Annual Financial Report

Annual Financial Report

Centrica PLC

27 March 2013

Centrica plc (the Company)
Annual Report and Accounts 2012

Further to the release of the Company's preliminary results announcement on 27 February 2013, the Company announces that it has today published its Annual Report and Accounts 2012 (Annual Report 2012).

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 Monday, 13 May 2013 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 2012
• Annual Review and Summary Financial Statements 2012
• Notice of Annual General Meeting 2013

The above documents may be viewed online at www.centrica.com/report2012 and are also available to download at www.centrica.com/2012reportdownloads.

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 27 February 2013. That information, together with the information set out below, which is extracted from the Annual Report 2012, 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 2012. Page and note references in the text below refer to page numbers and note numbers in the Annual Report 2012.

Principle Risks and Uncertainties

Risks and Uncertainties

Assessing and managing risk is a fundamental part of day to day business management across Centrica. The risks we face in a rapidly changing energy landscape continue to evolve over time. A number of measures helped to mitigate those factors in 2012.

2012 key risks

Our principal risks and uncertainties during 2012 are summarised below, together with a brief summary on how these have moved or been managed throughout the year.

Health, safety and environment - Safety is one of our core priorities and we continue to target risk and impact reduction. In 2012 we reduced the lost time injury frequency rate (LTIFR) and achieved significant safety milestones at a number of operations. For example, Centrica Storage had no lost time incidents recorded for more than five million man hours of work.

Brand and reputation - The Group continued to change and improve the offering to customers and provide more transparent billing, and continued to roll out an Energy Regulation Compliance Programme.

Legislation and regulation - Our contact programme with key stakeholders helps us respond to new initiatives and external market changes. As part of the Retail Market Review (RMR), we are engaging with Ofgem over their proposals, and we are also engaging with the Department of Energy & Climate Change (DECC) with reference to Electricity Market Reform (EMR).

Strategic growth - The Group continued to pursue a range of options across the gas value chain and undertook significant investment through upstream and North American acquisitions, including assets in the North Sea of £1.2 billion to secure an affordable energy supply.

Commodity prices - We continued to seek long-term supply arrangements and develop our asset portfolio. Increased wholesale and other costs forced us to raise gas and electricity prices in November; however, we worked to make tariffs easier to understand.

Competition - Affordability is a key issue for customers. We invested significantly in systems to ensure our customer service levels continue to improve and remain competitive. British Gas extended eligibility under the Warm Home Discount and developed offers with affinity partners, such as Sainsbury’s Energy.

Organisational change - We successfully moved our North American headquarters from Toronto to Houston. We made plans to recruit 1,000 British Gas energy apprentices in connection with the significant investment in smart energy. In respect of the upstream business we will create significant numbers of jobs in construction and across the supply chain for the Cygnus project, to develop the largest gas discovery in the southern North Sea for 25 years.

Supply chain - We reviewed and refined governance processes and many suppliers signed our responsible procurement clauses. Furthermore, we linked supplier audit activity to low cost country sourcing.

Information security, intellectual property and assets - We operate in a complex computing environment and the threat of cyber attack against our industry remains high. We invested in the transition of our data centres and improved our system of internal controls.

2013 presents our organisation with more challenges. Strong governance and a clear risk strategy equip us for uncertainties ahead.

2013 principal risks and uncertainties

The following risks could impact our future performance. The list is not exhaustive and items are not prioritised. The list, and the nature of the risks, may change during the year.

Health, safety, security and environment (HSSE)

What are the risks?

We face four principal categories of HSSE risks associated with our operations:

• an incident resulting in one or more fatalities or multiple injuries at an owned, operated, or other facility where the organisation has an interest;
• an incident which results in significant environmental damage or compliance breach;
• an incident which results in a fatality or major injury to members of the public; and
• a security event, requiring activation of our crisis management plan and/or business continuity plan.

Such risks may result in widespread distress and harm, significant disruption to operations, and damage to our reputation. The cost related to the recovery, clean up and/or resultant litigation could have a material financial impact.

Actual incidents, precautionary plant closures or suspension of activities on HSSE grounds could lead to loss of production or service and impact profits. Our operations have many inherent hazards, particularly related to exploration and production, power generation and offshore activities.

We also have non-controlled interests in organisations with inherently high hazards, relating to the exploration and production of oil and gas and nuclear power generation.

How do we manage these risks?

The Board and Executive Committee oversee HSSE risk and consider it one of our core priorities. 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 2012, business unit Health, Safety & Environment (HS&E) plans were put into place alongside the Group audit programme. These risks are tracked by control effectiveness assessments and performance metrics. We reviewed our HS&E audit operating model to ensure the 2013 risk-based audit programme accurately assesses compliance and provides assurance to the Board and Audit Committee. Security intelligence and operating procedures, as well as crisis management and business continuity plans, are regularly reviewed.

Brand and reputation

What are the risks?

As highlighted in the Corporate Responsibility Review, our ambition is to be the most trusted energy company. Failure to follow our global business principles of operating professionally, fairly and with integrity could harm our reputation, as could real or perceived customer service failings. Rising prices, increased political pressures and deep recessionary impacts have all increased the level of media coverage.

We need to ensure that we clearly communicate our future strategy to key stakeholders, in order to avoid an adverse reaction and loss of confidence in the Group.

Social media now allows consumers and pressure groups to mount damaging direct action and other campaigns more readily than before.

Failure to restore public confidence could impact Group revenues. Public exposure to criticism could damage our brand, increase governmental or regulatory intervention and reduce access to financial capital.

How do we manage these risks?

The Group supports transparency, fairness and competition, and has taken action to make bills clearer and to work with our customers to improve awareness about energy efficiency. We meet regularly with the media, government, NGOs, investment community, regulators and consumer groups as part of our relationship management strategy. Although some sections of our key stakeholders hold an ‘anti energy’ position, our Honest Conversation and Customer Board initiatives are recognised by industry critics as helping stakeholders understand the energy market.

The Group, through gas and power assets, offices and call centres and the 10 million visits engineers make to homes in the UK and North America every year, is very much part of local communities. We act as a responsible company within these communities and continue to help vulnerable customers.

In Ontario, Direct Energy launched a new customer promise with a commitment to see all customers without heat the very same day. This was based on the success of a similar service developed in the UK. Direct Energy is also a key supporter of a programme to provide people going through financially difficult times with assistance in paying their household bills.

Legislation and regulation

What are the risks?

Energy markets in the UK, North America and mainland Europe are closely regulated. Legal or regulatory changes could impact our ability to achieve financial goals.

New financial regulation was introduced in the US and Europe as a result of the global financial crisis. As part of this we are still awaiting finalisation of the rules and regulations in Europe and in the US, under the Dodd-Frank Act. These could adversely affect the manner in which we currently deal in the commodity markets. Governments and regulators, often under public pressure, have also stepped up levels of enforcement and intervention.

Retail sector competitiveness continues to face regulatory scrutiny, as the costs of higher wholesale commodity prices are passed on to customers, just as disposable incomes are falling and deepening recessionary impacts continue to be felt. In the UK, Ofgem’s updated RMR proposals could introduce significant risk to our downstream business, and reduce innovation and affordable choice for customers.

In North America, the legal and regulatory framework is primarily set at a provincial or state level, making generalisations difficult and our entry into new markets needs to be assessed on a case by case basis.

Public statements made by governing political bodies can cause concern. One of the challenges would be the abolition of existing or future ‘green’ subsidies, as occurred in the UK solar industry and in other energy sources around the world, such as the end of free carbon allowances in 2012 which will impact our upstream business.

Such developments may have a material adverse effect on our business, operations, financial condition and ability to meet long-term growth aspirations, especially if any case of compliance failure receives extensive media coverage.

How do we manage these risks?

We proactively engage stakeholders, including governments and regulators in the UK and North America to help shape these proposals and manage the risks they present. The Centrica Policy Group met regularly during 2012, setting Group-wide positions on each issue.

In 2012, we formed a Corporate Reputation Group to discuss threats from legislative and regulatory proposals. We also continued to roll out our Energy Regulation Compliance Programme.

Strategic growth

What are the risks?

Strategic issues, including capital investment in mergers, acquisitions, disposals, market position, climate change, sustainable development and new technologies, are affected by the global economy. As we implement our refreshed strategic priorities to deliver our vision to be the leading integrated energy company with customers at our core, we face an increasingly uncertain environment. Challenges include the intensifying uncertainty in the world economy reflected by concerns over further economic deterioration, pressure from higher wholesale prices, increased competition, reduced demand and recessionary impacts, all of which contribute to making market conditions challenging.

The economic condition of the countries and markets in which the Group operates, namely the UK and North America, are of concern, with the extent and timing of recovery uncertain. The UK entered a double-dip recession during 2012, with the threat of an unprecedented triple-dip in 2013. The US experienced the potential for a ‘fiscal cliff’ and the proximity of further ‘fiscal cliffs’ in 2013 exists with the possibility, from the interconnected global financial systems, of this not only impacting our overseas operations but also the Group as a whole.

Decisions on the future of energy markets also pose risks to our existing and future operations. The UK Government’s preference for converting coal power stations to co-firing biomass rather than building dedicated biomass facilities led us to end our investment in dedicated biomass power station projects. The US President’s re-election indicated continued support for all domestic energy sources; shale, power generation including nuclear, renewable, carbon capture and storage, although specific details remain uncertain.

The rise of the digital economy is adding to competitive pressures and with the internet entering a second phase dominated by mobile devices, the barriers to market entry are falling and customer loyalties can change swiftly. In the UK market, a significant number of our customers have changed in line with this, as they now choose to deal with us through accessing digital channels, such as the British Gas website and smartphone applications. Smart meters represent one of the biggest changes in the retail energy market since the 1970s and British Gas will operate, not only in an energy market but in an energy services and advisory market open to non-traditional players.

How do we manage these risks?

The Group pursues a range of strategic investment options across the gas value chain and in different geographies, to both deepen our customer relationships and secure the Group’s future energy requirements.

In 2012, we invested £2.7 billion to secure energy supplies and increase energy reserves. In addition, our investment in the Cygnus project, when complete and at peak production, will meet the energy needs of nearly 1.5 million UK homes. We continue to seek industry partnerships to supply the UK with gas, and three such supply deals have been signed since 2011.

In North America, the Group continues to deliver on its priorities. The residential, business and services footprint has grown, helping the upstream business perform well despite low gas and power prices.

We aspire to lead in the roll-out of smart meters to give consumers insight into how smart products will transform the way they understand their energy use. We are market leader in the supply for electric vehicle charge points and the Group continues to offer expertise in energy efficiency through domestic energy efficiency surveys and home insulation. Furthermore, the Group is mindful of the need to keep abreast of emerging technologies and the potential impact on the smart connected home of the future and as such we maintain links with technology experts to give us further advantage.

Commodity costs

What are the risks?

Volatile commodity costs affect our ability to price competitively and meet profit targets. The Group buys a significant proportion of the gas to supply Britain’s needs. This position sets the Group apart from the other counterparts in the UK market. To maintain supply and protect against possible price increases much of this is procured in advance in order to ensure a balanced supply and demand portfolio. Mild weather could reduce demand, leaving the Group with a surplus of gas which would have to be sold back to the wholesale market at a loss. This could contribute to customer bills not dropping when wholesale prices later fall.

There has been a significant impact from shale gas in North America where an immediate effect has been to lower wholesale gas prices in the US and weaken the traditional links between gas and oil prices. Such an emerging energy source could influence global energy markets over time, with the surplus of gas affecting the current liquefied natural gas (LNG) sector in particular.

Investment decisions key to Group 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.

Assets, including goodwill, may be impaired if discounted future cash flows from an asset are insufficient to cover its cost on the balance sheet. The excess asset cost on the Group balance sheet will be provided against and charged to the Group income statement. The cash flows of assets are sensitive to changes in:

• commodity prices;
• discount rates;
• reserve estimates/useful economic life;
• capital expenditure/operating expenditure assumptions (including changes in decommissioning estimates); and
• operational performance.

There are also a number of contractual capacity contracts, the economic value of which depends on volatile spread relationships.

How do we manage these risks?

The Group has an active hedging programme and tracks supplier risks through robust governance frameworks. Strategic investment decisions are 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 gas supply relationships with Statoil, Qatargas and Gazprom, the acquisition of additional assets and the securing of new licences for exploration blocks are examples of how we continue to develop our portfolio.

Change management

What are the risks?

The level of change experienced by our business is significant, deriving from:

• capital projects;
• IT change programmes; and
• organisational change.

We assess large capital projects as a means of growth. Such large-scale initiatives carry complexity and could result in the Group entering new markets, whilst exposing us to the risk of build quality issues, cost and timetable overruns, unsuccessful development of partnership opportunities and health, safety, security and environmental failures.

Internal IT change programmes are equally large and complex. Work on existing systems carries the risks of:

• trying to deliver too much change and over-stretching resources;
• change being completed but systems integrity being undermined and threatening business continuity; and
• cost overruns and/or expected benefits not being realised.

Organisational change stems from internal restructuring as we drive to make our business as efficient and effective as possible, without detriment to our levels of customer service. Our recent announcements mean that the Group will face a period of increased change activity in 2013.

How do we manage these risks?

Change is a constant in any successful organisation. The Group continues to change and adapt to remain competitive and provide the best service at the lowest cost. We address difficult decisions and challenging situations head on in order to provide energy to Britain’s homes and businesses.

Change activity is managed through a combination of project/programme boards and regular review at both a business unit and executive level. In 2012, we created a project management directorate to improve governance of large capital projects in our upstream business.

We also assess carefully the overall cumulative impact of the level of change across the organisation at any one time.

Information security

What are the risks?

Effective and secure information systems are essential for efficient management and accurate billing of customers, upstream operations and energy trading and hedging activities. The confidentiality, integrity and availability of our information systems could be affected by:

• accidental or deliberate exposure of share-price sensitive information, customer or employee and contractor personal data;
• viral effect of employees, crusader consumers or ‘hacktivist’ groups using social media channels that expose the Group to legal liabilities, damage our reputation or disclose confidential information;
• accidental or deliberate changes to financial and other data the Group relies on;
• lack of availability of systems due to inadequate infrastructure and data-recovery processes; and
• an external online attack that renders the Group unable to conduct normal business activities and/or results in the loss or exposure of personal data, intellectual property or other confidential information or the disruption of control systems.

The threat of cyber attacks against our industry continues to escalate to similar levels experienced by government agencies and financial institutions. There could be multiple sources of motivation for these attacks. These risks, however, which could arise from inadequate or inconsistent implementation of IT security controls, could seriously affect the Group’s reputation, lead to legal action and/or outages that could cause financial and operational loss. The US and EU data privacy proposals increase the implications of such risks materialising, due to proposals around public notification of any data breach and the scale of associated fines for non-compliance.

How do we manage these risks?

Controls include network segregation, monitoring, storage system access restrictions, regular third party security reviews and vulnerability assessments of infrastructure and applications. Our Group Information Systems (IS) risk team monitors and reviews adherence to the IS risk policy and works with the UK Government to exchange information and threat intelligence between government agencies and the energy sector.

Business continuity plans are in place to manage significant outages or interruptions. To improve efficiency, the Group continues to invest in systems, supported by strong project management, to minimise the associated implementation risk. In 2012, the Group continued to implement IS programmes, with specific efforts in North America to consolidate the systems of new acquisitions.

People

What are the risks?

Key to our ability to successfully deliver business plans and strategic growth is the attraction, retention and succession planning of senior management and individuals with key skills. This applies to customer service, the delivery of new systems, and in particular to areas where there is strong competition for technical and project management capability, such as our upstream business.

As we continue to change, the business must be organised in the most effective and efficient way possible to ensure its cost base is as low as possible, so that we can offer customers competitive prices and products. This includes both cultural and behavioural change as well as ambitious technical-change programmes.

As part of this, the Group also needs to maintain good relations with trade unions, primarily the Centrica Energy upstream business operational workforce and British Gas engineers. 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 widespread union unrest in the UK.

Failure to maintain a high calibre, engaged and stable workforce could compromise achievement of the Group’s strategy and could have a material adverse effect on its business, results of operations and overall financial condition.

How do we manage these risks?

We regularly review our organisation to make sure that people are empowered to make the right decisions at the right time, and to look for ways to work better, smarter and safer.

We regularly review the capability of the organisation to deliver our strategic objectives. An extensive exercise has been undertaken in critical areas to ensure we have the right capabilities to deliver our plans for growth and innovation.

In 2012, reward reviews were carried out in specific areas to retain key skills and prevent the possibility of an escalation in attrition.

The Group invests in developing all employees, including technical, behavioural and leadership skills. The Group engages with unions on restructuring and issues that could impact terms and conditions and provides channels for employees to discuss concerns. HR is involved in merger and acquisition activity to ensure that, following integrations, we retain key attributes and recruit the right talent, especially in an emerging market.

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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2012

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2011

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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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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

Joint ventures:

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Wind farms (as defined in note 16)

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27

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78

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459

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47

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25

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92

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312

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46

Associates:

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Nuclear (as defined in note 16)

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157

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598

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8

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73

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278

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516

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19

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65

Other

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4

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-

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18

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-

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-

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8

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17

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-

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188

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676

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485

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120

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303

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616

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348

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111

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 (2011: £nil).

Key management personnel comprise members of the Board and Executive Committee, a total of 14 individuals at 31 December 2012 (2011: 15). 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	Â	Â	Â	Â
31 December	Â	2012	Â	2011
Â	Â	£m	Â	£m
Short-term benefits	Â	8	Â	7
Post-employment benefits	Â	2	Â	2
Share-based payments	Â	6	Â	8
Â	Â	16	Â	17

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 2012. It is not connected to the extracted information presented in this announcement or the preliminary results announcement released on 27 February 2013.

The Directors, who are named on pages 152 and 153, 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. Accordingly, 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 UK 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 152 and 153 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 5 to 75, together with other disclosures given on pages 152 to 154, 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:

Centrica Investor Relations: [phone]

Centrica Media Relations: [phone]