STRATEGIC OVERVIEW

Good operational performance in a year of significant strategic change

In 2021/22, National Grid delivered good operational performance with high levels of network reliability across all our service territories.

During the year, we achieved a Lost Time Injury Frequency Rate (LTIFR)[1] of 0.13, slightly above our industry leading Group target of 0.10. Our focus on safety has been unrelenting through the pandemic and our leading safety indicators performance remain strong. The slight increase in Group LTIFR was driven by a number of slips, trips and falls and minor incidents. We have continued to focus on our safety performance, and towards the end of the year we completed a full review of safety. We are using the outputs to inform our Group-wide priority actions to further improve our safety performance.

A record year of investment: full-year financial performance (on a pro forma basis)

The full-year financials provided in the following two paragraphs compare underlying performance on a pro forma basis (adjusted in 2020/21 to include an estimate of the underlying post-tax contribution from WPD for an equivalent 9.5 month period, as if we had owned that business in the prior year, including estimated incremental finance costs to acquire WPD; and the equivalent current year beneficial earnings impact of not depreciating our Rhode Island business applied to the comparative period). A full reconciliation can be found on page 93.

Across the Group, capital investment for continuing operations increased by £1,059 million at constant currency to a record £6,739 million, an increase of 19% on the prior year (18% at actual exchange rates). This increase was principally due to higher UK ET capital spend on London Power Tunnels 2 (LPT2), the world's first T-Pylon construction at Hinkley-Seabank, increased activities on Visual Impact Provision (VIP); higher spend on reinforcements and connections in UK Electricity Distribution (WPD); higher capital spend in New York and New England versus prior year when COVID-19 related work suspensions were in place; and the successful purchase of an offshore wind seabed lease in New York through National Grid Ventures (NGV).

Underlying operating profit for continuing operations increased by £392 million at constant currency to £3,992 million, an increase of 11% on the prior year. This was principally driven by higher UK ET net revenue that funds higher investment levels; higher revenues following our rate order in our Massachusetts Gas business; the first year of operation of IFA2 and North Sea Link interconnectors; higher revenue from interconnector arbitrage; gains on investments in National Grid Partners which invests in companies innovating to accelerate the energy transition; and a lower adverse impact from COVID-19 compared to 2020/21.

When combined with RAV indexation[2], capital expenditure drove Group asset growth of 8.7%, slightly above the 6-8% Compound Annual Growth Rate (CAGR) we published as part of our five-year financial guidance in March 2021.

Transforming our business - delivering for our customers

This year has marked a significant strategic and structural shift for National Grid as we reach record levels of investment, enable the energy transition and deliver for our customers.

The transactions we announced last year will be transformational for our business, providing clear visibility and certainty of investment that will help deliver the journey to net zero in the jurisdictions where we operate. When complete, the transactions will enhance our role in the energy transition, drive long-term shareholder value, and pivot our asset base towards 70% electricity, up from around 60% in 2021.

Through our track record of delivery, and our drive for greater efficiencies and focus on digitalisation, our objective is to deliver a fair energy transition with affordability at the heart of our strategy and decision making. The recent rise in energy prices and increased focus on the cost of living has made this an even greater priority. This year, we have managed to keep bill rises minimised through new rate agreements; we have made good progress on our £400 million cost efficiency programme across the Group; and we have recently agreed the early return of £200 million of interconnector revenues to customers in the UK. We have continued to proactively support our communities with practical and financial support and we have realigned our organisational structure to move us closer to customers to enhance the service we provide. Longer term, our Clean Energy Vision that we recently announced aims to deliver fossil free gas to our US customers by 2050, meaning that home heating costs could be 15-20% lower than under a high electrification approach, helping to keep energy costs more affordable for our customers whilst enabling us to deliver net zero.

Repositioning our portfolio - enabling the energy transition

We have made significant progress during the year on the transactions we announced in March 2021.

Our £7.9 billion acquisition of Western Power Distribution (WPD), the UK's largest electricity distribution network, completed in June and approval was received from the Competition and Markets Authority (CMA) in September. The acquisition, which creates our UK Electricity Distribution (UK ED) business, pivots us further towards electricity, places us at the centre of the energy transition and underpins the certainty of growth in the longer-term.

The sale of the Narragansett Electric Company (Rhode Island) to PPL continues to make progress. We have obtained regulatory clearances and are awaiting the conclusion of the legal process for the sale of the business. We remain confident that the transaction will complete in the first quarter of 2022/23.

In March 2022, we announced the sale of a 60% stake in National Grid Gas (NGG - UK Gas Transmission and Metering) to a consortium of long-term infrastructure investors comprised of Macquarie Asset Management and British Columbia Investment Management Corporation (BCI). The terms of the transaction imply an enterprise value for NGG of approximately £9.6 billion. On completion, National Grid will receive £2.2 billion in cash consideration, subject to customary completion adjustments. Following the transaction, we will own a 40% minority equity interest in NGG through a new holding company. In addition, we will receive approximately £2.0 billion from additional debt financing in NGG at completion. The transaction is subject to certain antitrust and regulatory conditions. Subject to these clearances, National Grid expects the transaction to complete in the third quarter of this financial year.

National Grid has also entered into an option agreement with the consortium for the potential sale of our remaining 40% equity stake in NGG once the initial 60% stake sale completes. The option may be exercised by the consortium between 1 January 2023 and 30 June 2023. If the option is exercised, the consideration is expected to be paid in cash to National Grid on broadly similar terms to the transaction, subject to adjustment for dividends paid in the business at the time of exercise.

In March 2022, we completed the sale of our 50% stake in the St William Homes LLP (St William) joint venture to The Berkeley Group plc, for a cash consideration of £413 million. This resulted in an exceptional gain on disposal of £228 million and a further exceptional gain from the release of £189 million of deferred income arising on historical site sales made to that joint venture. Alongside this sale, National Grid and The Berkeley Group entered into a series of sale and purchase agreements for a number of additional sites we own which are expected to complete over the period to 2025 for a total additional consideration of approximately £270 million. Deferred consideration of £230 million in respect of sites previously sold to St William will be payable by The Berkeley Group to National Grid over the period to 2031. The sale is in line with our existing plans to focus on our core business and demonstrates our ability to crystalise the value of our portfolio of non-operational land.

Finally, in April 2022, the Department for Business, Energy and Industrial Strategy (BEIS) and Ofgem announced their joint decision to create a new Future System Operator (FSO) that builds on the track record and skills of the Electricity System Operator (ESO) whilst creating an impartial body with responsibilities across both the electricity and gas systems. The ESO will continue to work closely with all parties involved in the coming months to enable a smooth and successful transition. Appropriate compensation for transfer of the ESO will need to be agreed between the UK Government and National Grid.

Our new operating model - bringing our business closer to customers, regulators and communities

In April 2021, we moved to a new organisational structure that positions the Group strategically for the opportunities that net zero and the energy transition will bring. The business model is now based on seven business units, each of which are now run as end-to-end enterprises with financial responsibility with their executive teams, increasing the focus on efficient operational delivery. These units are UK Electricity Transmission, UK Electricity Distribution, UK Gas Transmission (treated as a discontinued operation), UK Electricity System Operator, New England, New York, and National Grid Ventures.

This new structure enables us to be closer to our customers, our regulators, and our communities, with a best in class service in a locally-focused manner. In addition, it will drive decision making down to the local level making us a more agile business, helping to develop new processes and digital solutions. Together with our strong track record of delivering efficiently, our new operating model will deliver a step change in productivity improvements right across the business for the benefit of our customers and communities we serve.

Progressing our Cost Efficiency Programme

In November 2021, we announced our cost efficiency programme targeting at least £400 million savings[3] per annum across the Group by the end of 3 years, even while our regulated assets continue to grow by over 20% over the same period. As we deliver this savings programme, as well as the new organisational structure, we expect to incur further implementation costs of around £100 million. In relation to the sale of our Rhode Island and UK Gas Transmission businesses, we expect to have further transaction and separation costs of around £95 million.

Since the beginning of the programme, which includes some efficiency savings in 2020/21, we have delivered around £140 million of savings across the Group. These are across four main areas:

1.  Process improvements - where we are reviewing work processes, particularly across the field workforce, to update and close out more jobs during the day which helps to increase productivity;

2.  Organisation restructuring - where we are restructuring our management organisation allowing for greater decision making in the field;

3.  Digital improvements - where we are increasing the use of drones rather than labour for network inspections, and utilising Vegetation Management software with satellite imagery to map the areas where vegetation poses a high risk to our networks; and

4.  Supply chain and contract efficiencies - where we are identifying savings on contractor costs by prioritising internal resource more effectively, reducing expenditure on third party vendors, and reassessing the number of licenses we need to procure for various systems.

We remain on track to deliver the £400 million savings target by the end of 2023/24.

Regulatory Progress

During the year, we made very good regulatory progress on our rate plans. Across the Group, over two thirds of our investment out to 2025/26 is now committed through rate settlements in our regulated businesses. This gives us good visibility for capital spend over the next five years as we invest to maintain network reliability and help enable the energy transition.

Our final RIIO-ED2 Business Plan (UK ED) was submitted in December 2021 and proposed £6.7 billion investment between 2023 and 2028. This represents a 27% increase on annual average expenditure in RIIO-ED1, whilst maintaining affordability for our customers. The Business Plan was co-created with more than 25,000 stakeholders, with 96% of customers finding the plan fully acceptable. We anticipate Ofgem's Draft Determination around the end of June 2022, followed by the Final Determination in Winter 2022.

Across the Group, we achieved a Return on Equity (RoE) of 11.4% in 2021/22 up 80bps on the prior year driven by the acquisition of UK ED, and higher interconnector revenues in our National Grid Ventures non-regulated businesses. This was partially offset by a lower RIIO-T2 return in UK ET as well as higher interest costs.

We completed the first year of the RIIO-T2 price regulation in our UK ET and GT businesses. For UK ET, we delivered an RoE of 7.7%, 140bps ahead of the baseline allowance as we completed projects started under the RIIO-T1 framework. For UK GT, we delivered an RoE of 7.8%, 120bps ahead of the baseline allowance. For UK ED, in the penultimate year of RIIO-ED1, we delivered an RoE of 13.6%, 400bps ahead of the allowed return. The ESO also successfully completed the first year of its RIIO-T2 price control under its new bespoke regulatory funding framework. This allows recovery of all efficiently incurred costs as well as incentivisation of the ESO to deliver an ambitious business plan and value for money for consumers.

In the US, New York achieved an RoE of 8.8%, or 99% of the allowed RoE; New England achieved an RoE of 8.3%, or 85% of the allowed RoE, slightly above our Half-Year guidance. During the year, we agreed rate settlements for our New York businesses, KEDNY-KEDLI and NIMO, and received a new rate order for our gas business in Massachusetts. We also filed for funding in Massachusetts to help modernise our electric grid network and made one of the largest US filings for EV charging infrastructure outside the state of California. We expect to hear the outcome of these filings in the second half of calendar year 2022.

For further information on RoEs for each of our business entities, please refer to the Business Review section on pages 27 to 52.

Delivering on our ESG commitments - progress through our Responsible Business Charter

We have made good progress in the first full year of delivery against the commitments in our Responsible Business Charter. At our core, we are The Energy Transition Company and we are determined to successfully deliver the transition to net zero and do right by the communities we serve.

 

In our role as a Principal Partner for COP26 in Glasgow, we launched a programme of events to raise public awareness of the progress and future change needed to fight climate change. In addition, we engaged widely to support the global diplomatic effort to build momentum for change, including our involvement in launching the UK and Indian governments' new initiative, 'Green Grid Initiative - One Sun One World One Grid'. Throughout COP26 we provided a clear message, which is that net zero is achievable, affordable and we need to accelerate action to reach net zero in line with International Energy Agency (IEA) milestone dates in the 2030s for electricity grids.

To help map out our future actions we plan to publish our first Climate Transition Plan as part of this year's Responsible Business Report (RBR). We are clear that energy needs to remain affordable through the transition in the long term, and to support our work in this we will publish our Fair Transition Statement this summer, an important step to set out and engage on the key challenges the transition presents to communities and customers.

Within the year, we saw an increase in Group Scope 1 & 2 emissions. This was driven mainly by Scope 1 generation emissions exceeding projected levels through increased operating hours at our Long Island generation plant. The plant is contracted to the Long Island Power Authority (LIPA) and was required to replace shortfalls in off-island generation and transmission during the year. Our total Scope 3 emissions increased slightly on the prior year, driven principally by higher customer gas demand as pandemic-related restrictions were eased.

However, looking forward, we now have an extensive programme of work committed to delivering the connections and network upgrades needed to help hit the UK Government's 50GW by 2030 offshore wind ambition, and in New York our joint venture with RWE was successful in securing a new offshore wind seabed lease. We have also announced new partnerships with Hitachi, and with Cardiff and Manchester Universities, on projects to help remove SF₆ gases from our networks. Across the Group, we have committed to a green car and light duty vehicle fleet across the Group by 2030.

In New York, we launched our Project C for community programme which aims to provide additional funds and volunteering to ensure we play our part as a responsible member of the community. We are funding this growth in activity through the conversion of unclaimed shares and dividends. This has allowed us to inject an additional £5 million through the year into community and environmental causes to help support economic growth, diversity, opportunity and nature in the communities we serve. We are providing this support through workforce development programmes, grants for neighbourhood improvement, STEM education funding, and urban greening programmes such as community gardens and large-scale tree plantings.

In the UK, the completion of our WPD acquisition brings a strong culture of commitment and action for customers and communities which we will fully incorporate into adjusted targets for next years' RBR. Our wider actions to deliver a diverse workforce remain on course to hit our 2025 diversity commitments, and we will aim to revise these commitments further to ensure we can hit our ambition to reflect the communities we serve in each region.

Finally, the recent rise in energy prices, coupled with the wider cost of living crisis, pose a significant challenge. This is particularly acute in the UK where we have taken initial actions to support the important frontline work of Citizens Advice. Our first actions have been to provide financial support of £1 million to develop the systems and tools to provide advice and guidance to more people, and, separately, a further grant of £1 million to provide energy bill payment vouchers direct to those most in need.

We will continue these levels of community support and take the actions needed to accelerate the path away from fossil fuels towards net zero, in terms of both energy efficiency and connection of low carbon supply sources. We demonstrated this in April through the announcement of our Clean Energy Vision in the US where we aim to fully decarbonise our electric and gas networks by 2050.

Our Clean Energy Vision - decarbonising our networks, keeping energy affordable for customers

On 19 April 2022, we announced our Clean Energy Vision, our plan to decrease our reliance on fossil fuels from our US gas and electric systems over time, enabling homes and businesses we serve to meet their heating needs without the use of fossil fuels by 2050. The announcement recognises our critical role in leading the clean energy transition for our customers and communities.

We plan to achieve this goal through four pillars. Firstly, we will continue to provide programmes for our customers to accelerate weatherproofing and energy efficiency improvements to buildings, including deep retrofits and measures that reduce peak gas and electric demand; secondly, we will eliminate fossil fuels from our existing gas network no later than 2050 by delivering renewable natural gas and green hydrogen to our customers; thirdly, we will support our customers by providing them with strategies and tools to capture and maximise the benefits of pairing electric heat pumps with their gas appliances; finally, we will support cost-effective targeted electrification on our gas network, including piloting new solutions like networked geothermal.

We acknowledge that Massachusetts and New York have ongoing public proceedings to help guide implementation of the critical plans needed to fight climate change. The Company is actively participating in those proceedings and will continue to engage in the public feedback sessions for our state climate action plans, highlighting the benefits of our fossil-free vision for all residents and businesses. Our vision, which will require legislative and regulatory changes to implement, proposes a hybrid approach that enables customers to have more affordable energy solutions and allows customers to retain choice in how to achieve net zero. Through this hybrid approach we estimate that home heating costs could be 15-20% lower than under a high or full electrification approach, helping to keep energy costs more affordable for our customers. In addition, it leverages existing infrastructure and requires less fossil gas generation, strengthens resiliency and reliability by decarbonising the gas system in parallel with the electric system, and it puts the skills of our existing workforce at the heart of the clean energy transition.

Our roadmap to achieving these goals sets milestones out to 2050. We will work with regulators to ensure that support legislation and regulatory policies are in place by 2025. By 2030, we aim to serve 10-20% of customer gas demand with RNG whilst running community scale projects blending hydrogen into the system. By 2040, we aim to blend 20% green hydrogen and 30% Renewable Natural Gas (RNG) into the gas network, further laying foundations to supply 100% fossil-free gas to our customers by 2050. We anticipate that, by 2050, 50% of heating will be through heat pumps, 25% through fossil-free gas, and 25% through a hybrid of electric and fossil-free systems.

Our vision is a more resilient and reliable solution for the states where we operate. A high electrification approach relies heavily on one system for power, transport, and heating. In addition, the weather characteristics of the Northeast make full-electrification less desirable, with a significant portion of the building stock categorised as 'hard to electrify'. By decarbonising the gas system in parallel with the electric system, we can create a more resilient energy network. Our vision also supports equitable outcomes for disadvantaged communities. By avoiding large upfront investments, our vision enables all customers to have access to clean energy in the future.

Board changes

Sir Peter Gershon stepped down from the Board with effect from 31 May 2021. Paula Rosput Reynolds, who joined the Board on 1 January 2021 as Non-executive Director and Chair Designate, assumed the position of Chair effective 31 May 2021.

Nicola Shaw, UK Executive Director, and Paul Golby, Non-executive Director stepped down from the Board at the conclusion of the Company's 2021 Annual General Meeting (AGM) on 26 July 2021. Nicola continued supporting the Company until the conclusion of the RIIO-T2 Competition and Markets Authority (CMA) appeal process.

Lord Livingston Of Parkhead (Ian Livingston) was appointed as a Non-executive Director of the Board from 1 August 2021, joining the Remuneration Committee on appointment and the Audit & Risk Committee on 1 September 2021.

Tony Wood and Martha B. Wyrsch were appointed as Non-executive Directors of the Board from 1 September 2021. On appointment, Tony joined the Safety & Sustainability and the People & Governance Committees and Martha joined the Remuneration and the Safety & Sustainability Committees.

On 27 July 2021 we announced Committee membership changes following a review by the Board. The changes were effective from 1 September 2021.

On 31 December 2021, Mark Williamson retired from the Board and on 1 January 2022, Thérèse Esperdy was appointed as the Senior Independent Director. In addition, Jonathan Dawson stepped down as Chair of the Remuneration Committee (however, remaining as a member of the Committee) and Ian Livingston became Chair of the Committee from 1 January 2022.

On 19 January 2022, Anne E. Robinson was appointed as a Non-executive Director of the Board and a member of the Safety & Sustainability Committee.