Group Financial Review

Group revenue

Group revenue from continuing operations was up 31% at £21.3 billion (2007: £16.3 billion). Revenue in our UK upstream and downstream businesses increased, with higher commodity prices reflected in higher achieved prices upstream, and higher retail prices downstream. There was underlying growth in North America, particularly in the commercial and industrial supply business, and this was also aided by favourable exchange rates.

Group operating profit

Group operating profit* from continuing operations was broadly flat at £1,942 million (2007: £1,949 million). Increases in gas production and development due to higher volumes and selling prices were offset by reductions in the industrial and commercial segment of Centrica Energy and British Gas Residential due to higher wholesale input prices.

Group profit

Group profit* on a continuing basis was down 20% to £904 million (2007: £1,123 million). The reduction in earnings* resulted primarily from a higher tax charge of £1,027 million (2007: £753 million). This increase reflected the change in mix of profits, with an increase in highly taxed gas production profit, and the lack of immediate tax relief on the losses incurred in Oxxio, offset by a £55 million deferred tax credit resulting from a change in legislation relating to the availability of tax relief for upstream decommissioning costs. The resultant effective tax rate for the Group was 53% (2007: 40%). Net interest payments were at £11 million (2007: £73 million), reflecting the relatively low level of net debt during the year.

The statutory loss for the year was £144 million (2007: profit of £1,507 million). The reconciling items between adjusted Group profit* and the statutory loss are related to exceptional items and certain re-measurements as explained below.

Earnings per share and dividends

Adjusted earnings per share* fell by 21% to 21.5 pence in 2008 from 27.2 pence in 2007.

The Group reported a statutory basic loss per share of 3.5 pence, down from basic earnings per share of 36.5 pence in 2007, reflecting the post-tax impact of certain re-measurements which were negative in 2008, having been positive in 2007.

In addition to the interim dividend of 3.47 pence per share, we propose a final dividend of 8.73 pence giving a total ordinary dividend of 12.2 pence for the year (2007: 11.57 pence), an increase of 5%.

Cash flow

Group operating cash flow before movements in working capital was down from £2,494 million in 2007 to £2,397 million. After working capital adjustments, operational interest, tax and cash flows associated with exceptional charges in prior years, this stood at £297 million (2007: £2,357 million). This decrease in operating cash flow is primarily due to an outflow of cash collateral associated with margining agreements, an increase in cash taxes paid and increased working capital that resulted from the higher retail prices.

The net cash outflow from investing activities increased to £1,122 million (2007: £964 million). This included expenditure on the new Langage power station in Devon, and on completing the Lynn and Inner Dowsing wind farm development, as well as the acquisitions of Strategic Energy in the US, the Caythorpe onshore storage opportunity and the gas assets in the Heimdal area of the North Sea.

There was a net cash inflow from financing activities of £2,603 million (2007: outflow of £888 million). This net cash inflow resulted primarily from the £2.16 billion Rights Issue described in notes 5, 29 and 30 and bond issues detailed in note 25.

Net debt and interest

The Groupís net debt level at 31 December 2008 was £511 million (2007: £795 million). This reflected the cash movements described above together with the increase in the sterling value of our foreign currency debt, as sterling fell against both the US dollar and the euro.

Net assets

During the year net assets increased to £4,386 million from £3,382 million as at 31 December 2007. The increase was primarily due to the impact of the Rights Issue, partially offset by non-cash negative movements in the mark-to-market value of hedging derivatives and actuarial losses on our pension schemes.

Exceptional items

Exceptional charges of £67 million were incurred relating to Oxxio, our business in The Netherlands. £45 million of this was an impairment charge to write down the carrying value of the goodwill that arose upon acquisition of Oxxio. The goodwill has been assessed as having a lower value as a result of lower expectations for future growth in customer numbers and for future margins due to the structure of the competitive market in The Netherlands. The remaining £22 million of the exceptional charge is a write-down of a receivable relating to historic overpayments of energy revenue tax by Oxxio. Uncertainty as to the timing and amount of the recovery of this receivable make it no longer appropriate to recognise the receivable as an asset.

Certain re-measurements

In our business we enter into a portfolio of forward energy contracts which include buying substantial quantities of commodity to meet the future needs of our customers. A number of these arrangements are considered to be derivative financial instruments and are required to be fair-valued under IAS 39. Fair valuing means that we apply the prevailing forward market prices to these contracts. The Group has shown the fair value adjustments separately as certain re-measurements as they are unrealised and non-cash in nature. The profits* arising from the physical purchase and sale of commodities during the year, which reflect the prices in the underlying contracts, are not impacted by these re-measurements.

The statutory results include charges to operating profit relating to these re-measurements of £1,415 million (2007: net credit of £235 million), primarily from marking-to-market some contracts relating to our energy procurement activities. As gas and power were delivered under these contracts, net out-of-the-money mark-to-market positions were unwound generating a net credit to the Income Statement in the period of £10 million (2007: net credit of £352 million). As forward prices decreased in the second half of the year the portfolio of contracts fair-valued under IAS 39 reported a net charge on revaluation of £1,421 million (2007: charge of £104 million). The remaining charge of £4 million (2007: charge of £13 million) reflects positions relating to cross-border capacity and storage contracts.

The net loss of £1,415 million on the re-measurement of energy contracts largely represents unrealised mark-to-market loss created by gas and power purchase contracts which are priced above the current wholesale market value of energy. This loss is calculated with reference to forward energy prices and therefore the extent of the overall economic profit or loss arising over the life of these contracts is uncertain and is entirely dependent upon the level of future wholesale energy prices.

Business combinations and capital expenditure

During the year, in Canada we acquired Rockyview Energy and 100% of the Canadian gas assets of TransGlobe Energy, and in the US we acquired Strategic Energy, an electricity supplier. We also acquired interests in gas and oil assets in the Heimdal area of the North Sea and Caythorpe, a depleted onshore gas field that we propose to convert to a gas storage facility, along with a number of smaller acquisitions for total cash consideration of £395 million as explained in note 35.

Details of capital expenditure are provided in note 6(e) of the Financial Statements.

Principal risks and uncertainties

The Groupís risk management process remains unchanged from 31 December 2007. A description of the impact of the volatility in wholesale commodity prices and the weakness of credit markets on financial risk management is provided in note 4 to the Financial Statements.

Capital management

During the year, the Group raised proceeds of approximately 2.16 billion, net of issue costs of approximately £65 million, through a three for eight Rights Issue of new ordinary shares at 160 pence per share. The Group raised £750 million from the sterling bond market in September 2008, with tranches maturing in 2018 and 2033, and Ä750 million was raised from the euro market in November 2008, in a single tranche maturing in 2013. Including bond issuance and new loans raised in the early part of 2009, we have raised over £4 billion of new debt and equity capital in the last six months. This puts us in a strong position to fund new investments and to maintain sufficient liquidity headroom to handle the significant swings in margin cash and working capital that result from volatile commodity prices.

Related party transactions

Related party transactions are described in note 37 to the Financial Statements.

Events after the balance sheet date

On 20 January 2009, the Group completed the acquisition of 50% of the issued share capital of Segebel SA for cash consideration of Ä515 million (£477 million) plus transaction costs, bringing the Groupís total ownership interest in Segebel SA to 100%. Further consideration of up to Ä105 million (£97 million) is payable, of which Ä70 million (£65 million) is expected to be paid in March 2009. This transaction results in the Group acquiring a controlling interest in Segebel SA which in turn, holds a controlling stake of 51% in SPE SA, a Belgian energy company. As such, this transaction also results in the Group obtaining a controlling interest in SPE SA which will therefore be consolidated as a subsidiary in the Groupís accounts. Details of this acquisition are provided in note 39 to the Financial Statements.

ACCOUNTING POLICIES

UK-listed companies are required to comply with the European regulation to report consolidated financial statements in conformity with International Financial Reporting Standards (IFRS). The Groupís significant accounting policies, including changes of accounting presentation, are explained in note 2 to the Financial Statements. Note 3 to the Financial Statements explains the critical accounting judgements and key sources of estimation uncertainty arising in the preparation of the Financial Statements.

Nick Luff
Group Finance Director
26 February 2009

* including joint ventures and associates, net of interest and taxation, before exceptional items and certain re-measurements