Annual Financial Report

Annual Financial Report

Centrica plc

26 March 2015

Centrica plc (the Company)

Annual Report and Accounts 2014
Annual Review 2014
Notice of Annual General Meeting 2015

In accordance with Listing Rule 9.6.1, Centrica has uploaded a copy of each of the above documents to the National Storage Mechanism. These documents are also available at centrica.com/ar14.

A condensed set of the Company’s financial statements and information on important events that have occurred during the financial year ended 31 December 2014 and their impact on the financial statements, were included in the preliminary results announcement released on 19 February 2015. That information, together with the information set out below, which is extracted from the Annual Report and Accounts 2014, 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 and Accounts 2014. Page and note references in the text below refer to page numbers and note numbers in the Annual Report 2014.

Principal Risks and Uncertainties

The following risks, both short and long term, 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, environment and security (HSES)

Risk climate: no change

What are the risks?

There are inherent hazards in our operations, in particular those relating to the integrity of our physical operating assets and to oil and gas exploration, production, transportation and storage and power generation. This includes non-controlled interests in organisations with whom we contract. The management of these assets is also subject to various laws, regulations and permits.

In addition, our engineers visit customer premises to undertake essential repair and maintenance work on gas and electrical installations, appliances and plumbing and drain services.

Security events such as malicious attacks, criminal or activist activity can also cause disruption to our operations.

Failure to manage risks arising from these assets and operations could result in major injuries or loss of life, significant disruption to production or services, damage to our reputation and environmental damage. The costs related to the recovery, clean up or any resultant litigation could have a material financial impact.

Insurance proceeds may not be adequate to fully cover all liabilities, lost revenue or increased expenses resulting from a major incident, particularly involving oil and gas exploration and production activities or the nuclear fleet.

Compliance with laws, regulations and permits, or changes to existing commitments, could significantly impact the cost of operation and make it uneconomic to continue managing certain assets.

How do we manage these risks?

The management of HSES risk is overseen by the Board and Executive Committee and remains one of our core priorities with a continued focus across all our assets and operations.

We undertake regular reviews and independent assessments of the processes in place to manage these risks to ensure they remain effective and continue to develop. This includes any third parties involved in our operations and building strong relationships and supporting any local communities we work within. We also continue to invest in training to ensure we maintain safe operating practices in both our upstream and downstream businesses.

Security intelligence and operating procedures, together with crisis management and business continuity plans, are regularly evaluated and tested to provide assurance that we are capable of responding promptly and adequately to such events.

Further information on our safety activities and performance can be found in ‘How We Do Business’ on page 21.

Looking forward

• Delivery of process safety improvement plans in our upstream business.
• Increased volume of smart meter installations in customer premises.

Political, regulatory and compliance

Risk climate: increased

What are the risks?

The markets in which we operate are subject to detailed legislation and regulation across different jurisdictions. This complex structure is continually evolving and any changes or uncertainty, or ineffective or incomplete implementation of any new obligations could adversely affect our business.

A worsening of the international political climate increases the possibility of sanctions or other trade limiting actions that could impact our ability to source commodities. Political and regulatory direction will play a major part in our continued progress. Future LNG exports from our gas facility project in North America could face US government limitations or refusal.

Following the 2014 Scottish referendum, there is uncertainty over the new powers including areas such as fuel poverty and energy efficiency, that will be devolved to Scotland and also any changes that could be made to the tax system in Scotland compared to the rest of the UK.

The lead-up to the UK general election has and could continue to result in consumer group lobbying, political statements and manifesto pledges that do not translate well into considered policy. This could increase the pressure on regulators to act, resulting in sharp fluctuations in investor confidence, an increase in the cost of capital and a reduction in the credit worthiness of energy buyers.

The CMA market investigation is due to conclude at the end of 2015 and could result in recommendations that are unfavourable to our business model. Ofgem is also focused on increasing transparency over energy company finances, as well as increasing pressure to lower retail energy bills as wholesale energy prices have decreased.

How do we manage these risks?

Our Group business principles, policy framework and corporate responsibility framework govern how we conduct our affairs.

We are committed to an open, transparent and competitive UK energy market that provides choice for consumers. We lead the industry in putting our customers in charge of their energy consumption through innovative products such as our Tariff Checker and Hive Active Heating^TM.

We proactively engage with our stakeholders, including government, legislators and regulators in order to shape proposals and manage risks. We work with regulators to find a better approach to intervention that agrees clear targets, for example switching times or complaint handling, against which we could demonstrate progress. We work with political parties to develop a consensus on energy policy that supports the transition to a secure, low cost, low carbon UK.

Looking forward

• Decision and any resulting remedial actions from the CMA energy market investigation.

Trust, perception and customer service

Risk climate: no change

What are the risks?

The challenges of day-to-day costs of living, including energy, have had a very negative impact on the public’s perception of energy suppliers. The fall in wholesale energy prices and the timing of the reduction in consumers’ bills, has further heightened political and media attention in this area. This is not only a concern for our customers but also damages investor confidence, increasing the prospect of potential further government or regulatory intervention at a time when substantial investment is required to secure supplies of energy.

Media attention and the position taken by political parties in the run-up to the UK general election could also lead to further uncertainty, as the political consensus that existed over key questions of energy policy has broken down.

Customers may switch supplier if they experience unacceptable customer service levels or if it is perceived that we are failing to maintain service quality.

The increased use of social media allows customers and consumer groups to engage, share views and take part in direct action and other campaigns more readily than before. Poor perception of the Centrica brands, our service levels or our level of transparency could undermine trust in us and lead to campaigns for change, as well as challenges in attracting and retaining new customers.

Hydraulic fracturing in the UK together with the Group’s exploration licence in Norwegian waters close to the Arctic could cause adverse publicity and damage to our brands as we explore opportunities for unconventional energy supply and generation or related technologies as part of our business strategy.

How do we manage these risks?

We remain focused on providing affordable energy and excellent service, working to deliver a fair, simplified and transparent offering to consumers and protecting the most vulnerable, fuel-poor households through initiatives to improve energy efficiency or with financial advice and aid. Through improved customer billing and CRM systems, taking the lead on smart metering and developing new innovative products, we help put customers in control of their energy consumption and reduce carbon emissions. In 2014, we led the industry in deciding to end the auto-rollover of contracts at renewal for our business customers.

To help people today and secure energy for tomorrow, we engage with NGOs, consumer and customer groups, political parties, regulators, charities and other stakeholders to understand their views and concerns, working together to identify solutions to help reduce bills and improve transparency to help rebuild trust in the industry. We have entered into initiatives, including our partnership with Shelter, and the launch last year of the Centrica backed pioneering social impact investment fund Ignite.

We actively manage our reputation with a number of different stakeholders including customers, investors, opinion-formers, employees, the media, governments and government agencies, political parties, and regulatory and trade union bodies.

Looking forward

• Media and political effect of the UK general election.
• Progressing with development of our UK hydraulic fracturing interest.

Strategic growth

Risk climate: increased

What are the risks?

Despite positive signs of recovery in the UK, uncertainty remains in the global economy and the economic sentiment could impact many parts of our business.

The UK market faces potential pressure in both the run-up to the UK general election and in the policy decisions taken by the next government.

The UK is also becoming increasingly dependent on gas imports and, as a result, international energy prices.

Growth in our North American downstream business will also be dependent in part on the successful integration of a number of newly acquired businesses.

The current political debate has exacerbated significant uncertainty in the UK energy landscape. This could impact future power, storage and upstream investment and the attractiveness of the UK energy supply business.

A number of emerging technologies and innovations have the potential to be disruptive to our business. In our upstream business, we face competition in developing and applying new technology to maximise recovery, in making unconventional sources of oil and gas economic and in generating power through low carbon solutions.

Improved energy efficiency and changing customer behaviour as a result of greater environmental awareness, reaction to past price increases and long-term weather patterns have led to a reduction in energy demand in our downstream business.

In the UK, gas demand is forecast to continue to decline over the next decade with the emergence of smart connected home solutions and electricity demand is forecast to decline by a smaller amount or remain flat. The retail energy environment is highly competitive across residential and business segments as well as energy services, including new business areas, such as smart enabled applications.

In the UK, the number of small suppliers has grown significantly and we have seen increasing levels of switching for the supply of energy and services. We could see heightened competitive pressures as new players, such as insurance companies, telecom companies, supermarkets and other large retail companies enter the services market and seek to strengthen their positions. The value of customer data has increased and the widening range of virtual interaction with customers through digital media, smart technology, the internet and mobile devices plays a greater role in the retail energy sector.

Climate change, new technologies and global economic conditions may be subject to circumstances beyond our control resulting in an adverse impact on our strategic growth.

How do we manage these risks?

We continue to pursue a range of options across the energy chain and in different geographies to both deepen our customer relationships and secure our future energy requirements. We remain committed to developing diverse alternative sources of supply and continue to explore for shale gas in the UK.

We continue to seek cost efficiency through innovation and investment in systems, positioning ourselves to deliver targets whilst maintaining a stable platform for investment.

The way we heat, power and light our homes is changing through a combination of environmental and financial concerns and the ease of use and prevalence of mobile and connected devices. The investment we are making in smart connected homes through smart meters, personalised customer energy usage reports, smart and time of use tariffs, applications for remote heating control and US appliance rental programmes has allowed us to create greater consumer visibility and control over energy consumption. Our innovative products will radically alter the way we operate and we continue to lead the industry as we look to develop connected boiler technology.

In 2014 we bought the former state-owned Irish energy company Bord Gáis Energy as we continue our focus on entering new deregulated markets. We will look to expand a services capability in this new market and introduce some of our established smart technology and products for the benefit of our new customer base.

Looking forward

• Impact of new market entrants (community, small, unconventional and existing).
• Impact of technology and innovation.

Commodity costs

Risk climate: increased

What are the risks?

A significant proportion of our profitability and price competitiveness is dependent upon our ability to manage exposure to increasingly volatile world energy markets. Commodity prices can fluctuate based on a large number of factors including supply and demand, as well as political and economic factors. Current international political factors may trigger an expectation of or actual disruption in supplies.

The price of gas in the UK market is particularly important for us given we supply a significant proportion of Britain’s gas needs. As the country secures an increasing proportion of gas from abroad, its price and availability will be increasingly shaped by international forces, combined with the additional challenge of transitioning to lower carbon generation.

Shale gas has already transformed the US energy market where gas prices have fallen to historic lows. The low cost of natural gas may result in new market entrants and cause margins to tighten. Shale gas could further influence global energy markets over time, in particular liquefied natural gas (LNG), which is becoming an increasingly important source of natural gas in the UK.

Seasonal variations and economic conditions make it difficult to forecast future energy demand, leading to significant uncertainties around commodity prices and the potential to result in a surplus of gas which cannot be sold profitably in the wholesale market or with short commodity positions that cannot be covered at a cost that can be passed on to customers. The Group also has a number of contractual capacity contracts, the economic value of which depends on market prices.

In 2014, we saw a significant fall in commodity prices, particularly in the second half of the year, impacting the profitability of our UK businesses. In the US, the extreme weather of the polar vortex caused significant market volatility in electricity and natural gas prices. Commodity price increases or decreases may require us to change the price at which we sell energy to our customers on variable tariffs. We may not be able to pass through all increases in commodity prices to customers in a given year. Where we do pass increased commodity prices on, or if we fail to pass on decreased commodity prices, customers may seek to switch to competitors.

Commodity price decreases may reduce profits and over the longer term may make certain exploration and development projects and existing operating assets uneconomic. Assets, including goodwill, may be impaired if future cash flows from such assets are insufficient to cover their cost on the balance sheet.

How do we manage these risks?

We have an active forward buying and selling programme to mitigate the risks of sudden commodity price movements and track supply chain risks to ensure security of supply.

Strategic investment decisions are made within a capital allocation framework that tests projected returns against various commodity price scenarios and are rigorously evaluated against Board-approved criteria prior to commitment.

We continue to selectively invest in assets around our existing hubs, while managing costs, looking to divest non-core and uneconomic assets, delivering new projects and purchasing stakes in other assets.

We continue to secure energy contracts, invest in low carbon and gas-fired power generation and purchase gas and oil producing assets to develop our portfolio, support downstream operations through contractual arrangements, asset ownership and make progress accessing new markets and securing new sources of gas. This enables us to secure energy supplies for the future whilst sheltering customers from volatility in the wholesale gas market.

Looking forward

• Impact of sustained downward pressure on oil and gas prices.

Change management

Risk climate: no change

What are the risks?

The successful delivery of business change is fundamental to our future success and includes organisational, cultural and technical transformation.

The delivery of certain large change programmes is technically complex. Planning to deliver too much change could result in a stretch on resources, undermine system integrity, cost more than originally planned or take longer than estimated to implement. Change programmes could also suffer from quality issues and planned benefits may not be realised or individual products as widely accepted as anticipated.

The scale of change in our downstream business is significant. Delays or challenges with changes to billing and other systems, the implementation of smart connected home products in the UK and US and integration of a number of acquisitions could adversely affect our operations, reputation and financial position if not successfully delivered.

We regularly review our assets, investments and organisational structures, seeking to divest or change those that no longer meet expected returns, to keep our cost base as low as possible. These changes can involve difficult decisions for our people and there is a risk that industrial relations could deteriorate.

How do we manage these risks?

Change activity is managed through a combination of programme and project boards and is regularly reviewed at both the business unit and executive level.

We have a defined capital allocation framework against which to review business asset and investment performance and will be increasingly selective in our investments, directing capital towards projects based on their ability to deliver business benefits against the framework.

We have a dedicated project management directorate to improve governance of large capital change programmes undertaken in our upstream business. Dedicated programme and project managers are assigned to all major change initiatives and apply defined methodologies and tools, together with defined governance processes, supported by both functional and business unit teams.

As part of our ambition to lead the energy industry and have the strong future we are capable of, we embrace innovative technology in our product offerings to customers, our IT systems and the way in which we operate our business. We have implemented new billing and CRM systems in our energy and services businesses in the UK and North America. We have developed new products that put UK and US customers in greater control of their energy consumption and we have led the smart meter roll-out in the UK.

Looking forward

• The delivery of a number of UK and Norwegian upstream projects.
• Embedding new billing and customer relationship management systems.

Information systems and security

Risk climate: increased

What are the risks?

Our business operations rely on information systems maintaining a high degree of availability, integrity and security, including those from third-party providers.

With the increasing digitisation of information, the use of social media and the continually evolving external cyberthreat landscape, corporate organisations are targets for malicious and unauthorised attempts to access information. Our businesses could be compromised by an incident arising from the accidental or deliberate exposure of sensitive data or intellectual property, inadvertent or deliberate changes to data or changes in asset control systems.

Attempts to appropriately collect, secure and dispose of information now face far greater scrutiny from regulators, customers and employees. Information security breaches could seriously affect our reputation, lead to legal action and regulatory sanctions and system outages that could cause financial and operational loss.

EU, US and Canadian data privacy requirements and proposed amendments, as well as regulatory changes, increase the requirements around public notification of any data breach and also the ability of the regulator to impose associated fines or penalties for non-compliance.

How do we manage these risks?

Our information security strategy seeks to integrate information system, personnel and physical aspects, overseen by the Information Risk Steering Group, which reports to the Group Risk Management Committee.

We seek to detect and investigate threats and incidents, including engaging with key technology partners and suppliers, to ensure potentially vulnerable systems are identified.

We regularly evaluate the adequacy of our infrastructure and IT security controls, undertake employee awareness and training and test our contingency and recovery processes.

We work collaboratively with working groups across the energy industry and public and private sectors.

These measures allow for controls and responses to be put in place that are both effective and proportionate, including cybersecurity crisis management and business continuity plans that have been evaluated and tested to provide assurance that they are capable of responding promptly and adequately to any such events, whilst recognising the evolving nature of the threat landscape.

Looking forward

• Compliance with the 2014 EU Data Protection Regulation and introduction of the 2014 EU Cyber Mandate.
• Increase in the Smart Metering and Connected Homes programme with the inherent risks associated with sensitive data.

People

Risk climate: increased

What are the risks?

The attraction, retention, development and succession of senior management and individuals with key skills are critical factors in the successful execution of strategy.

Cultural transformation, ambitious technical-change programmes, changes to our current structure and business operations could all result in challenges with attraction and retention for key roles across the business and have an adverse impact on the engagement of our people.

Ineffective trade union relationships could result in the threat of industrial action in our upstream business operations and engineering workforce.

Insufficient capability and capacity, at a time when we are subject to high levels of public scrutiny, could limit our ability to exploit opportunities and/or realise the full value of investments.

How do we manage these risks?

We have a clearly defined people strategy based on developing the right culture and engagement, talent development, training and reward and recognition.

We regularly review our organisational capability, critical business areas, reward strategies for key skills, talent management and learning and development programmes. We also perform external benchmarking to ensure we are attracting and retaining the talent we need to be competitive.

We engage with trade unions on restructuring and issues that could impact terms and conditions with clear and open processes to promote an environment of trust and honesty.

We provide channels for employees to discuss concerns, including whistleblowing, and regularly review the procedures in place to support them in the delivery and development of their role.

We continually promote wellbeing and equality through processes and campaigns to improve the vitality and fair treatment of all our people.

Looking forward

• Engagement and development of senior management team.
• Identification and succession of British Gas Managing Director and Chief Financial Officer positions.

Related Party Transactions

The Group’s principal related parties include its investments in wind farms and the existing EDF UK nuclear fleet.

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

Â

Â

Â

Â

Â

Â

Â

Â

Â

Â

Â

Â

Â

Â

Â

Â

Â

Â

Â

Â

Â

Â

2014

Â

Â

Â

Â

2013

Â

Â

Sale of goods and services £m

Â

Purchase of goods and services £m

Â

Amounts owed from £m

Â

Amounts owed to £m

Â

Sale of goods and services £m

Â

Purchase of goods and services £m

Â

Amounts owed from £m

Â

Amounts owed to £m

Joint ventures:

  Wind farms (as defined in note 6)

16

(126)

414

(104)

23

(110)

475

(69)

Associates:

  Nuclear (as defined in note 6)

-

(616)

–

(58)

27

(639)

-

(62)

Other

Â

5

Â

(42)

Â

24

Â

(2)

Â

2

Â

(7)

Â

21

Â

-–

Â

Â

21

Â

(784)

Â

438

Â

(164)

Â

52

Â

(756)

Â

496

Â

(131)

Investment and funding transactions for joint ventures and associates are disclosed in note 14. Shareholder loan interest income for wind farm joint ventures in the period was £34 million (2013: £32 million). 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 against amounts receivable from related parties was recognised during the year through the Group Income Statement (2013: £21 million). The balance of the provision at 31 December 2014 was £21 million (2013: £21 million).

Key management personnel comprise members of the Board and Executive Committee, a total of 15 individuals at 31 December 2014 (2013: 16).

Remuneration of key management personnel	Â		Â
Â		2014		2013
Year ended 31 December	Â	£m	Â	£m
Short-term benefits		7.9		8
Post-employment benefits		2.0		2
Share-based payments	Â	0.4	Â	6
Â	Â	10.3	Â	16

Remuneration of the Directors of Centrica plc	Â		Â
Â		2014		2013
Year ended 31 December	Â	£m	Â	£m
Total emoluments (i)		4.7		7
Gains made by Directors on the exercise of share options		3.6		0.3
Amounts receivable under long-term incentive schemes		2.6		–
Contributions into money purchase pension schemes	Â	1.0	Â	1

(i) These emoluments were paid for services performed on behalf of the Group. No emoluments related specifically to services performed for the Company.

Directors’ responsibilities statement

The Directors, who are named on pages 46 and 47, are responsible for preparing the Annual Report, the Directors’ Remuneration Report, the Strategic 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 Act 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.

The Directors consider that the Annual Report and Accounts 2014, when taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Group’s performance, business model and strategy.

Each of the Directors, whose names and functions are listed on pages 46 to 47 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 loss of the Group;

• the Strategic Report contained on pages 2 to 45 together with the Directors’ Report on pages 82 to 84, 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;

• as outlined on page 54, there is no relevant audit information of which PwC are unaware; and

• they have taken all the steps that they ought to have taken as a Director in order to make themselves aware of any relevant audit information and to establish that the Company’s auditors are aware of that information.

Enquiries:

Centrica Investor Relations: [phone]

Centrica Media Relations: 0800 107 7014