regulated businesses, underlying operating profit was £431 million, £95 million lower than last year. This reflects the benefit of new rate case outcomes, offset by the impact of U.S. tax reform, which, as you know, is offset on the tax line together with a £56 million increase in storm costs. The majority of these will be recoverable through our existing regulatory mechanisms. The higher than usual level of storm costs in the first half means that this year's profitability is more weighted towards the second half than usual. We expect to offset any further headwinds of tax reform, cost inflation and IFRS 15 over the remainder of the year, driven by the natural seasonality of the business and contribution from new rates coming into effect. As John has already mentioned, we had to implement contingency workforce plans from the end of June this year in our Massachusetts gas business. Incremental costs of £97 million have been recognized as an exceptional item in the first half of this year. Capital investment was $1.5 billion, $100 million higher. This included slightly lower capital investment in our Massachusetts Gas business as we focus on the implementation of our contingency workforce plans. Excluding the Massachusetts work contingency costs, returns for the U.S. are expected to be at a similar level to the prior year. Turning now to the latest on U.S. tax reform. As we've previously discussed, the reduction in the federal tax rate from 35% to 21% will be significantly beneficial to our customers. It will be economically neutral for utilities but will reduce our cash flows in the near term. There are 3 areas that I'd like to update you on this morning. Firstly, we now have clarity on bill reductions for all of our operating companies, including updates for KEDNY, KEDLI and Massachusetts Electric since we last updated you in May. Secondly, the return of the $2.2 billion deferred tax balance, this will now be returned over an average period of up to 50 years, significantly longer than an initial view of 20 to 30 years. And thirdly, rate base growth will increase due to the lower buildup of deferred tax into the future, largely as a result of bonus depreciation ending the utilities. Over time, this will be beneficial to both operating profit and cash flow. So now let me discuss how these items collectively flow through the income statement over the next couple of years. 2018-'19 will see a partial impact on operating profit of $210 million. This is more than offset by the full year effect of the lower tax charge, which will, therefore, represent a small benefit to earnings. 2019-'20 will have an additional impact to operating profit of around $110 million. There will not be a significant impact on the year on earnings as the overall operating profit impact will then be offset by the lower tax rate. In National Grid Ventures, our existing interconnectors, Grain LNG and metering businesses continue to perform well, delivering similar levels of profitability to the prior year. Capital investment increased to £212 million compared to £180 million last year. As John mentioned, we've ramped up cable laying and onshore construction on North Sea Link and IFA2. This was partially offset by lower investment at Nemo as the cable laying has now been completed. Other activities include our St. William joint venture with Berkeley Homes, our residual property business and certain central costs. At the half year, operating profit from the Property business was £38 million, £15 million lower than last year. For the full year, the majority of the expected property profits relate to the Fulham transaction, which is forecast to take place in second half. Corporate center and other contributed £38 million at the half-year point, including £94 million of benefit from legal settlements to recover costs associated with the U.S. systems implementation. Finance costs were £494 million, down 9%. We benefited by nearly £50 billion, including lower pension interest and a higher rate of capitalized interest offsetting the underlying increase from the growth in net debt. The second of interest charge will be higher as some of the benefits will lessen in the second half. Our effective interest rates decreased by 30 basis points to 4.4%. The underlying effective tax rate before joint ventures was 19.3%, down 360 basis points from last year, primarily due to the lower U.S. tax rate. As I mentioned earlier, the lower tax charge interest benefit and reduced share count helped EPS increase to 19.7p, 1.2p higher than last year. Operating cash flow was £1.9 billion, broadly in line with last year. Net debt increased by £2.6 billion to £25.6 billion. The increase includes ongoing business requirements of £1.2 billion and £1.4 billion of exchange rate impacts as the dollar has strengthened since the year-end. It was $1.4 to the pound at 31st of March. As we indicated in May, for the full year, and excluding the impact of exchange rates, we continue to expect ongoing business requirements to increase net debt for the year by approximately £2.5 billion. In the first half of the year, we raised over £1 billion of new long-term financing, all for our U.S. business. This included a $350 million 10-year bond in our Rhode Island business, which priced with a coupon of 3.9%, securing funding ahead of the new rate case coming into effect in September. Consistent with our policy, we will pay an interim dividend of 16.08p per share, representing 35% of last year's total. Scrip uptake on the full year dividend was 31% and we'll again be offering the scrip option at the half year. As we stated in May, we don't plan to buy back the scrip shares this year given the very strong asset growth levels we're seeing. Turning now to our focus on the efficient funding of our growth. Over the last 5 years, our asset portfolio has grown by 5%, on average, adjusting for the Gas Distribution disposal. We've maintained an A- credit rating for the group and with gearing steady at around 65% at constant currency. This has enabled us to raise debt cost effectively with access to a wide range of debt sources. As you know, with the combination of U.S. organic growth and interconnector investment, our portfolio is enjoying particularly strong asset growth. We are efficiently funding this growth through a mix of debt, internally generated cash flows and by utilizing the scrip option. In addition, we'll be retaining the proceeds from the disposal of our remaining 39% share in Cadent for reinvestment in our business. Putting this all together, with the strong CapEx visibility that we have, we expect gearing to be around the 65% level by 2021 on a constant currency basis. For this coming year, at year-end, we expect gearing to be a couple percentage points higher as we won't be receiving the Cadent proceeds until around June 2019. From 2022 onwards, the majority of our in-flight interconnector CapEx will be complete and EBITDA generated from these businesses will benefit the group from that point forward. Turning now to look at our expectations for the full year. Compared to our year-end technical guidance, there are 3 main updates. Firstly, in the U.S. regulated business, we've incurred higher-than-anticipated storm costs in the first half. So full year U.S. profitability is now likely to be slightly lower than last year. This will have no significant impact on ROE as the majority of these costs are recoverable under our regulatory mechanisms. Secondly, we've recognized legal settlements of £94 million in our other activity segment, which will benefit our full year performance. And finally, we expect the interest charge for the second half of the year to be slightly higher as some of the benefits in the first half are not repeated. So in summary, our performance remains on track and we expect the net benefit of the full year from the items I just described. Our capital investment has increased, supporting asset growth of at least 7% in the near-term and our financial position remains strong. And with that, I'll hand you back to John.

[John Pettigrew:]

So thank you, Andy. As you know, National Grid is a long-term business. Each step we take in the near-term is focused on creating long-term value for all of our stakeholders. So let me now turn to our major priorities for the second half, looking at them through the lens of the 4 long-term drivers of success for National Grid. To remind you, these are putting our customers first, optimizing the performance of our core business, seeking out growth opportunities in a disciplined way and evolving the business for the future. National Grid has a vital role to play in enabling customers to benefit from the changes in our industry. The energy transition and wider technology advancements mean that we're better able to give our customers a more cost-effective service. I strongly believe that performance optimization is central to our role to meet the changing needs of our customers. For a regulated utility like National Grid, a key element to maximize value for customers is stable and predictable regulatory frameworks. The incentivized optimization goes through innovation and efficiency. And regulatory frameworks are, of course, a major area of focus for us in the U.K. where we're in discussion with Ofgem on the [Technical Difficulty] control and on competition. On RIIO-T2, the framework decision document that was published at the end of July provides a solid foundation for this. Ofgem confirmed the key principles of RIIO-T1 will remain; that is, incentives, innovation and output-based regulation. There are, however, many areas that we'll continue to discuss with Ofgem, including achieving a fair return on equity that's reflective of the level of risk in transmission networks. Ofgem will publish their sector specific consultation in December, which will provide further detail on the cost of capital, incentives, outputs and other financial parameters for our transmission businesses. This consultation will conclude in the second quarter of calendar 2019. In the meantime, we'll continue to work with our new stakeholder panels to better understand customer expectations, which will help frame our response to Ofgem's consultation early next year. We'll, of course, provide you with updates on this consultation and the wider RIIO-T2 process as it progresses to 2021. The second area of U.K. regulated focus for us is the proposed introduction of increased competition. We support the principle of on-shore competition and will work with Ofgem to develop a framework that delivers value both for customers and shareholders. We will be to the consultation on the Special Purpose Vehicle model shortly, where together with the competition proxy model, Ofgem plans to increase license modifications in the next 6 months. In our view, these are complex models that don't present a clearer customer benefit case and we'll continue to engage with Ofgem on these. We believe that our long-term track record of efficient delivery puts us in a strong position to win in a competitive environment. We competitively tender around 90% of our costs, including both equipment and construction works. However, this doesn't mean that we're complacent. We'll continue to look for new ways to reduce our costs overall as we're doing with a cost efficiency program that we described earlier today. Let me now turn to the regulatory frameworks in the U.S. where we have a number of near-term priorities. With the completion of the refresh of rates for our distribution companies, we now have rates that allow us to invest appropriately to meet safety and reliability targets. For our next filings, we're proposing to evolve the regulatory frameworks. We'll do this whilst providing more options for regulators to meet policy outcomes on decarbonization and changing customer needs. An example of this will be Massachusetts Electric where we'll be filing later this month. As part of this filing, we'll be proposing a 5-year forward-looking incentive-based framework. In addition, although currently small, I'm pleased that incentivization is now a regulatory feature for many of our rate plans and one we aim to expand further into the future. We're also continuing to adapt our investment response to our customers' requirements and to anticipate their future needs. This focus is increasingly at the heart of every filing that we make. And our forthcoming Massachusetts Electric filing will include a request to significantly expand the rollout of electric vehicle charging infrastructure. This can provide over 17,000 new charging points across the state. We're also looking at the filing in New York for advanced metering infrastructure implementation, which follows a collaborative stakeholder process. If approved, we'll replace approximately 1.7 million existing electric and 640,000 gas metering points. This will represent a significant investment of over $650,000,000 over six years and we're planning to submit this filing later this month. And finally, U.S. regulatory priorities, we've also started reviewing the next steps for KEDNY and KEDLI, where the current three year plan concludes at the end of calendar 2019. Now let me spend a few moments on another key priority for us, our interconnectors projects. As I said at the start of the presentation, one of the strategic highlights for us in the last 6 months was the final investment decision on Viking Link, subject to the resolution of a number of minor issues. As a reminder, this link is a 760 kilometers, 1.4-gigawatt joint venture with a Danish transmission owner. Our investment will be £850 million. And when it goes live in 2023, it's expected to eventually contribute around £100 million of EBITDA as well as import over 80% clean energy. In the next six months, our priority will be to progress with Viking as well as the continued efficient delivery of our other 3 interconnector projects under construction. These represent a combined investment of £2.1 billion through to 2023. This is valuable growth driver for the group, contributing an expected £250 million of EBITDA when they're fully operational by the mid-2020s. For our core regulator networks, given the age of our assets in both the U.S. and in the U.K., asset health investment for safety and reliability remains a key growth driver. In the U.S., new customer-focused investment drivers, such as the electric vehicle and metering opportunities I've just discussed provides us with further potential in the medium term. And in the U.K., as I mentioned a few moments ago, we'll be working closely with the stakeholder panels as part of the RIIO-T2 process to make sure that we're planning the right investments to meet the customer needs from 2021. And this will be a key part of our work over the next 6 months. So our committed interconnector CapEx, clarity on investment into RIIO-T1 and the completion of our rate filing refresh in the U.S. provides significant visibility for group capital investment through to 2021 and beyond. These all combine to give us high-quality asset growth of at least 7% for the next 2 years and at the top end of our 5% to 7% range in the medium term. And with the final divestment of U.K. Gas Distribution, we now have a portfolio of businesses with high-quality growth for the future, supporting our investment proposition of growth and income for shareholders. Looking across the group, one of our key priorities is to deliver the capital plans we've been funded for as efficiently as possible. And we'll continue to do this in the second half of this year. Beyond our core regulated networks and interconnector investments, we're also developing other opportunities. In particular, we're investing in opportunities arising from the growth in large scale renewable generation. We have a small, but growing portfolio of renewables, with almost 30 megawatts of installed solar and storage in the U.S. and more under construction. As I mentioned at the year-end results, the long-term contracted nature of regulatory underpinning makes renewables well suited in the risk-reward profile of our portfolio. This is because they leverage many of our core capabilities in engineering and project development, Asset Management and financing. For these reasons, in the coming months we'll continue to look for opportunities in the rapidly expanding U.S. renewables space. We're also progressing wind generation opportunities. These include Deepwater Wind, a National Grid Ventures partner that was awarded contracts to install 400 megawatts by Rhode Island and 200 megawatts by Connecticut. We'll be advising Deepwater on the subsea cable construction and have options to purchase the subsea links when commissioned. So overall, we're well positioned to take advantage of the opportunities that arise from the ongoing energy transition. So in summary, we've delivered solid financial performance in the first half, with strong strategic progress, whilst continuing to grow the portfolio. We've influenced - we're influencing the evolution of our regulatory frameworks in both the U.S. and in the U.K. and significant activity is underway to make us a more agile organization. We'll continue to develop a disciplined approach to the many growth opportunities we have across the group and coupled with efficient delivery, this will create long-term value for customers and shareholders. Now Andy, Nicola, and I will be happy to take any of your questions.

[Christopher Laybutt:]

Chris Laybutt, JP Morgan. Two questions, please. The first, there were some headlines on Bloomberg about your dividend this morning and just wondering whether you could provide some clarification around the dividend and RIIO-2 and has there been any change to the policy or is the policy unchanged? And secondly, just in terms of government consultations that are currently underway in relation to U.K. regulation and regulated assets, one recently launched by the Chancellor. How do you think these might impact your business and is there any relevance for RIIO-T2?

[John Pettigrew:]

I mean, in the terms of dividend, the policy absolutely the same, which is we look to grow the dividend by half for the foreseeable future. We've always recognized the importance of sustainability of dividend to our shareholders. And as a business, we always look to try and work through rate filings and price controls and delivering our dividend. As I said in May, it's clearly underpinned by a sensible set of regulatory assumptions and that remains the same as I said in May. In terms of the consultations, actually there are 2 consultations out at the moment on regulation more broadly. So there was the one announced by the Chancellor last week at the budget, which was looking specifically at innovation and then there was the one launched that's been undertaken by the NIC looking more broadly at regulation. And I think our position is that we welcome those consultations and reviews from an innovation perspective. You know, I think there is an opportunity potentially to better align regulatory frameworks to innovation, particularly where it's very long-term, similar to the 5-year price control going forward. Quite often innovation takes much longer to deliver value for customers. So there is an opportunity there. And in the broader regulatory consultation, we'll be looking to see how we can contribute to that. As I said, we welcome it. I think there potentially are opportunities to think about the duties the economic regulators have in the context of a changing energy landscape going forward, particularly around things like encouraging infrastructure investments and meet energy policy targets.

[Iain Turner:]

Iain Turner from Exane. If I can ask three questions. On Nemo, is there any scope and do you have any incentives to make that available sooner rather than later and help the builders out? Secondly on U.S. tax reform, you've given us some helpful views on earnings. Can you just give us an idea what that means for cash flow in the same, sort of, basis? And then finally, and I think I asked this question 6 months ago, could you update on your thinking on Brexit and the impact that will have on your business?

[John Pettigrew:]

Why don't I take the first and the third, and I'll let Andy take the second? So in terms of Nemo, in simple terms, we're incentivized to complete there as quickly as possible. Actually, we're in the last phases of the construction of Nemo. So as I said in my speech, we're just about starting the testing process that will continue in vigor to December and we're looking to commission by March. So there is a very, sort of, set playbook you have to go through to commission an interconnector and we're very used to that given the work that we've done in the past and we'll be doing it as quickly as possible. But at the moment, our view is it will be done by March. In terms of Brexit, I think you asked if our position has changed, particularly - as you would expect with a company like National Grid, we work very closely with government and with regulators to make sure that we're considering all possible scenarios around Brexit. Our focus has been, as the system operator, considering security supply and we - our position is we don't see any significant issues at this point. We also look at it from an interconnector perspective and we believe the fundamentals of interconnection don't change in the Brexit. The internal energy market is the gold standard but if it's not the internal energy market, we know that we can trade on that interconnector effectively going forward. And then the third area, like any business, we're considering our supply chain and making sure that we've got the appropriate strategic spares in place. So I think we're well set in terms of considering the scenarios, but we continue to work both with government and Ofgem to make sure that we understand the fuller landscape. Andy?

[Andrew Agg:]

Yes, so on tax reform, the figures I mentioned in my speech, the £210 billion this year, the additional £110 billion to make the £320 billion next year will impact cash, we've always said in the short-term because of actual pricing loss position from a tax position. Those impacts flow through to cash only when we get to be in a cash tax paying position in the early to mid-20s. We do expect the cash as usual as out.

[Deepa Venkateswaran:]

This is Deepa from Bernstein. I have three questions. So firstly on your U.K. cost program that you've launched, it's very close to RIIO-T2. So isn't it possible that all the benefits of this will be entirely clawed back as you start RIIO-T2? So I was just wondering about the timing. Secondly, following from the previous question actually on the Viking FID that you've just taken, what are your assumptions about the CO2 differentials between the continent and the U.K. and the £100 million of EBITDA that you've given? Is that kind of robust even if the U.K. had, I don't know, a total carbon price of maybe £24 and the continent had something maybe substantially different from that, and so what's that? And the third one is just on the Massachusetts issue that you have with the unions. It seems like you're paying around £33 million per month for this temporary disruption. How long do you expect this to go on? And is there something in the second half as well that you're expecting?

[John Pettigrew:]

So let me start with the U.K. efficiency program. So I think if you go back to 2013, we've always set out as National Grid to deliver as efficiently as possible, recognizing the importance of affordability and value for many of our customers. And in the first 5 years, I really think we've been very successful in that. As we know, we've returned to £540 million to customers and currently transmission represents less than 3% of a bill. But in the context of you can never rest on your laurels, we're not complacent and with the changes that have gone on in the external environment and the changing demands that we see of our customers, we think it's perfect timing actually to make sure that we have an organization that not only can deliver the next couple of years that remains a RIIO-T1, but also that it positions us really well for RIIO-T2. So that's what we're doing. It's really a reflection of we're seeing very different needs from our customers from what they were back in 2013 and we think it's important to address. But we also think we've got a duty to make sure that we're driving value for our customers. As Andy said, the program itself will deliver about £50 million of OpEx reductions next year and £100 million in 2021. We think that will position us very nicely in our engagement was stakeholders as we think about RIIO-T2 as well. In terms of Viking, I mean, in Viking we do a whole host of scenarios in terms of what the market might look like so it's not just tax in terms of CO2, we also have to model for things like the arbitrage and what's the generation background is going to be looking like in Europe as well as in the U.K. So we're comfortable with the estimate we've provided today as a central estimate based on all those differing modeling and scenarios that we've done. So we do take into account that there could be changes in tax, but similar there are going to be changes in the generation background both in the U.K. and the U.S. and therefore, the arbitrage, which really drives the value for the interconnectors will also - could potentially vary. So we do a whole host of scenario testing and what we present today is a central range, which we think is probably our best view. In terms of Massachusetts and the work stoppage, let me just take you back and then I'll talk about the costs. So in terms of the work stoppage, we have been in negotiations with these two unions for a while. When we got to the end of the contract in June, we were in a position where unfortunately we hadn't agreed terms and conditions, impacting about 16,000 people in our U.S. business, and we've agreed these terms with probably 16 other unions. The 2 areas of dispute are healthcare and paying a small excess on initial healthcare claims and pensions and fundamentally that's about - for future employees moving from a DC scheme to - from a DB scheme to a DC scheme. The position is, in order to be able to deliver a safe and reliable network, we needed to bring contractors in, we need to ensure we have the right supervision so we can deliver safe and reliable network to our customers. And as I said in the speech, we've done about 40,000 jobs so far. The cost of that in the half-year is the £97 million that we've set out. We're hopeful that we will get to a resolution in a reasonably short timescale. We are in active dialogue with the unions as we speak today.

[James Brand:]

James Brand from Deutsche Bank. I also have 3 questions. The first is also on cost cutting in the context there but within the context against your outperformance targets in the U.K. of 2% to 3% for the rest of this regulatory period and obviously, at the moment, you're around the 2% mark. So not to ask you for clear guidance on kind of specific numbers, but if there is any context you can give us around the cost-cutting there, whether that's to hold the 2% level so you could be within that range or maybe hopefully push up the level of outperformance over the last couple of years in the period. And then the second question is also linked to that, is whether when you calculate totex outperformance, do take into account the restructuring costs or do you strip those out as exceptionals. And then thirdly, also again on Massachusetts, you had suggested from your comments that you'd gone through process in many states already, but I was just wondering whether there were many - or many unions already, whether there were many unions where you in the future [Technical Difficulty] kinds of discussions or whether you're most of the way through that process across the U.S.?

[John Pettigrew:]

I'll take the first and third and then I'll let Andy take the second. In terms of the efficiency program, our intention is to really underpin the 200 to 300 basis points of outperformance that we committed to. So that's what our guidance says, so I'm not going to point to any more specifically than that. What we have set out is we're expecting it to deliver around £50 million of benefit next year and £100 million per annum from 2021. Obviously, that gets shared with customers quite rightly, as part of our totex mechanism, but it will help to underpin that 200 to 300 basis points of commitment that we've made. And as I said earlier, it will also put us in a great position to move forward into RIIO-T2 as well. In terms of the unions, I would say the vast majority of the unions that we deal with in U.S., over the last few years, we have moved to these terms and conditions. There are a few local unions left that we will, as those contracts expire, come to address those similar issues. But the vast majority have actually been dealt with and the specific focus is on these two unions in Massachusetts at the moment. Andy?

[Andrew Agg:]

And on the restructuring costs, as John said, in the same way that the benefits of the efficiency program will flow through totex and be shared with consumers, the cash spend in terms of achieving those efficiencies will also go through the totex mechanism and we shared. So not the 127, the accounting entry, but as we spend the cash against that, that flow through totex.

[Fraser McLaren:]

It's Fraser McLaren from Merrill Lynch. I also have 3 questions. So first of all, the 94 million U.S. legal recoveries, is there any risk that the U.S. regulators try to nab any of that? Secondly, could you give us a bit more context please on the U.S. renewables ambition and what might that look like? Is it likely to be incremental investment or larger acquisitions? And then just finally again, on the Massachusetts union issue, could you help us to try - could help us please to get the £97 million cost so far into perspective in terms of for what these items are worth to you in Massachusetts?

[John Pettigrew:]

So let's start with the legal settlement. So this relates to our systems in the past, as you know, which we incurred those costs and a large part of those costs were incurred by shareholders. So there is no expectation that regulators will claw back on the £94 million. It will stay with National Grid. In terms of the renewables ambition. As I said back in May, I mean - and as I've said today, we do see the rapid growth in the renewables in the U.S. as an opportunity. It allows us to use a lot of the capabilities that we have in National Grid. And over the last few years, we've built up a small portfolio of both solar and storage and we continue to, so we have about 40-odd megawatts in construction with a battery, a large battery on Nantucket Island as well as some developments with NextEra on Long Island. So we've been building up the capability. Our approach to it will be exactly the same as our approach to all investments, which is we take a disciplined approach and if we see an opportunity on the risk-adjusted basis that delivers good returns for our investors then we will look at it very carefully and take it forward. In terms of acquisitions, our position has always been the same, which is they may well be small and modest acquisitions but our position on acquisitions is we've got very strong growth organically. We, of course, will look at an opportunity, but only if it was compelling to our shareholders and customers will we take it forward. In terms of the £97 million, so I wasn't quite sure what the context of the question was.

[Fraser McLaren:]

I was just wondering if you were to give the unions what they want how much would it actually cost you?

[John Pettigrew:]

Yes. So I think the most important point to bear in mind here is that - so the dispute is very narrow in terms of terms and conditions, but it is important from a U.S. regulatory perspective that we're mindful of the fact that customers ultimately pay for the costs of the work that we do, including pensions and healthcare. And the fact that we've agreed this with 16 unions, it's important that we protect that value as well. So we're protecting that value and ensuring that we're fulfilling our duties to make sure that we're delivering value for money for customers is the reason why this is really important.

[Verity Mitchell:]

Verity Mitchell, HSBC. I've also got 3 questions. The first one is on gas transmission. You've got an extra £80 million MOD payment for 2020. Is that - do we know about that already? Or is that in addition to the MOD adjustments we'd already seen? And secondly, sorry, going back to Massachusetts, can you just confirm - I mean, there's been lots of press speculation. Are you actually not doing any work at the moment expect emergency work? And in terms of your Mass. Electric filing, is there not going to be some reputational damage from this irrespective of the costs involved?

[John Pettigrew:]

That - why don't I take the second and I'll ask Andy to do the first one. So it's just the second one, I was - I want to make sure I have the context right.

[Verity Mitchell:]

The second one was - I understand that you're only doing emergency work at the moment. You're not actually fulfilling your normal business, is actually true? And what kind of reputational risks do you face with that given that you're just about to go into rates for Mass. Electric?

[John Pettigrew:]

So let me just put that into context. So some of you would be aware actually that just over a month ago there was quite a significant safety incident in Massachusetts with Columbia Gas, it wasn't part of National Grid, that resulted in a number of explosions, some injuries and a single fatality as well. So it was a very serious incident in Massachusetts that quite rightly resulted in the DPU, the regulation in Massachusetts, indicating they're going to do a safety audit across Massachusetts and we welcome that and we'll be working with them on that. Subsequent to that, we had a relatively minor event in Woburn in Massachusetts which impacted about 300 customers. The pipeline wasn't damaged, customers - there was no damage to customer property and we restored the customers within 24 hours. Within that context, the Massachusetts DPU suggested to National Grid that our focus should be, in the short-term, on emergency work, mandatory work and compliance work and effectively placing a moratorium on work outside of that. In Massachusetts actually, there are always moratoriums during the winter, so at times themselves place moratoriums to avoid too much disruption, particularly given the harsh nature of it. So effectively, a moratorium has been brought forward. We are continuing to work with the DPU. As you know, our focus as a company has always been on delivering world-class safety and it continues to be. And our performance during the work stoppage has been exceptional in that regard. But we will work with the DPU to understand what their concerns and issues are. The overall impact in terms of the capital investment plan, as you've seen in the first half, we're about £100 million up. Our expectation for the capital investment plan for the U.S. is that we're going to be similar to last year's levels, about £3.3 billion, maybe slightly lower. Massachusetts Gas represents less than 20% of our CapEx plans. So we're working with the DPU and making sure that we address any issues. In terms of the filings, I think - we have a very constructive relationship with the DPU more broadly. I think you've seen that with the most recent Massachusetts Gas rate case, where we settled on a 3-year rate case with 9.5% return on an increase in the capital investment. So I think - we continue to work very closely with the DPU and we have a very constructive relationship.

[Andrew Agg:]

And in terms of the proposed MOD adjustment for gas transmission, I mentioned the £80 million in my speech, that's our latest estimate that we expect to go through the MOD adjustment for '19-'20. That means it includes a number of things. It includes our estimate initially from the reopener impact and that'll get confirmed when the MOD adjustment process runs by the end of this month.

[Nicholas Ashworth:]

Nicholas Ashworth with Morgan Stanley. Just a couple of numbers - questions just to check. On the cost efficiency program in the U.K., you said it's £127 million in the first half. I think it also said in the statement that it will be a little bit higher in the full year. Do you know where that will go to for the full year? Secondly, can I just get an update on how much is actually invested so far in the interconnectors? And then finally, thinking about growth in the future, and you talked a little bit about renewables. In the U.S. as well, I know there's potentially a lot going on with transmission, the FERC 1000 and some of the projects which have come up for bidding there. Can you talk a little bit about that landscape, and I know all the focus at Grid - it feels like all the focus has been on distribution over the last few years. But I know there are more opportunities coming for transmission and given the business over here and the small business you have over there, what sort of opportunities are there for transmission at Grid over the next few years in the U.S.?

[John Pettigrew:]

Okay, so again, I'll give Andy the numbers one, the first one. In terms of investment in interconnectors, so we've got 4 under construction, so Nemo is nearly finished. We've spent to date around about £500 million of the £2.1 billion that I've set out. So we've still got significant investments to go between now and 2023. In terms of the U.S. landscape, it continues to be an area that we look at very closely. The opportunities for competitive transmission in the U.S. tend to be quite lumpy and sporadic. I think the last time we were together, we talked about an opportunity with Granite State, which was to bring clean energy down from Canada and Upstate New York into the Northeast. We had a proposal that would use some environment rights-of-way, but it was a wind solution and ultimately Massachusetts chose a hydro solution. There continues to be opportunities in early forms of development with different states issuing RFPs, which recently Connecticut have issued one, and we continue to look at that and to look to partner with people to see if there are opportunities. So nothing specific at the moment, it's quite sporadic, but there is definitely a lot of opportunity, and similarly on the offshore wind side as well as we've mentioned, with Deepwater. We see a lot of activity in the Northeast for offshore wind. Andy?

[Andrew Agg:]

Just in terms of the U.K. costs as you said, £127 million was the costs recorded at the half-year. Because that program is underway, as we speak, the final costs will be trued up as we go through the second half when we know what they eventually end up with. The total will then be in exceptionals for the full year as it is at the half.

[Nicholas Ashworth:]

Have you done a lot of it already? Or is - so is the incremental bit, is it more or..?

[Andrew Agg:]

I think more incremental rather than - so the £127 million is the majority of it.

[Mark Freshney:]

Mark Freshney from Crédit Suisse. Two questions. On the impact of the U.S. tax reform, the $320 million near-term adverse impact, is there anything you're having to do within the subsidiary level to move capital around to ensure that the subsidiaries continue to be appropriately capitalized? My other point is - or other question is, at the group level you mentioned the gearing would rise from 64, but you mentioned a couple of percent by year-end before getting the proceeds in from the sale of Cadent. But is there anything else that you would need to do at the group level in terms of rotation of capital to get that gearing down? Because it seems that given - you've just sanctioned Viking, it looks set to remain high for a sustained period of time.

[John Pettigrew:]

I'll hand over to Andy. I'll just reiterate that I think we're in a much better position now in terms of clarity and visibility on the impact of tax reform. So Andy - I think when we last met we were still waiting to get some clarity from a number of our regulators in terms of the impact of the 35% reduction to 21% and how the deferred tax credit was going to work. I think we now have that clarity. And as we said, £210 million impact this year increasing to £320 million next. So I think with that visibility we have a good sense of how we've managed it. But I'll hand it to Andy to talk about specifics.

[Andrew Agg:]

Yes. Thanks. So I'll take the first one. In terms of the U.S. operating companies, Mark, as you know, our policy broadly is to outrun all of our operating companies, U.K. and U.S. in line with their regulatory gearing levels. So, therefore, when there are changes like this, as we always do, we look to either raise debt or shift smaller equity injections or dividends to keep the actual gearing ratios in line. So we'll just allow for this change of cash from the tax reform in the same way we do with everything else. So there's no, sort of, specific action required in the short term. At the group level, as you said, I mentioned in my speech, we do see a little tick-up this year for a number of reasons. Some of that is some of the timing outflows that we're seeing in the U.K. and U.S. this year, some of it will be FX related. The Cadent proceed is coming in just after the year-end means that it is just a timing difference when that cash comes in. But to reiterate, as we've said previously, some of the other measures that we will continue to look at, so the efficiency programs, the rate filings, the scrip option, those are all about keeping the balance sheet in the right place and in my speech, again, we guided to being around the 65% gearing level by '21 as well.

[John Pettigrew:]

Okay, if there are no more questions, can I just thank everybody for coming today. As I said in my speech, I think solid set of results in the first six months with strong operational and strategic progress. And we continue to be on track to grow the business in the 5% to 7% range and actually for the next few years we're right at the top of that range. So thank you very much and safe journey.