Business drivers, risks and opportunities

Business drivers

Our principal activities include the operation of highly complex energy infrastructure networks. As a consequence, there are many factors that influence the financial returns we obtain.

We consider the following to be our principal business drivers:

Price controls and rate plans	The prices we charge for use of our electricity and gas transmission and distribution networks are determined in accordance with regulator approved price controls in the UK and rate plans in the US. The negotiation of these arrangements has a significant impact on our revenues. Their duration is significant in providing stability to our operations, allowing us to plan ahead and invest with confidence that we will obtain financial returns. Our price controls and rate plans contain incentive and/or penalty arrangements that can affect us financially based on agreed performance targets.
Multi-year contracts	Revenues in our Long Island electricity distribution and generation operations are subject to long-term contracts with the Long Island Power Authority. In addition, revenues in our UK metering services businesses and our Grain LNG import terminal are determined by contractual arrangements, which are long term and with ‘blue chip’ customers.
Safety, efficiency and reliability	Our ability to operate safely and reliably is of paramount importance to us, our employees, our contractors, our customers, our regulators and the communities we serve. Our financial performance is affected by our performance in these areas. Our objective is to deliver services as efficiently as possible. This allows us to limit price increases or to reduce prices to our customers and improve our own financial performance to the benefit of our shareholders.
Customer service	The quality of the service we deliver to customers, and the experiences that they have in dealing with us, whether through routine interactions or when problems arise, is important as it feeds through to the attitudes of regulators and is also linked to our financial performance.
Capital investment	Capital investment is a significant driver for organic growth. In our regulated energy networks, the prices we charge include an allowed return for capital investment determined in accordance with our price controls and rate plans. These provide incentives for us to enhance the quality and reach of our networks through capital improvements. For other businesses, our capital investment in new assets allows us to develop new revenue streams or to increase revenues from existing assets.
Other investment	Investment in new businesses is also a significant driver of growth, provided we can create value through operational improvements, synergies and financial benefits. Disposals can crystallise value for shareholders, where we believe the price on offer is better than the long-term return we can obtain ourselves or where a business does not fit with our long-term strategy.
Relationships and responsibility	Our reputation is vitally important to us. Delivering sustainable value depends on the trust and confidence of our stakeholders and this can only be earned by conducting our business in a responsible manner.

A number of other factors also affect our financial performance but are either less significant than our principal business drivers, or are mitigated by the way our operations are structured:

Weather and volumes	Changes in the quantities of electricity and gas delivered through our transmission and distribution networks may result in an increase or decrease in our revenues. Volumes are affected by weather, consumer demand and network availability as well as other factors. The impact of changing volumes may sometimes be offset by changes in costs or may sometimes result in an under- or over-recovery against our allowable revenues, with a corresponding increase or decrease in revenues in future periods.
Seasonality	Revenues from our gas distribution networks in the US are weighted towards the end of the financial year, as gas demand is typically higher during the winter months. This has also been the case for our gas transmission and distribution networks in the UK, but our current price control arrangements are less seasonal in nature. Otherwise, seasonality does not have a significant impact on revenues. With the exception of commodity and other volume-related costs passed through to customers, our operating costs are generally not seasonal.
Exchange rates	The reported results, cash flows and financial position of our US operations are affected by movements in the US dollar to sterling exchange rate. However, we hedge a proportion of this exposure through the use of US dollar debt and derivative financial instruments.
Commodity and other pass-through costs	We are allowed to recover commodity costs in the US and certain other direct costs in both the UK and the US, through charges to customers. The timing of recovery of these costs can vary between financial periods leading to an under- or over-recovery within any particular financial period. We are affected by commodity prices to the extent that they affect our own energy requirements, most significantly gas purchases for the operation of our gas transmission and gas distribution networks in the UK. The discontinued Ravenswood generation station was also affected by commodity prices, in particular the spreads between prices for the electricity it generates and the prices of the gas and oil it uses as fuel. Certain US commodity contracts are recorded in our balance sheet at their fair values. Although remeasurements of their contract values are reflected in our income statement, we expect to recover the net costs incurred under these contracts from customers in current or future periods.
Inflation	Without action to improve efficiency, our operating costs increase each year as a result of wage increases and inflation in external costs. In general, our revenues also increase each year, although not necessarily at the same rate, depending on our regulatory or contractual arrangements. As a consequence, our ability to control costs and improve efficiency is important to our ability to increase operating profits. Our price controls in the UK are linked to retail price inflation, as is a proportion of our UK borrowings, while certain of our electricity and gas regulatory settlements in the US allow us to recover additional distribution revenues from customers if there is a significant change in the rate of inflation.
Interest rates	The costs of financing our operations are affected by changes in prevailing interest rates, as some of our debt is at floating rates. We hedge some of our exposure to interest rates with fixed-rate debt and derivative financial instruments to maintain a proportion of our debt at fixed interest rates.

Risks and opportunities

We believe that the principal opportunities to achieve our vision and to deliver growth in shareholder value have been identified in our strategy and objectives.

Conversely, we risk failure in achieving our vision and in delivering growth in shareholder value if we do not fulfil our strategy or if we fail to achieve our objectives.

Delivering our strategy	We believe that by implementing our strategy and transforming National Grid, we will be able to deliver increased value to our shareholders. Conversely, if we do not achieve this transformation, or the benefits in efficiency and effectiveness are not achieved, then shareholder value will not grow as we hope or will diminish.
Operating performance	The operating profits and cash flows we generate are dependent on our operating performance – operating safely, efficiently and reliably and providing a quality service to customers. Our future growth is dependent on the delivery of our capital investment plans.
Talent	The skills and talents of our employees, and their motivation and dedication, are critical to the achievement of our objectives. Failure to develop our existing employees or to attract and recruit talented new employees could hamper our ability to deliver in the future.
Relationships	Our relationships with our stakeholders are critical to our future success. Maintaining these good relationships is dependent on focusing on the areas that are important to them, such as the quality of service we provide to customers, the quality of information we provide to regulators and the way we address the concerns of, and interact with, all our stakeholders.
Environment	Safeguarding our global environment for future generations is dependent on integrating sustainability and climate change considerations into our business decisions, influencing legislators and regulators to reshape energy markets to meet the climate change challenge and helping and supporting our employees, customers and suppliers in changing their behaviour to be more considerate of the environment.
Financial performance	Strong financial performance and operating cash flows are the basis for funding our future capital investment programmes, for servicing our borrowings and paying dividends, as well as for increasing our value to shareholders.
Responsibility	Strong corporate governance is essential to operating responsibly and the achievement of all our objectives. Our reputation as a responsible business is dependent on ensuring all our behaviours are lawful and ethical, on complying with our policies and licences and on living up to our core values. If we do not live up to these high standards we could be exposed to adverse financial or other consequences.

We set out how we intend to achieve our objectives and the progress we have made during the year against our objectives in our performance summary and performance against our objectives sections.

Risk management

Our approach to risk management is described in the Corporate Governance section. This sets out how we have established an enterprise wide risk management process with the objective of identifying risks that could have an adverse impact on National Grid.

In addition, information on how we have addressed certain of our financial risks is included in the financial position and financial management section of this Operating and Financial Review.

Risk factors

Through our risk management process, we have identified a number of significant risks and uncertainties in achieving our objectives as follows:

changes in laws or regulations;
breaches of environmental or health and safety law or regulations;
network failure or inability to carry out critical non-network operations;
achievement of business performance objectives, including regulatory targets and delivering anticipated cost and efficiency savings;
business development activity, including acquisitions and disposals;
regulatory treatment of commodity costs passed through to consumers;
reputation damage from disruptions to supply, even if outside our control;
fluctuations in exchange rates, interest rates and commodity prices and their impact on borrowings, derivatives and commodity contracts;
restrictions in borrowings, adverse changes in the global credit markets and changes in credit ratings or in tax rates;
future funding requirements of our pension schemes;
changes in accounting standards;
consumers, suppliers or other counterparties failing to perform their obligations; and
impact of seasonal or weather-related fluctuations.

Not all of these factors are within our control and, in addition, there may be other factors besides those listed that may have an adverse effect on National Grid.

These risk factors are described in more detail within the Corporate Governance section.

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