HAVE YOU EVER considered the prospect of going without power for an extended period of time? Not only you, but everyone around you for miles and miles. There’s no light, no heating, no refrigeration, no cash points, nothing.
Granted, it’s incredibly bleak, but it’s a possibility Channel 4 explored in great depth in a recent drama. The five-day outage depicted in drama Blackout saw the UK descend into what was essentially savagery and chaos. It showed widespread looting of shops; car crashes in the absence of reliable traffic lights and street lamps; deaths, both accidental and deliberate; and rioting up and down the nation.
Despite the flippancy of the programme, it does highlight the utterly pivotal role National Grid plays in all our lives.
“I saw the programme,” says its good-humoured finance director Andrew Bonfield, who also serves as head of the UK Hundred Group’s tax committee – the influential lobby group of FTSE 100 finance directors.
“But in [superstorm] Sandy, people in Long Island were without power for two weeks and they didn’t become savages,” he adds matter-of-factly. “I think it was a sensationalist programme, and it was done to make a story about how people would degenerate over time.”
In spite of the forbidding picture Blackout paints, National Grid is, in fact, one of the safest investor bets going. As if to illustrate that point, the company essentially has no competition in the UK, save for two areas in Scotland where Scottish & Southern and Scottish Power operate the power transmission system, while it owns four of the eight networks in gas distribution.
When Financial Director interviewed Bonfield’s predecessor Steve Lucas in 2008, it was noted that quarter after quarter, year after year, profits were up. That statement is as true now as it was then, with profits before tax up 6% and operating profits up 4% in 2013.
Of course, in that time, National Grid – like everyone else – has had to deal with the financial crisis, and Bonfield had to hit the ground running when he joined part-way through the crisis in 2010.
Given the nature of the business, as a key component of national infrastructure, the situation was – and is – slightly different to most. One of the effects of this is that, while the operation is about 60% debt-funded, it has strong reputation. The enterprise value is about £50bn, says Bonfield, of which £22bn is debt and £28bn equity value. As far as regulated assets are concerned, they total about £35bn, and debt total comes in at about £21bn.
“This is the first company I’ve ever worked at where you have to take on more debt every year – otherwise, you become inefficient,” he remarks. Bonfield explains that the company is 60% debt-funded, which goes towards financing new infrastructure and maintaining existing facilities. Its access to markets as diverse as Canada, US, Australia and Japan affords it stability.
During the financial crisis, National Grid was only out of the bond market for a month, maintaining a “fair degree” of liquidity. Indeed, National Grid was – and continues to be – able to maintain a position as one of the largest issuers of corporate bonds on the market.
“Stability comes from a couple of things, and one is the regulatory regime,” he explains. “As a regulated utility, we are regulated in both the UK and the US, and those regimes tend to be pretty stable, in that there doesn’t tend to be much volatility between each rate period.”
Additional regulation from Ofgem has helped, too, he adds, noting that “we just entered into a new rate filing process called RIIO (Revenue = Incentive + Innovation + Output), which came into effect on 1 April this year and covers an eight-year period”.
“Effectively, we know what our revenues should be, based on the capital we expect to spend and the cash we need to spend on operating expenses over the eight-year period for the UK business,” says Bonfield.
It means innovative, green projects, such as the London Power Tunnels and the western high-voltage direct-current (HVDC) link with Scotland, can be taken on, with about £30bn invested over the next eight years.
The US, however, is a more volatile area to operate in because its regulation functions on an as-needed basis, Bonfield explains. So a cost-plus-regulatory methodology is used, meaning filings are made more regularly.
You wouldn’t expect to see returns fall year on year, though,” Bonfield is quick to add.
In the short term, cashflows are also volatile in the US. Depending on the price of gas and electricity and the timing of customer payments, the regulatory mechanism for recovering costs from customers can result in significant cashflow swings from year to year.
So the biggest challenge for National Grid and Bonfield is the way the regulatory arrangements will work under REO, and reconciling this with IFRS accounting. Ordinarily, Bonfield says he would suggest IFRS is “vastly superior” to US GAAP as it is principles-based, but that is not the case for rate-regulated utilities.
“That’s because there’s a closer alignment [in US GAAP] between reported revenue and regulated revenue,” he says.
The result is that the UK side of the business could receive cash back from the regulator in one year, and then, due to the way the regulation functions, it may have to refund some at a later time – usually a year down the line. However, it still must be booked as income, although Bonfield knows he will have to return it.
Despite that change and the potential short-term instability its introduction may bring, Bonfield expects profits to grow as the asset base increases. But America offers volatility in another, more fundamental way: weather.
Superstorm Sandy, for example, cost National Grid $100m (£62m) in repairs to infrastructure, while the relatively tame UK weather saw repair costs kept low, despite the increasingly snowy and icy winters of recent years.
“The UK is relatively small, so the damage caused to the transmission system is normally pretty low,” explains Bonfield. “In the US, there’s a tendency, both in the distribution network and transmission network, for wires to be held above ground. In order to then maintain visual amenity, what does tend to happen is that people plant trees around them. Trees, wires, wind and water don’t mix, and there will be periodic storms.”
In the past three years, Bonfield has had to deal with the fallout of three major US storms. Hurricane Irene struck in 2011, while 2012 brought Sandy, and snowstorm Nemo hit the north-eastern states of the US early in 2013. Each caused hundreds of millions of dollars’ worth of damage, with millions of people affected.
“All three of those had significant impact,” notes Bonfield. “In the US, assets held underground are insurable, so all our gas pipelines are insured. Unusually, last year saw our first-ever property damage claim in the US because Sandy was flooding Long Island and water progressed into the gas distribution system.”
But it’s very different where electricity is concerned Stateside.
“All poles and wires are uninsured, and they’re effectively covered off by the regulator,” Bonfield says, in a statement seemingly anathema to British business, though it is part of a functioning American system.
“There are two mechanisms they use,” he explains. “Normally, in rates, you’ll have what they call a storm fund and you’ll build up a balance on the storm fund. You’ll build up a balance on the fund, on which you can build expenses, and customers will pay into the fund.
“Then you have the storm and the storm damage, and then you may end up spending, for example, more than $100m with Sandy – and you go and make a filing against your storm fund. But if you’ve overspent against your storm fund, you make a filing to the regulator for recovery of that [sum] through rates. All you have to prove is that the spend was related to the storm and it was prudent.”
IN BLACK & WHITE
2010 – present FD, National Grid
2009 – 2010 CFO, Cadbury
2002 – 2008 CFO, Bristol Myers-Squibb
2000 – 2002 Executive director, finance, BG Group
1990 – 2000 Various roles, CFO, Smith Kline Beecham
1984 – 1990 Price Waterhouse
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