Annual Financial Report

Annual Financial Report

Centrica PLC

30 March 2012

Centrica plc (the Company)

Annual Report and Accounts 2011

Further to the release of the Company's preliminary results announcement on 23 February 2012, the Company announces that it has today published its Annual Report and Accounts 2011 (Annual Report 2011).

The Company also announces that it has today posted to shareholders the Notice of an Annual General Meeting to be held at 2.00 p.m. on Friday, 11 May 2012 at the Queen Elizabeth II Conference Centre, London SW1.

In accordance with Listing Rule 9.6.1, copies of the following documents have been submitted to the UK Listing Authority and will shortly be available for inspection from the National Storage Mechanism, which can be accessed at www.hemscott.com/nsm.do:

• Annual Report and Accounts 2011
• Annual Review and Summary Financial Statements 2011
• Notice of Annual General Meeting 2012

The above documents may be viewed online at www.centrica.com/report2011 and are also available to download at www.centrica.com/2011reportdownloads.

A condensed set of the Company’s financial statements and information on important events that have occurred during the financial year and their impact on the financial statements, were included in the preliminary results announcement released on 23 February 2012. That information, together with the information set out below, which is extracted from the Annual Report 2011, is provided in accordance with the Disclosure and Transparency Rule 6.3.5 which is required to be communicated to the media in full unedited text through a Regulatory Information Service. This information should be read in conjunction with the Company’s preliminary results announcement. This announcement is not a substitute for reading the full Annual Report 2011. Page and note references in the text below refer to page numbers and note numbers in the Annual Report 2011.

Principle Risks and Uncertainties

Risks and Uncertainties

Understanding and managing our risks

Given the significant opportunities and challenges we face in our markets, it is important that our risk and control processes continue to evolve to ensure that risks are identified and assessed in a timely manner and that the controls designed to manage them are operating effectively.

The assessment and treatment of risks to delivering Centrica’s objectives are key disciplines that are practised throughout the organisation in our day-to-day management of business issues. In addition, a formal risk management structure exists to challenge risk, to ensure the visibility of significant risks and to help identify any emerging risks facing our business. The formal governance structure is described in more detail in pages 49 and 50 of our Corporate Governance Report.

During 2011, we reviewed our processes to ensure they remain appropriate and reinforce the linkage between risk and controls. Key improvements include: reporting internal audit activity against risk ‘themes’ designed to identify gaps or common issues across our businesses; updating our risk-assessment matrices; introducing new controls guidance to provide greater differentiation and more informed decisions over controls maturity; endorsing an updated business risk policy and standards, and increasing our focus on tracking mitigating actions.

In addition, we recently made changes to our governance for 2012, meaning that the Group Risk Management Committee (GRMC) is now chaired by the Group Chief Executive and membership reflects that of the Executive Committee. We expect these changes to streamline our governance process while ensuring that the Executive Committee continues to provide focused debate and challenge to the Group’s current and emerging risks. While not intended to be exhaustive, the following pages provide a summary of the Group’s key risks.

Strategic Growth

What is the risk? As highlighted in the Business Review, the Group continues to pursue a range of investment options across the energy chain in different geographies to both deepen our customer relationships and secure the Group’s future energy requirements. However, we face an increasingly uncertain environment shaped by a number of key challenges. These include the sovereign debt crisis, UK political and regulatory pressures, stretching carbon targets and North Sea fiscal changes, as well as changes in the level of support for renewable energy that makes future investment less certain. In addition, the Fukushima nuclear incident triggered further design reviews and licensing requirements in the UK, causing delays to a decision on nuclear new build (NNB) investment. The final investment decision is targeted for the end of 2012, although there remains much to be achieved before the decision can be taken. Should the business case not support NNB investment, this would risk a loss of up to £200 million in pre-development costs invested and the write-off of any value attributed to new-build within the goodwill on our balance sheet.

The US and Canadian economies also remain fragile, with recovery expected to be slow and prolonged. Uncertain customer demand and low wholesale prices pose risks to our key strategic objective to grow our integrated North American business. A failure to deliver material growth in North America could erode investor confidence and have a significant impact on the Group’s revenues and profits.

How do we manage it? The Group continues to invest in projects with a strong strategic fit and where returns are commensurate with the risk being taken. As detailed in the Business Review, we continue to make good progress on our capital investment programme through a combination of upstream gas and oil acquisitions in both the North Sea and North America, organic investment in our existing business and the establishment of long-term supply arrangements for both gas and liquefied natural gas (LNG). We have also formed a new strategic alliance with Qatar Petroleum International (QPI) to consider opportunities for energy-related investments. These are important steps to securing vital energy supplies for our customers. In respect of power, we continue to invest in expanding the scale of our offshore wind operations and we retain further investment options in respect of biomass, new build CCGT and nuclear. The UK Government has also reiterated its support for new nuclear. We are actively engaged with the UK Government on nuclear policy, attend NNB meetings and have a series of project governance meetings in place with EDF.

Our downstream business continues to progress through the integration of acquired businesses and the establishment of strategic partnerships in respect of emerging technologies. We continue to seek and execute opportunities for growth designed to achieve a leading position in North America for energy and related service provision. The Clockwork integration has been completed and the acquisition of Home Warranty of America (HWA) positions us as the first home services provider in the US to be able to offer the dual capability of home energy services and protection plan products, adopting the market-leading model developed by British Gas in the UK. Our acquisitions of Gateway Energy Services, First Choice Power and Vectren Retail continue to build on our successful strategy of acquiring smaller suppliers and increasing our market share in deregulated markets.

Commodity Prices

What is the risk? The UK now imports almost 50% of its gas from overseas, which makes us vulnerable to price movements around the world. In 2011, higher consumption in Asia, the impact of unrest in the Middle East and North Africa, and increased gas demand as a result of the Japanese earthquake, combined to increase wholesale costs. A significant proportion of the Group’s profitability depends on our ability to manage our exposure to wholesale commodity prices. We must continually assess the risk of procuring these commodities at fixed prices to meet uncertain levels of demand that are subject to both seasonal variance as well as macro-economic factors.

There is a risk that surplus commodity positions cannot be sold to the wholesale markets profitably and that any commodity shortages cannot be covered at a cost lower than the end sales price. In particular, we offer a number of fixed-price products, which are fully hedged at the start of the contract. These products are competitive when prices increase but when prices fall we can experience customer losses and could be exposed to surplus commodity positions. Significant longer-term price increases or decreases may require us to change the price at which we sell to our customers on variable tariffs. Where we do pass increased commodity prices on to our customers, or do not pass on lower commodity prices, customers may switch to our competitors, which could have an impact on our business. In addition, investment decisions key to our strategic growth plans, particularly in respect of upstream assets such as gas fields or power stations, are based on evaluations underpinned by forecasts of longer-term commodity price development. These reflect prevailing market prices and are supplemented by assessments of underlying industry fundamentals. The Group could suffer significant loss of value if commodity prices fall significantly from levels foreseen at the time of asset acquisition, leading to lower profits and lower than expected returns.

How do we manage it? We manage these risks through an active hedging programme controlled through robust governance frameworks. These were reviewed in 2011 to ensure they remained appropriate for the scale and nature of our hedging operations. Strategic investment decisions are also made within a capital allocation framework designed to ensure that proposals are rigorously evaluated prior to acquisition and that they meet Board-approved financial criteria over the life of the project. The long-term gas supply relationships with Statoil and Qatargas, the acquisition of increased stakes in the Statfjord fields and the securing of new licences for exploration blocks on the Dutch continental shelf in the Southern North Sea are examples of how we continue to develop our asset portfolio.

Brand and Reputation

What is the risk? As highlighted in the Corporate Responsibility report on page 29, our ambition is to be the most trusted energy company. However, 2011 saw a continued erosion of consumer trust in all energy suppliers, including British Gas, driven mainly by increasing energy prices and a perceived lack of fairness in pricing structures at a time of deteriorating economic conditions. This has contributed to an increased level of debate as to whether consumers are receiving a fair deal and an increased focus on the contributions UK households will have to make through energy bills to pay for Government social and environmental levies and initiatives to fund the replacement of old and high-carbon energy infrastructure. This debate has also served to highlight the level of confusion on this subject amongst both customers and other stakeholders.

The Group recognises that rebuilding confidence in our brand and reputation, as well as that of the wider energy industry, is essential to the future success of our business. Failure to restore consumer confidence could further damage our brand, lead to customer losses and impact the Group’s revenues. A failure to maintain our reputation with key stakeholders could also lead to further intervention by the UK Government or the Regulator in the Group’s businesses.

How do we manage it? As discussed in the Business Review we have taken a number of steps designed to rebuild trust in the energy industry. In November we announced a simplification of tariff structures and launched the ‘honest conversation’ about the future of energy in Britain. We have written to each of our customers to assist them in checking whether they are on the right tariff and have provided a breakdown on the bill of the actual costs of providing the energy our customers consume. We have also made sure that our most vulnerable customers receive the £120 Warm Home Discount.

We continue to work with our customers to help them manage their energy usage through improved awareness and a range of energy efficiency measures. In addition we maintain a regular dialogue through both our British Gas Customer Panel and the CR Advisory Group. The Group also has a programme of relationship management with Government, Ofgem, and other key stakeholders as well as relevant North American state and federal regulators. We also manage the risk of non-compliance on matters that could lead to prosecutions, fines and reputational damage. In addition, in 2011 we undertook a review of our reputation management risks and in 2012 have established a Reputation Management Group which will report formally on a quarterly basis to the Executive Committee.

Regulation and Legislation

What is the risk? We are facing an unprecedented level of scrutiny of our businesses by all stakeholders. This could impact the Group’s future investment decisions and its ability to meet its long-term growth aspirations. Following the financial crisis, the G20 commitment led to a wave of financial regulation in the US and Europe. It is not possible to understand the precise impact of this until the definitions and details are established, should the new regulations be agreed. There are continuing regulatory risks around retail sector competitiveness as higher wholesale commodity prices feed through to customer bills. In the meantime, a decrease in customer disposable income continues to be felt. In recent months, in the UK, Ofgem has stepped up its focus on enforcement activity and the proposals resulting from the recently published Retail Market Review (RMR), if not modified, will introduce significant further risk to our downstream business in the UK and, potentially, to the pace of smart meter roll-out as well as reducing choice for our customers. Domestic energy suppliers are set targets by the Government to reduce carbon emissions, through defined programmes of work. If the business is unable to meet targets, fines can be levied. In addition, the Government has announced its intention to legally mandate the replacement of all meters with smart meters. Depending on the deadline and the order of replacement, contractual payments may have to be made to meter owners.

In the 2011 March Budget, the UK Government announced an increase in supplementary corporation tax (SCT) on UK oil and gas production from 20% to 32%. This change not only impacts the Group’s revenues, but also undermines stability and investor confidence. The UK Government is also introducing reforms into the electricity market to encourage investment in low carbon generation and secure affordable supplies.

In North America, every jurisdiction differs; the regulatory and legal framework is primarily set on a provincial or state level, making generalisations difficult. Texas appears to be the most stable and positive environment, while continuing to promote a liberal electricity market. The Ontario market continues to be a tough regulatory environment.

How do we manage it? We are actively engaging with stakeholders, including government and regulators in the UK, the US and Canada so we can help shape these proposals and manage the risks they present to our business. The Centrica Policy Group continued to meet on a regular basis during 2011, attended by the Board and Executive to discuss and agree Groupwide positions on each issue. In 2011, we completed a Group-wide anti-bribery and corruption programme designed to ensure compliance with the UK Bribery Act 2010 and the US Foreign and Corrupt Practices Act (FCPA).

Competition

What is the risk? We continue to face intense competition risks in the retail energy supply markets in both the UK and North America. Price and product-led switching in our residential businesses has been driven by strong competition from both existing competitors and new entrants in residential services businesses. In addition, we are seeing a general trend towards new business areas such as home energy management. New technology allows non-energy, web-based firms to access customer energy consumption data, with or without the agreement of energy suppliers. This new data will not simply be used for billing, but also to provide the customer with advice, new products and new services. Together, these factors compromise customer growth when compared to our projections. As a result of competitor activities, the Group could lose market share, which could affect profitability and our ability to meet growth aspirations.

How do we manage it? We regularly review our operations to ensure they are organised as effectively and efficiently as possible. Together with robust management of our cost base, this supports our retail business in offering our customers competitive prices and products. We continue to lead the industry in delivering energy efficiency and need to ensure stakeholder effort is focused on driving these growth areas through a market design which delivers the transition to ‘smart’ energy and promotes investment in energy efficiency solutions in homes and businesses. In 2011, we launched Nectar and Sainsbury’s Energy, along with four other affinity deals. Our British Gas website was voted the best by uSwitch, the comparison and switching service, and we have doubled the number of self-service transactions via the web.

Organisational Change

What is the risk? It is important that as our business grows, structures are regularly reviewed to ensure that activities are organised in the most effective and efficient way. In this way we ensure that our cost base is as low as possible so we can offer our customers competitive prices and products. The successful delivery of any resultant business change is key to our future success. This includes both cultural and behavioural change as well as delivery of ambitious technical-change programmes. We recognise that attracting and retaining both senior management and skilled and motivated personnel is a critical factor in the successful execution of the Group’s strategy, from the provision of enhanced customer service, through new systems and processes, to the development and management of upstream assets.

The Group also needs to maintain good relations with trade unions, primarily in the operational workforce in the Centrica Energy upstream division and the engineers in British Gas. There is a risk that industrial relations with the GMB and/or UNISON fail or become ineffective as a result of a breakdown in negotiations over employment terms or as a response to a wider climate of union unrest in the UK. Failure to maintain good relations with the unions could compromise achievement of the Group’s strategy and could have a material adverse effect on our business, results of operations and overall financial condition.

How do we manage it? Change activity is managed through a combination of project/programme boards and regular review at both a business unit and executive level. The current level of restructuring activity also requires us to have in place extensive employee communication and support mechanisms, as well as regular consultation with trade unions and employee representatives. We continue to invest in the development of all our employees, including technical and behavioural as well as leadership skills. We engage with union representatives on restructuring and issues that might impact employees’ terms and conditions, and provide a range of communication channels for our employees to discuss any concerns.

Health, Safety and Environment

What is the risk? The Group faces four principal categories of Health, Safety and Environment (HSE) risks associated with our operations, namely:

• a major incident at a high-hazard facility resulting in multiple fatalities and injuries;
• a major incident which results in significant environmental damage;
• an incident which results in a fatality or major injury to a member of the public; and
• an incident that causes a significant number of employee injuries or an employee fatality.

Any of these types of incidents could result in widespread distress and harm, as well as significant disruption to operations and damage to our reputation. In turn, resultant legal action could have an indirect financial impact. Actual incidents, precautionary closures of plant or a suspension of activities on HSE grounds may lead to loss of production or service and impact our profits. The operations of the Group have many inherent hazards, particularly related to the exploration and production of gas, power generation and offshore activities.

How do we manage it? Oversight of our HSE risks is provided by the Centrica Board and Executive who continue to consider safety a top priority. We provide regular training to all our employees and colleagues, including those in our customer-facing businesses and those working to ensure the safe operation of our assets.

We remain committed to understanding, managing and reducing the environmental and ecological impacts of our activities through innovation, technology and cultural change.

In 2011, there were additional training and behavioural programmes, as well as a new audit programme in which we partner with third-party consultants to assess compliance and provide assurance to the Board and Audit Committees. These risks are tracked by control effectiveness assessments and performance metrics. More details on our HSE reporting and activities can be found in the Corporate Responsibility section of the report on pages 34 to 35.

Information Security, Intellectual Property and Assets

What is the risk? Effective and secure information systems (IS) are essential for the efficient management and accurate billing of our customers, effective power generation, and successful energy trading and hedging activities. The confidentiality, integrity and availability of our information systems could be affected by factors that include:

• accidental or deliberate exposure of customer and employee personal data;
• accidental or deliberate changes to financial and other data that we are reliant on to support our business;
• lack of availability of systems due to inadequate infrastructure and data recovery processes; and
• an external online attack resulting in an inability to undertake normal business activities and the loss or exposure of personal data, intellectual property or other confidential information, or the disruption of control systems.

Any of these risks could materialise due to inadequate or inconsistent implementation of IS security controls and affect our reputation with current and potential customers. They could cause a breach in regulations which results in legal action against the Group, and outages and interruptions which could affect our ability to conduct day-to-day operations and cause us financial loss.

How do we manage it? Controls are in place to manage these risks, including network segregation, monitoring, access restrictions on storage systems, regular third-party security reviews and vulnerability assessments of infrastructure and applications. In addition, there is a dedicated Group IS risk team tasked with monitoring and reviewing adherence to the IS risk policy across the Group. Business continuity plans are in place to help recover from significant outages or interruptions. To improve efficiency, we continue to invest in our systems, supported by strong project management to minimise the associated implementation risk. In 2011, it became apparent that the threat of cyber attacks against the energy industry had increased to a level previously only experienced by financial institutions and government departments. We are working closely with the UK Government on the exchange of information and threat intelligence between the energy sector and government agencies. We are also working with National Grid to establish an information-sharing node for the energy sector.

Supply Chain

What is the risk? We own a variety of gas and power assets in the UK and North America and also have partner-operated assets overseas. This portfolio continues to grow as we invest capital to secure energy supplies for our customers. There is a risk of terrorist activity, including threats to the energy sector which may include sabotage of power stations, gas platforms or pipelines, which could in turn affect security of supply or cause a break in supply to our customers.

Any failure to supply customers could impact negatively on our reputation, the results of operations and our overall financial condition. We have also outsourced several activities, including IS services, and back office and processing functions that support our businesses in the UK and North America. Some of the Group’s outsourcing contracts are in offshore locations such as India, South Africa, Poland and Portugal. Where we depend on these third-parties for certain aspects of our operations, we cannot guarantee the security of these supply chains. Any failure of our outsourcing partners to deliver the appropriate level of service to the Group could have a detrimental impact on our costs, our reputation or our levels of customer service, and could consequently affect the Group’s revenues and profits. The Group is also exposed to the performance of existing ageing nuclear power plants; this includes potential losses of production as a consequence of emergent technical issues, component failure, outage over-runs or other operational considerations. In addition, stations may close earlier than expected due to technical problems. Operational problems with the existing fleet of nuclear power stations may result in reduced dividends from the joint venture with EDF Energy and imbalance charges for the Group.

How do we manage it? We continue to invest in a range of options to ensure a flexible and reliable supply, including the potential development of additional storage facilities. All new outsourcing and offshoring initiatives have robust project governance and are challenged and reviewed by senior management in business performance reviews. We regularly review country risk and have business contingency plans in place in the event of terrorist activity or adverse social/political events in our offshore locations. In addition, we have developed a Group approach to managing key-supplier risk and, in light of the continuing global economic conditions, have performed a risk-based review of the financial health of our key outsourcing partners. The operational performance of our nuclear assets is closely monitored and controlled to ensure we continue to get value for our investment.

Related Party Transactions

During the year, the Group entered into the following arms length transactions with related parties who are not members of the Group and had the following associated balances:

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2010

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Sale of goods and services £m

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Purchase of goods and services £m

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Amounts owed from £m

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Amounts owed to £m

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Purchase of goods and services £m

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Joint ventures:

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Wind farms (as defined in note 16)

25

92

312

46

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82

206

37

Associates:

Nuclear (as defined in note 16)

278

516

19

65

278

284

33

53

Other

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Investment and funding transactions for joint ventures and associates are disclosed in note 16. The terms of the outstanding balances related to trade receivables from related parties are typically 30 to 120 days. The balances are unsecured and will be settled in cash. No provision for bad or doubtful debts owed by related parties was required (2010: £nil).

Key management personnel comprise members of the Board and Executive Committee, a total of 15 individuals at 31 December 2011 (2010: 14). Key management personnel and their families purchase gas, electricity and home services products from the Group for domestic purposes on terms equal to those for other employees of the Group.

Remuneration of key management personnel

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Short-term benefits

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Post-employment benefits

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Share-based payments

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21

Directors Responsibility Statement

This statement is repeated here solely for the purposes of complying with Disclosure and Transparency Rule 6.3.5. This statement relates to and is extracted from the Annual Report 2011. It is not connected to the extracted information presented in this announcement or the preliminary results announcement released on 23 February 2012.

The Directors, who are named on pages 42 and 43, are responsible for preparing the Annual Report, the Directors’ Remuneration Report and the Financial Statements in accordance with applicable law and regulations. Company law requires the Directors to prepare financial statements for each financial year. Under that law the Directors have prepared the Group Financial Statements in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union (EU) and the parent company Financial Statements in accordance with United Kingdom Generally Accepted Accounting Practice (United Kingdom Accounting Standards and applicable law). Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Group and the Company and of the profit or loss of the Group for that period. In preparing these Financial Statements, the Directors are required to:

• select suitable accounting policies and then apply them consistently;
• make judgements and accounting estimates that are reasonable and prudent;
• state whether IFRS as adopted by the EU and applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the Group and parent company Financial Statements respectively; and
• prepare the Financial Statements on the going concern basis unless it is inappropriate to presume that the Company will continue in business.

The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company’s transactions and disclose with reasonable accuracy at any time the financial position of the Company and the Group and enable them to ensure that the Financial Statements and the Directors’ Remuneration Report comply with the Companies Act 2006 and, as regards the Group Financial Statements, Article 4 of the IAS Regulation. They are also responsible for safeguarding the assets of the Company and the Group and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities. Furthermore, the Directors are responsible for the maintenance and integrity of the Company’s website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions. Each of the Directors, whose names and functions are listed in pages 42 and 43 confirm that, to the best of their knowledge the Group Financial Statements, which have been prepared in accordance with IFRS as adopted by the EU, give a true and fair view of the assets, liabilities, financial position and profit of the Group. In addition, they confirm that the Directors’ Report contained in pages 2 to 63, together with other disclosures given on page 138, includes a fair review of the development and performance of the business and the position of the Group, together with a description of the principal risks and uncertainties that it faces.

Enquiries:

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