Regional Review - Europe

a significant increase in
contributions from our
uk power plants

Profit from operations in Europe increased significantly to £574 million from £450 million last year. This was principally due to strong contributions from our UK assets and first full year contributions from Levanto and Indian Queens, together with a first-time contribution from Maestrale for the four months from September to December 2007. Our contracted assets in Iberia, Italy and Turkey continue to deliver consistent operational and financial performance.

In 2007 the UK power market saw dark spreads falling and spark spreads increasing. Rugeley benefited from our decision to forward contract its output for 2007, when power prices were higher in 2006, whilst Deeside was able to take advantage of its largely uncontracted position as its achieved spark spread increased from £22/MWh to £23/MWh⁽¹⁾. Saltend’s earnings were flat compared to 2006, due to the lower amortisation charge on the gas supply contract being offset by the impact of higher gas costs.

For 2008 we have forward contracted 85% of our expected merchant output at Rugeley, 95% at Saltend, and 60% at Deeside.

Results – Europe
	Year ended 31 December 2007 £m	Year ended 31 December 2006 £m
Profit from operations	383	615
Exceptional items and specific IAS 39 mark to market movements – losses/(profits)	191	(165)
PFO (excluding exceptional and specific IAS 39 mark to items market movements)	574	450

First Hydro’s earnings were up compared to 2006 as the asset captured higher prices during periods of increased power price volatility. The storage capacity of one of First Hydro’s upper reservoirs was expanded in October 2007, to give an extra 8% capacity.

Earnings at ISAB, in Italy, were down year-on-year following a planned outage and a revised fuel indexation methodology.

The Czech Republic experienced very mild weather during the first half of the year, and as a consequence heat sales were lower compared to 2006, but this was partially offset by higher power sales at an improved margin. In August, International Power Opatovice signed a new three-year contract with the existing offtaker to sell 65% of its expected output until the end of 2010.

During the year, International Power more than doubled the size of its European wind portfolio, acquiring 100% ownership of 660 MW of operational wind generation. Details of these acquisitions are shown below:

Name of wind farm	Location	Acquisition/ completion date	MW (net) in operation*	MW (net) under construction*
Delfzijl-Zuid	Netherlands	July 2007	16	–
Maestrale	Italy and Germany	August 2007	581	55
Schkortleben	Germany	September 2007	28	–
Delfzijl-Zuid 2	Netherlands	December 2007	15	–
Karstaedt 2	Germany	December 2007	20	–
Total			660	55

* As at date of acquisition.

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At Levanto, which was acquired in November 2006, a further 69 MW of wind farms that were under construction at acquisition started commercial operation in 2007, with the final 6 MW due to commence operation in 2008. Construction of the 8 MW Horn wind farm, located in Germany, has been completed. In addition, 55 MW of capacity which was under construction at the time of the Maestrale acquisition has now reached commercial operation. As at 5 March 2008, our European wind portfolio comprises 1,153 MW in operation and 6 MW under construction.

In June, International Power created a common ownership platform for its UK⁽²⁾ assets (75% International Power and 25% Mitsui). As part of the agreement, International Power sold a 25% equity interest in Rugeley, Deeside and Indian Queens to Mitsui and acquired an additional 5% equity interest in First Hydro and Saltend. In addition Mitsui provided a £200 million credit facility to support trading activities of the UK assets, and International Power also acquired the right to additional returns from Paiton ( Indonesia) equivalent to 9.2% of Paiton’s earnings and cash distributions⁽³⁾, equalising the returns for International Power and Mitsui from this important asset. The sale and purchase of the interests in the UK assets and Paiton resulted in a net cash payment of £106 million to International Power and an exceptional profit on disposal of £174 million.

The installation of FGD equipment, required to significantly reduce sulphur emissions at Rugeley, is underway with final commissioning scheduled in the third quarter of 2008. A major planned outage and the FGD tie-in installation will together take approximately four months. Rugeley is currently burning ultra low sulphur coal in order to comply with the emissions requirements of the Large Combustion Plant Directive (LCPD). The resulting load factor is expected to be 55% in 2008, down from 65% in 2007.

Construction of FGD and Selective Catalytic Reduction (SCR) equipment at Tejo Energia (Pego) in Portugal is also progressing well, and is expected to be completed in the second half of 2008. On completion of this project Pego’s emissions of SO₂ and NO_x will be significantly lower than the limits imposed by the LCPD.

The new Elecgas 830 MW CCGT project, in Portugal, reached financial close in March 2008 together with finalisation of the tolling agreement and EPC contracts. The entire output of the new plant will be sold to Endesa Generacion S.A., a subsidiary of Endesa, under a 25-year tolling contract. The CCGT plant will be constructed by Siemens and will be located adjacent to the existing 628 MW Pego coal fired plant. The total project cost is estimated at €580 million (£443 million), which will be funded by a mix of debt and equity in an 85:15 ratio. For its 50% share, International Power’s equity investment will be €44 million (£34 million).

Notes:

(1) Adjusted to reflect the fuel optimisation that was achieved by trading our coal and gas power station assets as a portfolio.

(2) Ownership in Derwent Cogeneration Limited, 33% held jointly by International Power and Mitsui, is unchanged as a result of this transaction.

(3) Via the acquisition of an economic interest from Mitsui, this transaction equalised the returns for International Power and Mitsui from Paiton (at 40% each) but did not entail any transfer of shares or change of management structure.

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during 2007 we doubled
the size of our european
wind portfolio

Market environment and growth prospects

Demand growth for power, rising fuel costs, planned plant retirements and tightening environmental legislation (for both carbon and sulphur emissions) are key factors affecting the power industry in Europe. We see these factors in each of the nine European markets in which we operate, and we work continuously to ensure our portfolio is optimally positioned.

For example, we have significantly increased our renewables portfolio in Europe by expanding in markets that offer a secure and attractive environment for wind generation, and we are investing in economically viable major environmental upgrades, such as the installation of FGD equipment in both the UK and Portugal, to ensure these coal fired plants are best positioned for the long-term. We are working to deliver new projects to meet power demand growth such as the Elecgas project and an 840 MW greenfield CCGT plant in the port of Rotterdam, in partnership with Eneco.

A significant proportion of our European installed generation is located in the UK, where electricity demand is growing at just over 1% per annum. A key factor affecting the supply/demand balance in the UK is the quantum of capacity that will be retired by 2015. The LCPD requires plant to achieve stringent sulphur emission levels. If plant operators decide not to invest in sulphur emission abatement (termed as ‘opting out’ of the LCPD), then the power plants in question have to close by 2015 and can only operate for a defined and restricted amount (20,000 hours in total) until that date. In the UK, some 11,200 MW of coal and oil fired plant has ‘opted out’, and, as shown in the reserve margin chart, if operators begin to use up most of their allotted 20,000 hours over the next 3-4 years then 'opted-out' plant could begin to retire much earlier, by 2011/2012. This would accelerate the requirement for new-build.

UNITED KINGDOM RESERVE MARGIN

We see expansion opportunities from both greenfield development projects and acquisitions – both for thermal assets and renewables. Our strong presence in regional markets and our flexible, efficient generation ensures we are well positioned.

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Snapshot – regional markets

Europe

36% of International Power’s portfolio is located in Europe

Key merchant markets for International Power: UK and Czech Republic

Total installed capacity: 76 GW
Market type: fully liberalised – merchant market
Demand growth: 1.1%
Peak reserve margin: 19% in 2007
Peak demand season: winter
CO₂ Emission Reduction Target:
– Signed up to the Kyoto Protocol
– 12.5% reduction by 2012 from 1990 levels
International Power’s current installed capacity in the market 3,783 MW (net)
– 1,324 MW gas, 788 MW coal, 1,566 MW pumped storage, 105 MW oil

Czech Republic

Total installed capacity: 16 GW
Market type: fully liberalised – merchant market
Demand growth: 0.5%
Peak reserve margin: 21-46%⁽¹⁾
Peak demand season: winter
CO₂ emission reduction target:
– Signed up to the Kyoto Protocol
– 8% reduction by 2012 from 1990 levels
International Power’s current installed capacity in the market 585 MW (net)
– 585 MW coal/gas

International Power actively trades in the Czech bilateral market, but also has a three-year offtake contract with a local offtaker

Rest of Europe

Total collective installed capacity in International Power’s existing markets is 410 GW

Existing markets: Germany, Italy, France, the Netherlands, Portugal, Spain and Turkey

Market type: fully regulated markets – with long-term offtake contracts
Fuel mix: various
Regulated tariffs for wind assets in Germany, Italy, France and the Netherlands
Peak demand season: winter for northern countries and summer for southern countries
CO₂ emission reduction targets:
– Germany, Italy, France, the Netherlands, Portugal, Spain and Turkey signed up to the Kyoto Protocol
– Reduction targets under EU Burden Sharing agreement are Germany (-21%), Italy (-6.5%),
France (0%), the Netherlands (-6%), Portugal (+27%) and Spain (+15%), from 1990 levels by 2012
International Power’s current installed capacity in the market 2,484 MW (net)
– 960 MW gas, 314 MW coal, 1,153 MW wind, 57 MW hydro

(1) Dependent on level of interconnector capacity assumed.

UK MARKET CAPACITY BY FUEL
TYPE (MW)