Investing in Innovation and Growth Annual Report 2006 WorldReginfo - ca79cde0-4cee-4a2c-99f7-2fd88f968768 The RWE Group—a brief portrait We are one of Europe’s leading electricity and gas compa- nies. Last year, our 69,000-strong workforce generated some €44 billion in revenue. Our major power generation, sales and trading markets are in Germany, the UK and Central Eastern Europe. This is where 20 million electricity customers and 10 million gas customers rely on our products—and a high degree of supply security. Our proprietary gas and oil production operations in Europe and North Africa are making an increasingly important contribution to securing future energy supplies. In the future, we will focus even more on the energy business. Having successfully divested Thames Water, we plan to sell American Water in 2007. This will give us added momentum for substantial capital investment—in sustained security of supply and profitable growth. Capital investment is the main topic of this annual report. The power plant cooling tower depicted on the cover is a symbol of the largest capex programme in RWE’s corporate history. WorldReginfo - ca79cde0-4cee-4a2c-99f7-2fd88f968768 RWE Group divisions effective January 1, 2007 RWE AG (Group Centre) RWE RWE RWE RWE RWE RWE RWE Power Dea Gas Trading Energy npower Systems Midstream RWE Power is Germany’s biggest RWE Gas Midstream has been in RWE npower is responsible for our UK power producer. The company charge of the commercial optimization energy business. The company has an produces lignite and generates of our non-regulated gas procurement, integrated business model. Operations The RWE Group electricity from coal, lignite, nuclear transport and storage business since include the generation of electricity fuel, gas and renewables. January 2007. from coal, gas, oil and renewables as well as the sale of electricity and gas. RWE Dea produces gas and oil, RWE Trading ranks among Europe’s focussing on Europe and North Africa. leading energy traders. We trade RWE Systems is our internal service In the report on the financial year electricity, gas, coal and oil as well as provider. Its tasks run the gamut that just ended, RWE Dea is still energy derivatives to hedge price risks. from IT, real estate management and reported as a business unit of central purchasing to personnel and RWE Power. RWE Energy is our sales and grid infrastructure services. company in Continental Europe. The company operates in twelve regions in and outside Germany. We provide electricity, gas, water as well as related services from a single source. The Water Division is no longer included in this overview. It principally consists of our North American company American Water, which we intend to divest via a public offering. WorldReginfo - ca79cde0-4cee-4a2c-99f7-2fd88f968768 2006 key figures at a glance • Sale of Thames Water completed successfully • Operating result up 14% • Net income significantly up on previous year due to one-off effects • Proposed dividend doubled from previous year to €3.50 per share • Net financial assets of €4.7 billion at year-end RWE Group 2006 20051 +/- in % External revenue € million 44,256 39,487 12.1 Germany € million 26,607 23,034 15.5 Outside Germany € million 17,649 16,453 7.3 EBITDA € million 7,861 7,095 10.8 Operating result € million 6,106 5,371 13.7 Income from continuing operations before tax € million 3,657 3,156 15.9 Net income € million 3,847 2,231 72.4 Recurrent net income2 € million 2,466 2,257 9.3 Return on capital employed (ROCE) % 18.7 16.6 – Weighted average cost of capital (WACC) before tax % 9.0 9.0 – Value added € million 3,169 2,451 29.3 Capital employed € million 32,764 32,444 1.0 Cash flows from operating activities € million 6,783 5,304 27.9 Capital expenditure € million 4,728 4,143 14.1 Property, plant and equipment € million 4,494 3,667 22.6 Financial assets € million 234 476 -50.8 Free cash flow3 € million 2,289 1,637 39.8 Earnings per share € 6.84 3.97 72.3 Recurrent net income per share € 4.38 4.01 9.2 Dividend per share € 3.504 1.75 100.0 12/31/06 12/31/05 Net financial debt € million -4,720 11,438 -141.3 Net debt5 € million 6,864 23,435 -70.7 Workforce6 68,534 85,928 -20.2 1 Figures adjusted; see commentary on page 44. 2 Net income excluding the non-operating result and excluding non-recurrent effects in the financial result, the tax expense and income from discontinued operations. 3 Cash flows from operating activities minus capital expenditure on property, plant and equipment. 4 Dividend proposal for RWE AG‘s 2006 fiscal year, subject to approval by the April 18, 2007 Annual General Meeting. 5 Net financial debt/assets plus provisions for pensions and similar obligations. 6 Converted to full-time positions. WorldReginfo - ca79cde0-4cee-4a2c-99f7-2fd88f968768 Setting the stage for the energy of the future The task is enormous: Some 60,000 megawatts of power generation capacity need to be replaced in Germany. RWE alone will have to replace more than half its installed capacity. To accomplish this task, we will implement the largest investment programme in our company’s history—spending up to 25 billion euros by 2012. A substantial portion of this is earmarked for the construction of power plants. New, efficient techniques will help us rise to the challenges of climate protection, security of supply and economic feasibility. The world’s largest lignite-fired power plant with optimized plant technology, which will go onstream as early as 2010, will play just as important a role as the nearly CO2-free power station scheduled for completion by 2014. By 2020, renewables-based energy is supposed to account for 20 percent of all electricity generated in Europe. This is the goal set by the EU Commission. We want to make a major contribution to this cause. Be it hydro or wind power, biomass plants, geothermal energy or wave power, we will make use of any technology that proves to be economically feasible over the long term. After all, we want to ensure climate friendly security of supply, that makes economic sense—for our customers, our shareholders, and our employees. Read more about this in the RWE Special on pages 119 to 140. WorldReginfo - ca79cde0-4cee-4a2c-99f7-2fd88f968768 2006 CONTENTS TO OUR INVESTORS REVIEW OF OPERATIONS OUR RESPONSIBILITY 4 Letter from the CEO 19 Strategy and structure 96 Supervisory Board Report 8 The RWE Executive Board 23 Economic and political 101 Corporate Governance and 10 RWE on the capital market environment Compensation Report 35 Major events (Part of the Review of Operations) 44 Notes on reporting 112 Workforce 45 Business performance 114 Sustainability 62 Key figures by division at a glance 64 Finance and capital expenditure 71 Net worth, financial position and earnings situation of RWE AG (holding company) 74 Workforce, research and development, procurement 78 Risk management 84 Outlook for 2007 WorldReginfo - ca79cde0-4cee-4a2c-99f7-2fd88f968768 Icon legend: Cross reference to the Cross reference Navigation around RWE Special with page number www.rwe.com 01 Investor Relations > Financial reports 02 RWE Group > Research and development 03 Investor Relations > Frequently asked questions > Other questions 04 Investor Relations > Shares > Corporate Governance 05 RWE Group > Responsibility RWE SPECIAL CONSOLIDATED FINANCIAL FURTHER INFORMATION STATEMENTS 120 From the power plant 142 Income Statement 202 Material Investments to the home 143 Balance Sheet 205 The RWE Group’s 126 Interview with Harry Roels: 144 Cash Flow Statement value management “We plan for future 145 Changes in Equity 207 Boards and Committees generations” 146 Notes 215 Glossary 130 Washing, separating & storing 201 Auditor’s Report 218 Index 134 Treading new paths 220 Imprint 138 A global challenge Financial Calendar Five-Year Overview (Part of the Review of Operations) WorldReginfo - ca79cde0-4cee-4a2c-99f7-2fd88f968768 4 Letter from the CEO Harry Roels If we look back on the last few years, it becomes clear that fundamental economic and political changes as well as the increasing speed with which our markets are developing have become perennial issues. We live and work in exciting times, in which the stage for the energy infrastructure of future decades must be set anew—both on the national and European levels. This requires forward thinking and action on a grand scale, since power plants and grids are the lifeblood of modern economies. At the same time, consolidation activities are being stepped up in our sector. Moreover, hardly a day passes without us being confronted by new issues of energy policy. As you can see, our competitive environment will change fundamentally. This is why 2006 was a really challenging year for us. But it was also an especially suc- cessful one. We achieved all the financial targets we set ourselves in the last three years. We clearly exceeded the goal of growing our operating result organically by an average of 5%: from 2004 to 2006, the average growth was roughly 12%. By achieving our aim to reduce costs by about €700 million a few months ago, we made a substantial contribution to this. RWE’s success is also your success: We had set ourselves the goal of increasing the dividend by at least 15% on average every year. If we included our proposed dividend for 2006 of €3.50 per share, the increase for this period would be 41%. This is an excellent performance in the European energy sector. WorldReginfo - ca79cde0-4cee-4a2c-99f7-2fd88f968768 To Our Investors Review of Operations Our Responsibility RWE Special Consolidated Financial Statements Further Information 5 • Letter from the CEO One of last year’s milestones was the successful sale of Thames Water.