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Email PageChief Executive Officer’s statement
improved earnings, free cash flow
and share price
significant expansion of our
renewables business
exceptional access to growth
opportunities in targeted markets
Dear Shareholder
2007 was a year of further growth, with significant improvement in earnings, free cash flow and, very importantly, our share price. The key drivers were increased earnings in our European and North American markets. Although this improvement was partially offset by the impact of a very severe drought in Australia, the strength of our global portfolio ensured that we made good overall progress.
Our position in five key international regions continues to provide both a very solid earnings and cash flow profile for the Group, and exceptional access to growth opportunities. Let me give you a few of these regional highlights for 2007.
Portfolio performance
In Europe, we benefited from much improved margins at our UK plants, principally due to the well-timed contracting of our 2007 output, and through high levels of operational performance. We also standardised our shareholdings with Mitsui in our major UK plants, (75% International Power, 25% Mitsui) and this provides an efficient structure for the future. Our continental European portfolio also had a good year with consistently high availability at our long-term contracted plants. Our Levanto wind farm, acquired in November 2006, was successfully integrated and delivered a full year contribution in 2007.
In the US, our markets in Texas and New England maintain their underlying recovery as the balance between installed capacity and peak demand continues to tighten. However, because it was a relatively cool summer in 2007 and air conditioning demand was lower, underlying margins showed only a modest improvement over last year. New England benefited from a full year of capacity income, and 2007 also saw a full year contribution from our coal fired Coleto Creek plant, where we successfully installed a major upgrade to its dust extraction equipment. All our long-term contracted plants continued to perform well.
Both the Middle East and Asia are markets where output is totally covered by long-term offtake contracts, and where our financial return is primarily dependent on high levels of plant availability. Our track record is consistently strong here, and we had another very good year. Earnings grew in the Middle East principally through a first full year contribution from the Tihama project in Saudi Arabia, and we were pleased to announce in August 2007 the award of our latest project in the Middle East, Fujairah F2, a
Performance at all our Asian plants was good, and we successfully divested our 18% stake in Malakoff in Malaysia in 2007, crystallising a significant £115 million profit. We also acquired a further 9% economic interest in Paiton (Indonesia) from Mitsui.
The Australian business faced a challenging year, principally due to the very severe drought. The lack of water had the effect of reducing hydro output, and restricting some thermal power generation where fresh water was needed for cooling. This, in turn, made pricing exceptionally volatile and adversely impacted us when we needed to cover contractual positions if our plants were not available for operational reasons or when the transmission networks could not cope with demand. On the positive side, this volatility has resulted in a significant improvement in forward prices, so the outlook for the Australian business is much improved
Industry trends
The key trends in our industry continue to be security of supply, the drive for lower carbon dioxide (CO2) emissions and environmental upgrades, and the provision of affordable power in the face of rising prices for both new power generation equipment and for fuel. These are major issues in all the markets in which we operate, and span the energy, economic and political agendas. Power generation is by its nature a large-scale and long-term industry, so the decisions we make today have an impact many years into the future.
We believe that security of supply is best protected by having a diversified and balanced power generation fleet – in terms of both technology and fuel type. This ensures no undue reliance on any one fuel or technology provider, and our global portfolio encompassing natural gas, coal, wind, pumped storage, hydro and oil addresses this point directly. We have excellent, in-depth skills across this wide range of technologies. Security of supply also means that the regulatory structure in each market needs to be transparent and consistent over the long-term – without this, it is extremely difficult to make long-term investment decisions, and we are therefore very strong supporters of free and open markets with a minimum of government intervention.
The environmental debate in the power sector is often centred on CO2 reductions, but in reality is much wider and includes the reduction of sulphur and other emissions. We are addressing all of these issues. On CO2, some 57% of our portfolio is modern, efficient gas fired generation, and we are implementing efficiency improvements at our coal fired plants in the UK and Australia to reduce their CO2 intensity. In Australia we are also working with both the state and federal governments to see how brown coal can be dried prior to burning, which could provide a very significant reduction in CO2 output, and we are working on a pilot plant for CO2 capture. These are early but important steps, and we want to ensure we are at the forefront of these initiatives. In the UK and Portugal, we are installing flue gas desulphurisation (FGD) equipment in 2008 to reduce sulphur emissions at our coal fired plants. In the US we installed an improved dust extraction system that also allows improved mercury capture.
2007 was also a very significant year for the expansion of our renewables business. We acquired 660 MW of operating wind farms, including the Maestrale wind farm portfolio, based principally in Italy. The Maestrale portfolio is now run alongside the Levanto wind farm portfolio, which we acquired towards the end of 2006 and is based principally in Germany. Our strategy is to work with wind farm developers to source further growth opportunities where we can add value, and we now have some
Outlook for growth
Growth in demand for power in all our markets – both the developed and the developing world – is clearly good for the outlook of our business, but, of course, new power generation has to be affordable for the local market. This is a major challenge as the global market is now experiencing very significant cost escalation in both power generation equipment and in fuel costs, all driven by high worldwide demand. We are very experienced power developers with a good track record and strong relationships with the major equipment manufacturers, and therefore we can continue to deliver good value as demonstrated by our latest project award in the Middle East for a large power and desalination plant.
Our strategy remains to deliver growth in shareholder value through operating our existing portfolio to the highest standards, and by growing in our targeted markets. We are well positioned financially, with strong free cash flow and liquidity, and good access to the non-recourse project finance market, which remains relatively resilient through the recent tightening of the global credit markets. We have an excellent highly skilled team and I would like to thank all our employees worldwide for their enthusiasm, commitment and professionalism. Our business is in good shape, we have a strong platform for the future, and a range of growth opportunities across the portfolio. We will keep our financial discipline to ensure we employ our capital wisely, and we will remain agile to capture opportunities in our target markets.
