National Grid plc (NYSE:NGG) Q2 2023 Earnings Conference Call November 10, 2022 4:45 AM ET
Company Participants
Nick Ashworth – Director of Investor Relations
John Pettigrew – Chief Executive Officer
Andy Agg – Chief Financial Officer
Conference Call Participants
Martin Young – Investec
Mark Freshney – Credit Suisse
Dominic Nash – Barclays
Ahmed Farman – Jefferies
Verity Mitchell – HSBC
Jenny Ping – Citi
James Brand – Deutsche Bank
Sam Arie – UBS
Nick Ashworth
Good morning and welcome to National Grid’s Half Year Results Presentation. I’m Nick Ashworth, Head of Investor Relations and it’s great to have so many of you on the call today.
Firstly, please, can I draw your attention to the cautionary statement at the front of the pack. As usual, a Q&A with John and Andy will follow the presentation. So please, can you join via the conference call to ask a question. All of today’s materials are available on our website and for any further queries after the call, do feel free to reach out to me or one of the IR team.
So with that, I’d now like to hand you over to our CEO, John Pettigrew. John?
John Pettigrew
Thank you, Nick. Good morning, everyone and welcome to the call. As usual, I’m here with Andy Agg, our CFO. And following our presentations, we’ll be very happy to take your questions.
The strong results we’ve announced today alongside our upgraded 5-year financial frame reflect the resilience of our business during some of the most turbulent and challenging economic conditions we’ve seen in years. Between April 2021 and March 2026, we now expect to invest up to £40 billion, up from the £30 billion to £35 billion we originally expected. Of this, £29 billion will support the decarbonization of our energy systems. This will deliver asset growth of 8% to 10% per annum, drive average underlying earnings per share growth of 6% to 8% per annum, whilst maintaining our strong balance sheet and attractive dividend.
Our investment in critical infrastructure is fundamental to the successful delivery of decarbonization, greater security supply and improved affordability for customers. And our focus on these areas is creating significant opportunities for us today and will drive our growth long into the future. In the near term, as we head into the winter, affordability is understandably front of mind. We’ve continued to progress our 3-year cost efficiency program, delivering a further £85 million of savings in the first half on top of the £140 million last year. This is helping us keep our parts of the bill as low as possible whilst delivering asset growth over the 3 years of around 30%.
At the same time, we’ve taken steps to help our most vulnerable customers who needs additional support right now. We’ve announced that we’ll provide £65 million to families most in need of support in the U.K. and the U.S. to help them with their higher energy bills over the coming 2 winters. This is in addition to the accelerated return of £200 million of interconnected revenues that we announced back in May.
Despite this backdrop, we’ve continued to make excellent progress to deliver on our key strategic priorities during the first half. In May, we completed the sale of our Rhode Island business. We’re also on track to complete the sale of a 6% stake in our U.K. Gas Transmission business to a Macquarie-led consortium by the end of this calendar year. As part of this regulatory clearance, the CMA is expected to complete its review at the end of November. The consortium also has an option on the remaining 40% on broadly similar terms.
Following the acquisition of Western Power Distribution in June of last year, we made good progress in integrating it into the wider group and have renamed the business National Grid Electricity Distribution. The conclusion of our strategic pivot repositions our portfolio towards electricity and gives even greater visibility to our growth trajectory over the long term.
So turning to our financial performance. Whilst reported results are elevated in the first half given structural changes to our portfolio, I’m really pleased with the performance of the business. On an underlying basis, that is excluding the impact of timing, exceptional items and the contribution from Gas Transmission & Metering which is classified as a discontinued business, operating profit in the first half was £2.1 billion. This reflects a full 6 months of contribution from both the U.K. Electricity Distribution and our NSL interconnected to Norway, the planned property sales to Barclay Group which formed part of the sale of our St William joint venture in March as well as improved operational performance across all of our regulated networks.
Excluding the timing impact of owning U.K. Electricity Distribution for longer and the property sales, underlying operating profit was up 8% compared to the first half of the prior year at constant currency. Underlying earnings per share was 32.4p and we now expect full year underlying EPS to be in the middle of our new 6% to 8% growth range.
Capital expenditure for our continued operations was £3.9 billion, 26% above the prior year, reflecting a full 6 months of U.K. Electricity Distribution, higher investment across both New York and New England and in National Grid Ventures, higher investment on the Sellindge converter station rebuild, our Viking interconnector and our Isle of Grain expansion project. And in line with our policy, the Board has proposed an interim dividend of 17.84 per share, reflecting 35% of last year’s full year dividend.
Turning next to our safety and reliability performance. Safety, as always, remains a critical focus across the business. In the first 6 months, we saw a slight improvement in our injury frequency rate to 0.12 but still behind our target of 0. million. Following this tragic event in Massachusetts in May, where a U.S. employee lost his life, we’ve redoubled our efforts to reduce safety incidents and implemented further learnings through an updated safety strategy rolled out across the group.
Moving to reliability which has remained excellent across our U.K. and U.S. networks. In the U.S., we’ve seen fewer storms than last year. The few we’ve had only impacted a small number of customers with everyone reconnected within 25 hours. In the U.K., we’ve managed well through the summer despite the volatility of energy markets. This demonstrates the effectiveness of new tools in the electricity system operator is using which support both the energy transition and the reliability of our networks today.
And I’m sure many of you would have seen the winter outlook published last month. Given the uncertain outlook for gas this winter across Europe, both the electricity and gas system operators have set up not only the base scenarios but also provided additional downside cases. With regards to the electricity system operator, its base scenario forecasting electricity capacity margin of 6.3%, a similar level to recent winters and within the required reliability standards. The gas system operator is forecasting available peak capacity of over 600 million cubic meters per day compared to a 1-in-20-years peak demand of 480 million. We’re confident of delivering our usual high standard reliability across our engine networks in the months ahead and remain vigilant as we move through winter in both the U.K. and the U.S.
Moving now to the operating performance across the business, starting with U.K. Electricity Distribution. I’m really pleased with the performance of the business since we acquired it in June last year. I’ve seen firsthand the passion and knowledge the team brings to delivering for its customers which I’m convinced will help to drive further improvements to performance across all our businesses. Capital investment reached £584 million in the half, following a 10% increase in new customer connections driven by low-carbon technologies. And as we approach the end of ED1, our key priority is to reach a settlement on the ED2 price control.
At the end of June, we received the draft determination and we’re working with Ofgem on 4 key areas: first, streamlining the number of uncertainty mechanisms to reduce complexity and allow for efficient investment; second, to agree more symmetrical incentives, having seen the significant customer service benefits of these in ED1; third, narrowing the gap on Ofgem’s proposed 19% reduction to our expenditure so we can deliver the outcomes our customers have asked us for; and last, given the macroeconomic situation and critical need for investment, we must reach a sensible outcome on the financing package, in particular, a fair allowed cost of capital that reflects the higher cost of equity and debt we’re now seeing in the market.
Moving on to our U.K. Electricity Transmission business. We made good progress with our capital program, investing £629 million in the first half. This increased investment was principally due to higher spend on our £1 billion London Power Tunnels project as we undertake our first full year of tunnel boring work under our initial overhead line projects as part of our East Coast reinforcement program, starting with the Branford to Norwich circuit. We’ve also continued to make good progress on our Hinkley C connection project which is now over 75% complete and on track for full completion by December 2024.
On the regulatory front, in August, the ESO published the first holistic network design which lays out a plan for a coordinated onshore and offshore network to efficiently meet the government’s ambitious targets for 50 gigawatts of offshore wind. I’ll come back later and talk about the key decisions needed in the next 6 months to allow us to support the government in its aims.
Finally, in the U.K., gas transmission continue to be reported as a discontinued operation following the announced sale. The business has continued to perform well with capital investment of £174 million, up 33%, reflecting higher spend on asset health and in line with our RIIO-T2 regulatory allowances.
Now before moving on to the performance of our U.S. businesses in the first half, I want to spend a moment on the Clean Energy Vision we launched earlier this year. As those of you who attended our investor event in Brooklyn know, we envisage a fossil-free future for our networks by 2050. We’re targeting a hybrid electric and clean gas approach that will utilize the gas networks, provide continued security supply and allow customers to have a choice, all whilst keeping customer bills lower than an all-electric alternative. I’m pleased that we’ve had such a positive response from policymakers, regulators and local communities to this vision.
So focusing first on New York. Our capital investment program at over £1.2 billion during the half was 27% higher at constant currency. This was largely driven by increased resilience and storm hardening spend as well as large-scale renewable connection projects such as the SmartPath Connect project, where we’re upgrading 110 miles of transmission lines in Upstate New York. Our leak-prone pipe replacement program continued on track with 123 miles of pipeline replaced.
On the regulatory front, in July we received approval to proceed with the Phase 1 projects under the state’s Climate Leadership and Community Protection Act, or CLCPA. This represents around $600 million of investment before 2030, including projects such as the 129 miles of circuit rebuild in our Niagara Mohawk service area to support incremental renewable generation capacity. And by the end of this year, we also anticipate a response on the CLCPA Phase II order which includes a further $2 billion of investment to enable over 2 gigawatts of renewable generation in Upstate New York.
Moving across to New England. It’s been a busy regulatory period for us. In September, the Massachusetts regulator approved our annual rate adjustment for electric of $44 million and for gas of $64 million. These rates became effective at the beginning of October. Also in September, the DPU approved our 5-year demonstration program for community ground source heat pumps and we aim to select a first site by the end of the year. And in October, the DPU approved just over $300 million of investments as part of our grid modernization plan.
In the period, capital investment grew by 7% at constant currency to £862 million due to increased asset condition work in electricity distribution and transmission, continued leak-prone pipe replacement with 71 miles delivered in Massachusetts in the half. This growth was partially offset by lower investment in Rhode Island as we completed the sale to PPL at the end of May.
And finally, moving to National Grid Ventures, where capital investment reached £478 million, up £181 million in the prior period. This reflects progress on the Sellindge converter station rebuild, expansion work on our Isle of Grain LNG facility, continued construction of the Viking Link with 558 kilometers or 73% of the cable now laid and increased investment in renewables with a construction of over 670 megawatts of solar projects in the U.S. Elsewhere, we continue to make progress on our multipurpose interconnectors and the case for further network integration to European countries through offshore wind farms. And in the U.S. our offshore wind joint venture with RWE has been developing proposals that we expect to submit to New York State in January as part of their third solicitation for offshore wind.
So with that operational overview of the first half, let me now hand over to Andy to take you through the financials before I come back and talk about our priorities for the rest of this year. Andy?
Andy Agg
Thank you, John and good morning, everyone. I’d like to highlight that, as usual, we’re presenting our underlying results excluding timing, exceptional items and the dual results are provided at constant exchange rates. And as a reminder, we continue to report our U.K. Gas Transmission business, including our legacy gas metering business as a discontinued operation whilst we complete the 60% stake sale. As such, all earnings from this segment have been excluded from the underlying earnings of the continuing group.
Before turning to our financial results for the half year, I’d like to start by expanding on the comments John has made about our strong and resilient business model. This is partly driven by the regulatory frameworks we have in place but it goes much further than this. It’s the efficient delivery we drive and the long-term financing strategies that we put in place. Together, these enable us to manage the impact of changes in exchange rates, inflation and interest rates and it’s why we’re able to deliver an attractive balance of growth and yield year after year.
In order to reduce exchange rate volatility from our U.S. businesses and to reduce the exposure of our ratings metrics to changes in FX, we consistently hedge around 70% of our U.S. assets with dollar-denominated debt. This means from an earnings perspective, our general rule of thumb is that for every $0.05 move in the U.S. dollar sterling exchange rate, we expect to see a plus or minus 1p move in EPS on an annualized basis.
Moving to inflation; as we said back in May, in the near term, inflation is broadly neutral to our EPS as higher U.K. underlying operating profit is offset by higher index-linked debt costs. In due course and assuming inflation moderates, U.K. operating profit will benefit from real returns on a higher regulated asset base. This should then translate into improved earnings as the level of index-linked interest costs reduce.
Finally, with interest rates moving higher, we do expect our funding costs to rise as we look forward. Our regulated operating businesses broadly match leverage to our regulatory frameworks which enables us to recover efficient debt costs. We also have just under £12 billion of debt at the holdco level with maturities out to the early 2030s. The higher expected interest cost of this refinancing has been factored into our updated 5-year financial frame.
And so putting all this together, our updated 5-year frame demonstrates the strength of our business model. For the period from April ’21 to March ’26, we now see capital investment for the group of up to £40 billion from our prior guidance of £30 million to £35 billion. As we said in May, inflationary impacts were taking our expected CapEx to the top end of our prior range. This has now been further increased by a stronger U.S. dollar and incremental confirmed investment for the energy transition. This higher level of investment will increase our asset growth CAGR to 8% to 10% over the period and drive a higher EPS CAGR of 6% to 8% from the FY ’21 baseline. And we continue to aim to grow the dividend in line with average CPIH.
Importantly, these high levels of investment and growth can be delivered whilst credit metrics remain within the bands required to maintain our strong investment-grade credit rating. Indeed, once the transactions are complete, even with higher levels of investment, we expect net debt to RAV of around 70%. Nearer term, as well as updating our 5-year financial frame, we’re also upgrading our FY ’23 EPS guidance. We now see underlying EPS for this year growing in the middle of our new 6% to 8% CAGR range based on our assumption of an average U.S. dollar exchange rate of 1.2% for the year and after taking into account the new winter support package that John talked about earlier. As well as the move in FX, we are also seeing an improvement from higher capitalized interest as rates have increased as well as some improvement across our interconnected portfolio and from higher fuel gas income at the Isle of Grain across our National Grid Ventures division.
So turning to our half year performance. Underlying operating profit on a continuing basis increased by £647 million to £2.1 billion. This increase in operating profit was mainly driven by a full 6 months of earnings in the period from U.K. Electricity Distribution following its acquisition in June 2021, the completion of property sales following the sale of our stake in the St. William joint venture to Barclay Group, a higher interconnector contribution following the commissioning of our Norwegian interconnector, NSL, in October 2021 as well as good underlying performance across our regulated businesses.
Higher operating profit, partially offset by a rise in interest costs, has resulted in underlying earnings per share increasing by 42% to 32.4p, Capital investment from continuing operations was markedly up to £3.9 billion, 26% higher than the prior year. This reflects the full 6 months inclusion of U.K. Electricity Distribution capital investment this period as well as higher noncash lease additions in New York and New England. In line with our policy, the Board has proposed an interim dividend of 17.84p per share, representing 35% of last year’s total. Scrip uptake in the summer on the full year dividend was 9% and will again be offering the scrip option at the half year.
Now let me take you through the performance of each of our business segments, starting with U.K. Electricity Distribution. Underlying operating profit was £579 million, up £322 million from the prior year. This was largely driven by the additional 2.5 months of earnings this year alongside higher index revenues and a small gain on disposal of its smart metering business. Capital investment increased to £584 million for the half year, an increase of £269 million compared to the prior period. We’ve achieved network reliability of 99.995% and have the industry-leading broad measure customer satisfaction score of 9.01 out of 10 across our 8 million customers.
Moving to Electricity Transmission, where underlying operating profit was £564 million, up £12 million compared with the last half year. Whilst we’ve seen a good first half performance, as we announced back in May, we returned £69 million related to the Western Link settlement in the period. Capital investment was £629 million in the period, delivering system resilience, asset health and new connections. And we’re making good progress on our significant capital projects with tunnel breakthroughs at London Power Tunnels 2 and the installation of new [indiscernible] at our Hinkley Connection project. Finally, in the U.K., the electricity system operator saw underlying operating profit up £3 million in the period to £52 million.
Moving now to the U.S., where underlying operating profit for New York was £202 million, £40 million higher than the prior year. This reflects higher revenues through our rate case settlements and our successful efforts to recover COVID costs from prior periods, partially offset by higher environmental provisions. Capital investment was £1.2 billion, £264 million higher than prior year at constant currency. £150 million of this increase was driven by noncash lease additions which are not expected to be repeated in the second half.
Turning to New England. Underlying operating profit was £316 million, £32 million higher than the prior period. This reflects higher rates in our Massachusetts gas business under its new rate settlements and the annual performance-based regulatory reset in our Massachusetts electric business, partly offset by the disposal of Rhode Island in May resulting in 4 months or about a £60 million lower contribution. Capital investment was £862 million, £58 million higher than prior year at constant currency. This was driven by around £150 million of additional investment in Massachusetts, offset by lower levels in Rhode Island given its sale in the period.
National Grid Ventures continue to perform well with underlying operating profit, including joint ventures, up £133 million to £331 million in the half year. This primarily reflects the contribution from our Norwegian interconnector which commissioned in the second half last year; increased profit at the Isle of Grain driven by higher fuel shrinkage income; and insurance proceeds received following the 2021 fire at our converter station in Sellindge. The rebuild of the IFA asset is on track with 500 megawatts of the 1-gigawatt off-line due back this month and the remaining 500 megawatts expected to return to service in December 2022. This results in 2 gigawatts of expected available capacity going into this winter. Capital investment across National Grid Ventures increased £181 million to £478 million in the period.
Operating profit for other activities for the half year was £145 million, £130 million higher than last year. This is principally driven by property sales completing in the first half as part of the St William transaction, partially offset by fair value losses at National Grid Partners given adverse market conditions. Capital investment was £46 million, broadly flat on the prior year.
As John said, we expect to complete the sale of a 60% stake in our Gas Transmission & Metering business by the end of the calendar year. We therefore continue to report this segment as discontinued. For the period, operating profit excluding timing was £381 million. This was £49 million higher than the prior year, largely driven by the cessation of depreciation as the business is treated as held for sale. Capital investment was £174 million, £43 million higher than the prior year.
Net finance cost was £732 million, up £221 million, primarily driven by index-linked debt given higher levels of inflation in the period. This period also included an additional 2.5 months of U.K. Electricity Distribution and bridge facility financing costs. The underlying effective tax rate before joint ventures was 19.7%, 70 basis points higher than the prior year. For the full year, the underlying effective tax rate, excluding the share of joint venture post tax profits is expected to be around 22%. Underlying earnings were £1.2 billion with EPS at 32.4p, up 42% on the prior year.
Moving now to cash flow. Cash generated from continuing operations was £2.4 billion, up 16% compared to the prior year. This reflects the full 6 months contribution from U.K. Electricity Distribution and the sale of property sites to the Barclay Group in the half year. Net cash outflow in the period amounted to £3.1 billion given higher levels of capital investment and high levels of cash dividend given the lower scrip uptake. Net debt increased by £3.7 billion to £46.5 billion, with a stronger U.S. dollar accounting for £3.4 billion of this. The remaining net cash outflow was broadly offset by proceeds from the sale of Rhode Island. For the full year, net debt is expected to reduce by £5 billion from this September level, assuming a US$1.2 exchange rate driven by the expected receipt of sales proceeds from Gas Transmission & Metering as well as the sale of our interest in the Millennium Pipeline.
Finally, I want to touch on our debt structure. As of September, our split of net debt is 71% fixed, 19% floating and 10% index-linked. As we close the sale of Gas Transmission and continue to pay down and refinance the bridge loan that we’ve had in place since the acquisition of Western Power, we would expect the level of floating rate debt to be more in line with levels pre transactions at around 10%. We remain comfortable with our funding requirements which are on average between £5 billion to £6 billion per annum. And in the first half, we’ve already completed £4 billion of bond financing.
So to summarize the first half. We’ve shown that we have a strong and resilient business model and performed well against a volatile economic environment. Demonstrating this, we’re upgrading our 5-year financial framework as well as upgrading our earnings outlook for FY ’23.
With that, I’ll hand you back to John.
John Pettigrew
Thank you, Andy. The next 6 months is shaping up via defining period where decisions will be made which could have lasting repercussions around the speed and the cost of delivering clean, secure and affordable energy and with it, whether ambitious climate goals are met over the next decade. As one of the biggest investors in delivering net zero, we are vital to the continued safety and resilience of our networks today, whilst enabling the clean energy of tomorrow. Our foremost priority for electricity distribution is to agree a settlement for ED2 that will come into effect in April 2023.
In Electricity Transmission, we’ve presented Ofgem and government with clear plans through to the end of the decade on the network reinforcements needed to deliver offshore wind and we expect decisions on this over the coming months. As you know, the government has set a target to deliver 50 gigawatts of offshore wind capacity by 2030 and a fully decarbonized electricity system by 2035. The scale of this challenge is enormous. It requires the industry to deliver over 5x the amount of electricity transmission infrastructure in the next 7 years that has been built in the last 30.
The holistic network design I referred to earlier lays our plans to connect this 50 gigawatts. It’s identified 19 major onshore transmission projects in our service territory. Delivering all of these projects would mean a potential investment of £14 billion. Alongside this, Ofgem recently published an open letter as part of its initial engagement process ahead of the next RIIO price control period. We agree that now is the right time to test whether the current regulatory framework is appropriate to meet the strategic challenges facing our energy systems. But it’s clear that to have any hope of hitting the U.K.’s ambitious targets, we need ever greater collaboration between industry, the U.K. government and Ofgem with a relentless focus on delivering.
We’ve been clear with Ofgem and BEIS that urgent progress is needed in 5 areas. First, industry requires commitment on the infrastructure needed to be delivered so that the supply chain has the certainty it needs to scale up and deliver at pace. Second, we need a regulatory framework that allows for anticipatory investment. Without this, industry will continue to face long connection queues and significant constrained costs. Third, urgent planning reform is needed to reflect the scale of the U.K.’s net zero ambition and the urgency in which investment is needed. Fourth, clear long-term economic benefit is needed for communities when new infrastructure is built. And finally, an agreement on key parameters of financial framework that fairly represents the proportionate risk and reward of the work required.
We’re actively engaged in discussions with government and Ofgem as the regulator looks to make final decisions on the East Coast projects by the end of the calendar year. And as we think about the regulatory framework for RIIO-T3. Now is the time for action. Any delay in decision-making or failure by Ofgem to put appropriate regulatory frameworks in place here or with ED2 will increase the risk of the U.K. missing its targets and could ultimately increase the cost of the energy transition in the long run.
So moving now to our U.S. priorities. We’ve developed a very collaborative and constructive relationship with Governor Hoch [ph] in New York. We look forward to continuing to work with her following the reelection earlier this week. Our priority will be to develop a similar relationship with Governor Healy following her election in Massachusetts. And as we look to the coming winter and beyond, our focus remains on delivering safe, affordable and reliable energy for our customers while also working to develop the pathways and regulatory frameworks that are going to be needed for a clean energy future in the U.S. Northeast.
From a regulatory perspective, there’s a lot to achieve as we look to the second half of this year. In Massachusetts, the approval for up to $400 million of advanced metering infrastructure funding will deliver a full-scale rollout of smart meters across our customer base. In addition, the DPU approval of our Massachusetts Phase II electric vehicle filing which is a $275 million full year proposal to deliver up to 32,000 public workplace and residential EV ports. And we’re actively engaging with the DPU for approval of these filings by the end of 2022.
In New York, we’re already working on our 2024 KEDNY and KEDLI rate cases which we expect to file next spring. And across the U.S. Northeast, we’re advocating we’re working with all stakeholders on progressing our clean energy vision. In December, the New York State Climate Action Council is expected to make its policy recommendations on the role of gas networks in meeting the state’s net zero targets. These recommendations will be followed by consultations, regulatory processes and legislation and we’re closely engaged in the debate.
And in Massachusetts by the end of the year, the DPU is expected to issue an order on the role of gas distribution companies in achieving 2050 targets. We’d been vocal in our views around the customer benefits of the hybrid solution and are actively working with all stakeholders to make this a reality.
At the federal level, the Infrastructure Investment and Jobs Act and the more recently announced Inflation Reduction Act are supporting the energy transition in the U.S. The latter includes the largest funding package targeted at energy in U.S. history. The act will see investment of $369 billion, incentivizing over $1 trillion of investment in domestic energy production, electrification and clean energy manufacturing over the next decade. By lowering the cost of technologies like hydrogen and renewable natural gas, the act lends support to our clean energy vision for a fossil-free future by increasing affordability of decarbonization goals. The act also supports our priorities in Nashco Ventures [ph], where we’re working with others on the Northeast hydrogen hub centered around our assets on Long Island.
Now before I finish, I just want to touch on our Responsible Business Charter which we launched 2 years ago. Delivering as a responsible business is incredibly important to me as the CEO of National Grid. Since its release, we’ve updated you on our progress via the publication of 2 responsible business reports. Whilst I’m pleased with the progress that we’ve made, we want to go further. In 2023, we’ll be launching the next iteration of our charter, revising a number of our targets and strengthening our ambitions where appropriate. I look forward to sharing this with you in the first quarter.
So in summary, this has been a period of significant progress alongside strong financial performance. Our underlying resilience in challenging economic conditions is demonstrated by the upgrades we’ve made today to both our near-term earnings outlook and our 5-year financial framework. As we’d hear from world leaders at COP27 this week, investment in the clean energy transition is the way out of this current crisis. Connecting clean energy at scale and at pace will bring consumer bills down increased resilience in energy security and, of course, will be key to achieving the net zero goals.
That’s why the opportunities in front of National Grid are so exciting and reinforce the vital role that we have and making the energy transition happen. The next 6 months will be pivotal to determining the speed and scale of network investment over the next decade. And as we gain clarity, we’ll update you on the long-term plans in the first half of next year.
So with that, Andy and I will be happy to take your questions.
Question-and-Answer Session
A – John Pettigrew
Okay. So let’s make a start on questions. So I’m going to start with Martin Young from Investec and then I’ll go to Mark Freshney from Credit Suisse after that. So Martin, would you like to ask your question?
Martin Young
A couple of questions. The first 1 is to sort of pick up on what you’ve been alluding to by one of your long-term picture. You put a number on what those onshore projects might entail in terms of CapEx if they all come to fruition. But obviously, there’s the offshore network transmission review that’s ongoing. You talked a bit about the U.S. If I were to try and sort of stitch that all together and I know it’s early days, should we be looking at a ballpark number of about £8 billion of investments per year from 2027 onwards? And given that it’s not just about wires, it’s about the whole value chain, what else do we need from the politicians given that some of the things that are being talked about could actually be an impediment to the speed at which renewables are brought on if the investment landscape is somewhat muddied by revenue caps and/or windfall taxes?
And then the second question really sort of gets to the situation that we could be facing this winter. I hear what you say about the ESO putting out a range of scenarios. They obviously have a number of tools at their disposal to make sure that the lights stay on. But I’m conscious of reciprocity with our neighbors in Europe. What happens in terms of the redistribution or the recharging of balancing market costs to our friends on the continent if we believe to help them out over winter. It seems possibly a little bit unfair that British consumers to face higher charges if we’re helping somebody else has. So any sort of high-level comments that you might have on that, please?
John Pettigrew
Okay. Thank you, Martin. Two big questions. Let me have — let me deal with both of those. So first, in terms of just the longer term view on investment. Well, let me just start by just reiterating. So today, the first thing we’ve done is to set our expected investment until 2026 which is an increase from the £30 billion to £35 billion to £40 billion. So that’s a substantial increase in investment that we’re making. As we look longer term to the targets that are set for 2030 and beyond and we have — as we’ve said historically, we expect to see continued levels of high investment, I think it’s a little bit early to start to determine exactly what that looks like on a year-by-year basis. And you would have seen in my speech that I said that once we got a bit more clarity which I think we’ll get over the next 6 months, we’ll be able to update the market.
I mean, in the U.S., we’ve got a pretty big rate filing in KEDLI and KEDNY, so we need to work through that and make sure that we understand what the CapEx of that. We’ve got a number of transmission projects that we’re seeing starting to develop in the U.S. as well. In the U.K., obviously, we’ve got the outcome of ED2 and making sure that we get a landing on that. And Ofgem are currently consulting on the regulatory framework for the onshore transmission related to the 50 gigawatts. So we’ve got a lot of information that’s going to be a lot clearer in 6 months’ time than we have today. but there’s no doubt that the investment that we’re seeing between now and 2026 is going to continue into the long term.
In terms of impediments, again, I think I said out in my speech that over the next 6 months, there are some key decisions that need to be made. One of the key ones is being clear on the regulatory framework for the onshore transmission work that will support the 50 gigawatts. And Ofgem obviously are consulting a lot at the moment and have set a target of the end of this calendar year to make a decision. That’s important. So we know who is doing the work, whether it’s ourselves, whether it’s going on to competition, whether it’s the Scots.
On top of that, I’ve mentioned the fact that anticipatory investment is going to be really important if we’re going to accelerate the energy transition and things like the planning process as well are in that. Again, the U.K. government set a target to reduce the planning process by half. We’re very supportive of that. We’re responding to the consultation on it. And then finally, community benefit is going to be important as well. So many communities are going to be hosting infrastructure on behalf of the U.K. and there’s a consultation out on that. So there’s some key decisions that need to be made in the next 6 months which will give us a lot more clarity about exactly what investments we’re being asked to do and in what time frames we’re being asked to do them.
In terms of the winter, so let me just reiterate, our position hasn’t changed from the winter outlook report that we published by the electricity system operator and the gas system operator a month or so ago. So for electricity, our expected view is that there is sufficient generation to meet demand. Plant margin is about 6.3%. Those that are close to this will know that’s very similar to what we’ve seen in previous winters. And on the gas side, there’s about 600 million cubic meters a day available against a 1 in 20-year peak demand of about 480 million. So again, plenty of gas available. Quite rightly as a prudent system operator, as you’d expect, with everything that’s going on in Europe and with the Russian-Ukraine situation, they’ve set out and downside scenarios. But to be clear, they’re not what they’re expecting. What they’re expecting is there sufficient generation to meet demand.
In terms of the interconnectors, I mean, one of the fantastic things about interconnectors is they do flow both ways. And therefore, they provide support to Europe when Europe needs support and vice versa. I suspect that will continue this winter as it does in other winters. So the good thing about them is the peaks on the systems are different. And therefore, the ability and the flexibility they provide to import part of day and export other parts of the day is really valuable to the system operator. So I think it’s just worth remembering that we get benefits when they’re exporting to us and they get benefits when exporting to them and that’s a really valuable tool, I think, for us this winter.
Okay. Why don’t I go to Mark Freshney at Credit Suisse. And then I’ll go to Dominic Nash at Barclays.
Mark Freshney
John, can you hear me?
John Pettigrew
Yes, Mark.
Mark Freshney
I’ve got 2 questions. The first question for Andy. Clearly, borrowing costs for all regulated utilities are the highest they’ve been in 15 years. And you’re talking about things like yield to first call on some hybrids at 8%. You’ve given us a lot of comfort on balance sheet. But can you talk through some of the other measures that you could take if there’s another increase in CapEx guidance. And I’m thinking in terms of asset disposals or alternative sources of finance that you could take.
And secondly, I’ve got a question for both of you on returns going into ED2. I mean, the cost of equity indexation works in your favor but it’s — we’re talking about an 80 or 70 basis point increase in returns on equity when you can see what’s happened to bond yields and share prices. So my question is, why — how confident are you? And what message would you give to Ofgem on the cost of equity going into the 30th of November and getting something on top of the standard indexation for equity and indeed debt?
John Pettigrew
Okay, Mark. Well, why don’t I take the second question and then let Andy take the first one on the borrowing costs. I mean, in terms of ED2, as I said this morning and as you’d expect, since the draft determination, there’s been a huge amount of dialogue between National Grid and Ofgem, as there always is, in discussing all the key parameters that are important to get to a filing decision that’s acceptable. So as I said, we’re working with Ofgem on the uncertainty mechanisms, on the efficiency challenge as well as incentives.
Clearly, with what’s happened in the external market, then part of the conversation we’re having at the moment is around what’s an appropriate allowed cost of equity and cost of debt. We’ve seen what’s happened to the market with risk-free rates and what implications might be for total market returns as well. So I couldn’t say much more other than we’re in ongoing dialogue with Ofgem. We’re expecting to see a final determination at the end of November. And we’d expect to see some response from the draft determination given what’s happened in the market.
Andy?
Andy Agg
Yes. Thanks, Mark. Yes. I mean, just quickly to remind as we set out this morning, the revised 5-year frame with a higher level of CapEx now up to £40 billion through to FY ’26. That takes account of our expectations of higher interest rates feeding through and that’s very much aligned with what we see in the forward curves that are out there today, so just to be clear on that. And again, just there’s no assumption within that or further use of hybrid — you referenced pricing of hybrids at the moment. Clearly, we have a couple within our debt book today. Obviously, we will look to do the right thing with those as they approach first call and so forth. But we have no intention within that 5-year frame of further hybrid [ph] issuance. So that remains available to us. You already have seen this year with the Millenium sale that if the conditions are appropriate and there is value from a shareholder perspective, that we’ll potentially — where there are noncore assets like that. But to be clear, there’s nothing assumed in the 5 years and we’re very comfortable with the frame that we’ve set out and that it is very aligned with our — the metrics that we need to maintain.
And just 2 other quick ones. One is remind you also, we’re driving £400 million of operating cost efficiency through to FY ’25 as well. That’s the program we announced last year. That remains very much on track. So that is clearly a mitigant to some of the higher interest costs. And then finally, I’d just echo John’s point around as we look forward to ED2 and, obviously, future price controls. We’re also working hard with Ofgem around the debt tracker mechanism in the U.K. to ensure that, that tracker appropriately takes account of the higher interest rate environment and the higher levels of CapEx that are expected going forward. So that will be a key point as we look forward to final determinations.
John Pettigrew
Thank you, Mark. So let’s go to Dominic Nash at Barclays and then we’ll go to Ahmed at Jefferies after that. So Dominic, ask your question.
Dominic Nash
A couple of questions from me, So sort of kind of following on from Mark’s question that you kind of answered and didn’t. But I was quite intrigued by your pension position, your — in the back of your report. And it looks to me that you’re putting a discount rate now of 5.35% with inflation of 3.5% which is a huge change from March to September. And so sort of like 2-ish questions around this is, is that — do you think that’s kind of reflective of the change that we’ve seen really since the July draft determination on the increase in returns which is a couple of hundred bps potentially on risk-free? And certainly, did you have a pension liquidity issue because I saw that your assets have fallen quite considerably with the LDI issues in the pension.
And then the second, going back to the Ofgem ED2 number. Could you just remind us again what you asked for going into the determination? And can you just confirm that it’s still a single item CMA referral if it doesn’t meet what you think you need?
John Pettigrew
Why don’t I take the second part Dominic? I’ll Let Andy pick up the first part. I mean in terms of what was in our business plan, I think in terms of return on equity, it was 4.96%, I think, if I remember rightly. And then often, the draft determination came back with 4.75%. In terms of the acceptability of a final determination, I’m going to say what I always say because it’s what we believe which is that ultimately you have to look at the overall package when it comes to a final determination. So as well as what the overall allowed cost of equity and debt is. Also we need to look at things like the speed of cash, we need to look at the incentives and we need to look at things like the uncertainty mechanisms as well.
So, it’s the overall package that will determine its acceptability and whether we can deliver what our customers have asked for us. As you know, in the electricity sector, we do have the ability to go to the CMA on a single item and we did that as part of the transmission fund determination. But ultimately, we won’t be able to make that decision until we see the final determination and the overall package that Ofgem is proposing.
Andy?
Andy Agg
Yes. Dominic, just on pensions, the 2 points in turn. So in terms of the discount rate, yes, you’re absolutely right. So we’ve — from March to September 30, we’ve moved to a discount rate on U.S. and U.K. actually which is consistent at this time of around 5.35. That’s probably 250 basis points up in the U.K. That’s from an accounting perspective, just to remind you, that’s the IFRS accounting that we’re required to adopt. Just to be very clear, from a funding perspective, we’ve seen no significant impact of the recent volatility because although we’ve seen a reduction in the value of our assets reported as of September 30, it’s been offset by a reduction in the liability because of the higher discount rates. So you’ll have seen the numbers this morning, relatively consistent overall pension asset.
In terms of LDIs, you’re right. And again, it’s reported in the income statement. So like pretty much every defined benefit scheme in the U.K., our schemes did have exposure to the LDI issue. It was a relatively manageable amount for us. It was spread across the different schemes. We obviously worked closely with the trustees to ensure that it was managed appropriately. We don’t expect any significant valuation impact from it. And you’ll see that with one scheme, we have extended a short-term loan just to manage through cash flow over the next few weeks and we expect that to be repaid certainly over the next couple of months. So we supported the trustees but no significant issue for us.
John Pettigrew
Thanks, Andy. So why don’t we go to Ahmed from Jefferies and then I’ll go to Verity at HSBC. So Ahmed, if you’d like to ask your question.
Ahmed Farman
I’ve got a few questions, start first, a few — a couple on the guidance. Could you — I think in one of your earlier comments, I think you were mentioning that the increase in the CapEx outlook from the top end of the previous guidance to the current number is a combination of FX and some underlying more investments in projects. Could you just provide some sort of granularity on what’s the breakdown between the two? And then my second question is in terms of FFO to net debt and RCF to net debt, I see this the way you sort of, I think, outline the net debt to RCV on the margin is a sort of slight upgrade in your outlook. And I’m just trying to understand if that’s also the case in some of the more cash flow-based credit metrics. Because I would have thought that the EUR 5 billion or so increase in CapEx, there’s at least £2 billion, £3 billion that slows down to the debt. And just not clear on the other side if there’s sort of some sort of offset on the cash flow metric. So that’s those my 2 questions.
And then the final one on policy. Your presentation clearly sort of outlines the case for accelerated investments and the need to accelerate energy transition. But at the same time, all of this is now coming with arguably a higher cost of capital. The sector also is looking under the current regulation would be compensated for inflation which is also running at a pace high numbers right now. I just wonder how you see that in the context of the current environment where [indiscernible] you’re in a cost of living crisis. And I appreciate the component of the bill that relates to national is really small but nonetheless, it is an environment of intensive affordability. Any thoughts on that would be very helpful.
John Pettigrew
Okay. Let me do the first and the third and then ask Andy to do the second. I mean, in terms of the update in our long-term capital program to £40 billion. I think in May, we talked about being at the top end of our £30 million to £35 million range. And with our latest view, about half of the increase towards the £40 billion is really macroeconomic events which is really exchange rate and inflation. And then second half is just increased clarity around the work that we need to do. So we’ve got more visibility about CLCPA in New York, for example and the transmission work we’re doing there. We’ve got a bit more clarity on some of the early projects that are supporting the offshore wind in the U.K. and the way that we treat connections in WPD which have driven a technical adjustment as well as in there as well. So it’s about half macroeconomic, half increasing work.
In terms of how we think about the investment in the current climate going forward, I think, first and foremost, at a macro level, I’d say that we very much see the resolution of the crisis that we’re in to continue to accelerate the investment towards a low-carbon future. So obviously, high prices, commodity prices for customers is causing a lot of difficulty. And by investing in the networks, that enables us to be able to connect a lot more of the low carbon generation which ultimately will reduce bills for customers, will increase energy independence for the U.K. but will also continue on the path to a low-carbon future.
Clearly, in terms of how we think about it, we need to make sure we’ve got the right regulatory framework in place to support that investment and that is a stable and long-term environment. And that’s one of the things I said is a key decision that needs to be made over the next 6 months. And from an affordability perspective, it’s always worth just reminding people that for electricity transmission in the U.K., for example, we currently are £20, I think, of the £2,500 [ph] of the bills. So although it’s a major capital investment program, actually relative to the current commodity prices that people are experiencing, we keep a focus on making sure that we’re delivering that £20 as efficiently as possible. So that’s how we think about that.
Andy?
Andy Agg
Yes. Ahmed. On the debt and credit metrics points, as you referred to, we updated our view on where we expect leverage to land post the transactions to around 70%. That’s marginally inside what we previously guided to, as you noted, In terms of metrics — credit rating metrics, the ones we target are unchanged in terms of both the 7% for RCF to debt and also the FFO metric. We report those on an annual basis. So obviously, we’ll update the actuals come year-end. But broadly, we’ve got those significant change to update within the 5-year frame. We continue to be comfortable but delivering that CapEx within the metrics that we need to maintain to retain the current credit metrics. It’s the number of drivers. It’s not just the CapEx. Obviously, there’s the impact of FX as our underlying performance. So no change to our overall perspective on credit rating metrics.
John Pettigrew
Okay. Thank you, Andy. So I’ll go to Verity at HSBC and then I’ll go to Jenny Ping at Citi. So Verity, do you want to ask a question?
Verity Mitchell
First is — they’re all in the U.S. actually. The first one is just about that. It looks like from your commentary that you’re going ahead. Could you talk a bit more about the auction in January and also your aspirations to actually be a partner in the investment in this project? And then secondly, just conceptually, as you go from more filings, do you think rocketing bond yields will mean that the U.S. ROEs might go up in future filings? I mean, we’ve talked a lot about U.K. regulation. And then thirdly, just specifics on the Inflation Reduction Act. What could you see coming out in the short term that you could take advantage of in all this funding at a very high level? But anything that you’re working on in the medium term on that.
John Pettigrew
Yes. Thanks, Verity. I’ll take the first and third and Andy take the second. In terms of our partnership with RWE for the offshore wind New York point, then we’re busy at the moment in preparing our response to the solicitations. You’re right. It is due to be submitted in January. And our folks at the moment is making sure that we make the most competitive and compelling proposition to the state on that. In terms of our long-term aspirations, we’ve always said that we will always be very disciplined in the capital investment that we spend is outside of the regulated networks. We’ll continue to apply that discipline. So once we see the response to the solicitation, we’ll have a much clearer view of what the returns are on those investments. And ultimately, it is at that point that we’ll determine whether it’s right to make the capital investment going forward. And we do have the option to be able to pass on that should we need to.
In terms of the Inflation Reduction Act, it’s a huge support mechanism for the energy sector in the U.K. And I think for us, as I mentioned in our speech, I think it creates a lot of opportunities, particularly in areas like hydrogen and our fossil-free vision. We are now moving out of the sort of adequacy phase of describing what that vision might look like and into the action phase which will require things like demonstration projects. So the support that it’s providing to things like renewable natural gas and hydrogen, I think, can only act as wind in the sails of the proposition that we put forward and the vision that we put forward.
And similarly, in National Grid Ventures, we’re doing a lot of work at the moment in collaboration with a large number of players in the Northeast on what hydrogen hub might look like. And again, the support that the act is providing, I think it’s going to be very helpful in that context. I’m not sure there’s going to be immediate short-term benefits but I think in terms of the long-term direction, it is certainly very helpful.
Andy Agg
Yes. Verity, on the return — U.S. returns, yes, I think actually, if you look back over the last few years, despite a long run of reducing interest costs, actually, we’ve seen allowed ROEs sustain at what we think is a sensible level. But you’re absolutely right. If you just look at the methodology which tends to be more prescribed in the U.S., you would expect that rising bond yields to feed through into those calculations as we go forward. It’s obviously too early to say what may or may not happen. I think John mentioned earlier, we’ve got our 2 rate filings downstate in KEDNY and KEDLI due in the early part of next year, Mass electric due in the third or fourth quarter of next year. So that, I think, will be the first time we’ll get to see whether we’re seeing those bond deals feeding through into allowed returns.
John Pettigrew
Okay. So should we go to Jenny at Citi and then we’ll go to Pavan at JPMorgan, please.
Jenny Ping
John, Jenny here. So 3 questions, please. Firstly, you talked earlier about the potential disposal of further on non-core assets if required, such as those of Millennium Pipeline. Can you just outline what — or how you define as non-core? NGT, I guess minority is part of that but is it any other parts of the ventures business? Or how should we think about this? Secondly, can you just give us an update on where we are in your discussion about inflation with Ofgem. They obviously hinted at the draft determination stage that they are thinking about the various different aspects of it but we’ve yet to see a consultation paper from them. So what is the latest dialogue there? And then just following on from Verity’s question about the U.S. ROE. Andy, to your point, we didn’t really see any ROE declines as rates have fallen. So what arguments will you be putting forward to see the reverse of that and actually getting the higher rates to feed through the ROEs?
John Pettigrew
Thank you. I’ll let Andy pick up the first and then I’ll pick up a second 2. So let me start with the inflation with Ofgem. So you’re right, Jenny, we — obviously, we saw that — I was Chairman [ph], as part of the draft determination, raised some relatively technical questions, I think, around inflation and interaction between expected inflation, actual inflation and the real cost of debt. My understanding is that they’re not intending on addressing that as part of the ED2 fund determination and they’ve yet to make a decision on whether to do a consultation.
From our perspective, as you can imagine, in the dialogue, we made it very clear that actually, when you look on a fundamental regulatory perspective in the U.K., inflation is incredibly important and well understood and it’s massively important in terms of encouraging the infrastructure investment that’s needed. Also, it’s really important not to need to react to sort of high inflation in 1 or 2 years. If you look over a 10-year period, actually, there have been long periods in the regulatory cycle, where expected inflation has been lower than — the national inflation has been lower than expected. And therefore, actually, I suspect there isn’t actually a material issue there to be dealt with. So we will be feeding that back to Ofgem over a period of time. But at the moment, there is no consultation and we’ll be reiterating the importance of that stable regulatory framework going forward.
In terms of U.S. ROEs, it varies by state, as you know. So in the New York, it’s relatively mechanistic in terms of how they look at U.S. ROEs. So any changes to the macro environment are ultimately going to feed into the submissions that we make as part of KEDLI and KEDNY and the way that the PSC will look at it. What that means, ultimately, I guess, will be determined when we ultimately make the filing itself. In Massachusetts, they do different approaches. So obviously, we’ll be feeding in the sort of what we’re seeing in the macro environment and what that means for returns. But ultimately, we can only deal with it as we do each of our rate cases and that’s exactly how we’ll approach it.
Andy, noncore?
Andy Agg
Yes. Jenny, yes. I think you referred to comment answer to one of the earlier questions around sort of generic tools. Just to be clear, we’ve — as you’ve seen over the last 12 months with the St. William process to Barclay Group and obviously the more recent Millennium pipeline, if there are attractive opportunities, it’s absolutely right that we consider those if we think that it’s likely to crystallize value appropriately. Just to be clear, post the pivot that John talked about in his presentation, we’re very happy about the portfolio we have and that’s the portfolio that we’re planning to take forward and continue to deliver our investment plans.
John Pettigrew
Okay, thank you. So why don’t we now go to Pavan at JPMorgan, then we’ll go to Sam at UBS.
James Brand
Just had one quick follow-up to Jenny’s, please. Other question on Ofgem and looking at actual risks expected inflation. So did you make any assumption in your guidance about any potential inflation sharing? Or should we not assume that given there’s no consultation in place?
Andy Agg
Yes. Just, Pavan, thanks. Yes, I mean, to sort of — without going through the details, John has just covered it. No. Just to be clear, the 5-year frame is based on the regulatory framework that we have in place today. And obviously, we take account of the inflation curves as we put that guidance together. But no change from what we have and what we’re working with under the current price controls.
John Pettigrew
Should we go to Sam, UBS and then we can go to Bartlomiej at SocGen.
Sam Arie
Great results and a nice sort of upgrade on the guidance. And I think that everyone’s been through kind of most of the questions that we wanted to cover. So I’m scraping the barrel a little bit now. But maybe I could just ask you something about your FX assumptions because that’s been an important part of the update today. I just apologize in advance, this is all written out in your materials but you probably know we’ve got a ton of companies reporting today and we haven’t read all the detail yet. But I think you said you’re using 1.2 for the dollar effect for the rest of this year. And I suppose I just wanted to check, do you then assume that stable at the same level through the 5-year guidance? So, I guess if the pound were to jump back up somehow would that become maybe a bit of a headwind in the future?
And I guess that at the P&L side, there must be — well, I was going to ask, is there a mark-to-market on the U.S. dollar part of the debt that goes in the other direction for you? I think to some of the U.S. dollar debt was about half of the net debt, something like that. Or is the U.S. dollar debt valuation hedged somehow FX? So I wasn’t sure exactly what you do there. And then so the last bit of this is — I guess, I am scraping the barrel. But is it still fair to assume that with the new overall CapEx guidance that the U.S. CapEx plan is kind of indefinitely self-funding? So for example, you won’t be needing to fund U.S. dollar CapEx commitments in the future in pounds, that will make sense and kind of minor questions. I think I have a great update today but thanks for your help on these points.
John Pettigrew
Thanks, Sam. I’ll ask Andy just to cover those off.
Andy Agg
Yes. Thanks, Sam. Just to be clear, so the assumption that we’ve used throughout the 5-year frame is a dollar exchange rate of 1.2x. As you said, that’s slightly above where we are today. But we just — we wanted to be clear and consistent throughout the 5-year frame and that was also the number that we’ve used in terms of our guiding around where we expect net debt to move to in the second half. I mean, back to your question of how significant can the swings be give you an example. So we’ve moved from around 1.35 to around 1.2 average this year versus last year. That’s had a relatively small earnings impact in the first half. But the rule of thumb I mentioned in my presentation is $0.05 is about £0.01, obviously, plus or minus in either direction on an annualized basis. So that’s the sort of the rule of thumb.
And yes, finally, in terms of net debt, the move — the increase — reported increase from March to September, includes about £3.4 billion of FX impact from the strengthening dollar with the closing rate at 30th September been 1.12. So just to give you a few — a sense that how that feeds through. But just a quick reminder, obviously, yes, while debt does mark up with the dollar, obviously, our U.S. dollar assets also significantly strengthened. And that’s the whole purpose of the dollar hedge that we keep in place on a long-term basis.
Sam Arie
Sorry, just maybe, John, can I just one point about the U.S. sale financing?
Andy Agg
Sorry, the second part of your question, yes. Yes, as a reminder, our U.S. opcos, we raised debt within them very much in line with regulatory gearing which is the funding that then predominantly funds the U.S. CapEx. And that is pretty much all dollar-denominated debt. That’s what is very much in line with the regulators’ expectations across our U.S. opcos as I see no expectation of that changing. Obviously, at the holdco level, we issue in a range of currencies, as you will have seen over the years. But we tend to swap that money into either sterling or dollars, depending on where it’s needed. So I see access to a wide range of markets as a sensible part of our funding strategy and we’ll look to optimize which markets we access based on rates at the current time.
John Pettigrew
Okay. I’m going to take which looks like the last question on the call but then I’ve got a couple of questions that have come through online which I’ll take after that. So Bartek [ph], if you’d like to ask your question?
Unidentified Analyst
A couple of things I would like to get a clarification on. Firstly, on the U.S. I’m wondering whether in the short term, let’s say, the next 1, 2 years until you do the next rate filings, you can see a pressure on ROEs coming from the fact that your cost of debt may be increasing much faster or maybe above what has been approved by the regulator. Or the inflation protection does work with the lag or you see some bad debt provisioning increase. I wonder whether there is the potential or likelihood for ROEs in — the actual ROEs in the U.S. to decline. That was my first question.
Secondly, on your FY ’23 underlying EPS guidance, just to clarify whether this winter support, you mentioned £65 million, whether this is included in the underlying earnings or not. And thirdly, you said you have rising cost of debt included in your 5-year guidance. If you can maybe tell us what increase are you assuming over the next 5 years in terms of the cost of debt.
John Pettigrew
All to you, Andy.
Andy Agg
It’s fine. Bartek [ph], thanks for that. Let me take those in turn. Economically, the main thing for us when we’re financing our U.S. OpCos is that we always get a regulatory agreement sort of the issuance plans. We issue with inside those arrangements and therefore, we were entitled to the pass-through treatment. There is, of course, potentially timing lags when we do go to market versus when those rates get trued up. But the key thing for us economically is that we’re then held over time. And so there might be a few months of phasing but we’ve considered that in the 5-year frame and certainly the guidance that we’ve given out for this year.
You asked about bad debts as well. Again, we work — obviously worked very hard work supporting our customers, working with our regulators across the states that we operate in. We’ll have to see obviously as the winter outturns. But again, we — as you’ve seen through the years, we have a number of mechanisms to make sure that as long as we manage the position efficiently, we would expect to recover customer bad debt costs in the years ahead. In terms of the — with support packages, just to confirm, yes, the £65 million is included in the FY ’23 guidance. And then in terms of the 5-year frame, I think as I said in my presentation, we’ve assumed the forward curves feeding through the refinancing of the debt book.
And obviously, the increased financing, I mentioned £5 billion to £6 billion of financing a year, mentioned just shy of £12 billion at holdco level with maturities out to the early 2030s. So that’s all assumed in terms of the refinancing of that book as we go through the 5 years.
John Pettigrew
Okay. Thank you, Bartek [ph]. So I’m going to go now — I think we’ve got a couple of questions that are coming online. So Nick, could you read out the questions, please?
Nick Ashworth
Thanks, John. So yes, we’ve got one from Deepa at Bernstein. So I know we talked a little bit about credit metrics under the 5-year frame and where they’re going. Her question is, can you explain why the margin credit metrics are better under the higher CapEx program? Is it the benefit of inflation and FX on existing assets? And then the second part is, what are your expectations on ED2 WACC. Particularly if any changes to cost of debt methodology changes, what increase the cost of equity do you expect?
John Pettigrew
Okay. So let me take the second and let Andy take the first. I mean, as I said earlier, One of the key things that we’re in discussion with Ofgem the moment is what is the appropriate allowed cost of equity and cost of debt. I mean, just to give a rule of thumb, for 100 basis points increase in the risk-free rates, you’d expect to see around about 20, 25 bps on the cost of equity and about 10 bps on the WACC. So all that sort of information is feeding into our views of what’s appropriate cost of equity. But as I said earlier, that will form part of the decision-making process as we look at the overall package.
In terms of credit metrics, Andy?
Andy Agg
Yes, Deepa. Just to be clear, what I mentioned in my comments earlier was the marginal improvement in the leverage that we expect when the transaction close to around 70%. But from a credit ratings metrics perspective, in terms of RCF, FFO, we haven’t moved our expectations from what we’ve previously guided on. But we continue to expect our overall metrics to be aligned with what we need to maintain our strong investment-grade credit rating.
John Pettigrew
Thanks, Andy. I think this is probably the final question.
Nick Ashworth
From James Brand at Deutsche. So you’re now targeting 70% net debt to RAV over the medium term. Does this include an assumption that you sell the remaining stake in U.K. Gas Transmission? And if you could lower leverage further to the high 60s, would this be preferable?
Andy Agg
Yes, James. Just to be clear, we’ve said that the 70% is where we expect to land post transaction. We haven’t given sort of medium or long-term guidance in terms of leverage but we would expect leverage along with the ratings metrics to stay aligned with the credit ratings. That will largely be impacted, obviously, by CapEx, by things like as FX and other performance aspects over the next few years. The question is, if you look overall, a few basis points, the WACC curve is relatively flat. So I think the question implies, would I like lower leverage? No, I’m very happy with the level of leverage that we will get to once the transactions close.
Nick Ashworth
And does the 70% include the remaining GT…
Andy Agg
Sorry. I missed the first part. In terms of Gas Transmission, just to be clear, no, where our assumption is that we closed the 60%. Obviously, as you’ll be aware, the consortium has an option on the remaining 40% that we’ll really entirely within that decision to call. We haven’t assumed that. So we assume that we continued ownership.
John Pettigrew
Okay. In which case, thank you, everybody, for joining us today. We really do appreciate you joining us this morning. As I said in my summary, a very strong set of results and I think demonstrating the resilience doing what has been a fairly turbulent economic time. As you know, our focus is now on delivering a significant CapEx program going forward. But there’s some key decisions that we’re looking to make and looking for others to make over the next 6 months. But thank you for joining us and we’ll see you all very, very soon.
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