Annual consolidated financial statements

Annual consolidated financial statements 2012

Annual consolidated financial statements

4 Annual consolidated financial statements 2012 Contents Contents

5 01 02 Independent auditor s report page 7 Annual consolidated financial statements page 11 03 Consolidated management report 04 Certification page 307 page 185

1 Independent auditor s report

8 Annual consolidated financial statements 2012 Independent auditor s report Independent auditor s Report Ernst & Young, S.L. was re-elected auditor of IBERDROLA, S.A. and of IBERDROLA, S.A. and its Consolidated Group pursuant to resolutions adopted at the General Shareholders Meeting held on June 22, 2012, following a proposal of the Audit and Risk Supervision Committee of the Board of Directors of IBERDROLA,S.A. dated May 3, 2012. The criteria for apponting and hiring the auditor, as well as the supervisory powers of the Audit and Risk Supervision Committee, are contained in the Annual Corporate Governance Report of IBERDROLA, S.A. for fiscal year 2012.

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2 Annual consolidated financial statements

12 Annual consolidated financial statements 2012 Financial statements Translation of Consolidated financial statements originally issued in Spanish and prepared in accordance with IFRS, as adopted by the European Union (Note 53). In the event of a discrepancy, the Spanish-language version prevails. IBERDROLA, S.A. AND SUBSIDIARIES Consolidated statements of financial position at 31 December 2012 and 2011 ASSETS Note 31 December 2012 Thousands of euros 31 December 2011 (*) NON-CURRENT ASSETS: Intangible assets 8 19,403,188 20,272,579 Goodwill 8,308,917 8,272,894 Other intangible assets 11,094,271 11,999,685 Investment property 9 519,566 523,419 Property, plant and equipment 10 53,422,953 52,406,117 Property, plant and equipment in use 48,924,070 45,998,858 Property, plant and equipment under construction 4,498,883 6,407,259 Non-current financial assets 2,548,183 2,857,894 Investments accounted for using the equity method 11.a 438,269 764,821 Non-current equity instruments 11.b 675,353 697,367 Other non-current financial assets 11.d 1,031,142 907,223 Derivative financial instruments 25 403,419 488,483 Non-current trade and other receivables 12 468,341 538,819 Deferred tax assets 27 4,514,951 4,545,185 80,877,182 81,144,013 CURRENT ASSETS: Assets held for sale 18 215,829 243,494 Nuclear fuel 14 310,442 327,199 Inventories 15 1,895,831 2,112,572 Current trade and other receivables 6,425,867 6,222,036 Income tax receivables 28 253,028 566,294 Other tax receivables 28 486,677 290,951 Other current trade and other receivables 16 5,686,162 5,364,791 Current financial assets 4,047,323 4,876,208 Current equity instruments 11.c 130,286 20,116 Other current financial assets 11.d 3,401,362 4,097,536 Derivative financial instruments 25 515,675 758,556 Cash and cash equivalents 17 3,043,901 2,091,007 15,939,193 15,872,516 TOTAL ASSETS 96,816,375 97,016,529 (*) The Consolidated statement of financial position at 31 December 2011 is presented for comparative purposes only The accompanying Notes 1 to 53 and the Appendix are an integral part of the Consolidated statements of financial position at 31 December 2012 and 2011

13 IBERDROLA, S.A. AND SUBSIDIARIES Consolidated statements of financial position at 31 December 2012 and 2011 EQUITY AND LIABILITIES Note 31 December 2012 Thousands of euros 31 December 2011 (*) EQUITY: Of shareholders of the parent 19 33,759,982 32,887,873 Share capital 4,604,170 4,411,868 Unrealised assets and liabilities revaluation reserve (492,699) (385,758) Other reserves 28,672,118 27,648,118 Treasury shares (500,124) (383,762) Translation differences (1,364,168) (1,207,138) Net profit for the year 2,840,685 2,804,545 Of non-controlling interests 324,819 319,927 34,084,801 33,207,800 NON-CURRENT EQUITY INSTRUMENTS HAVING THE SUBSTANCE OF A FINANCIAL LIABILITY 20 370,499 467,673 NON-CURRENT LIABILITIES: Deferred income 21 5,785,907 5,229,808 Provisions 3,928,340 3,426,858 Provisions for pensions and similar obligations 22 1,902,233 1,372,369 Other provisions 23 2,026,107 2,054,489 Bank borrowings 28,851,208 30,453,501 Bank borrowings and other financial liabilities- loans and others 24 28,428,485 29,872,231 Derivative financial instruments 25 422,723 581,270 Other non-current payables 26 515,660 394,992 Deferred tax liabilities 27 9,093,491 9,741,959 48,174,606 49,247,118 CURRENT EQUITY INSTRUMENTS HAVING THE SUBSTANCE OF A FINANCIAL LIABILITY 20 106,882 114,664 CURRENT LIABILITIES: Liabilities related with assets held for sale 18 83,547 111,797 Provisions 434,503 572,964 Provisions for pensions and similar obligations 22 6,607 9,361 Other provisions 23 427,896 563,603 Bank borrowings 5,100,773 4,173,951 Bank borrowings and other financial liabilities - loans and others 24 4,455,617 3,356,269 Derivative financial instruments 25 645,156 817,682 Trade and other payables 8,460,764 9,120,562 Trade payables 29 6,113,145 6,044,351 Income tax payable 28 617,882 817,837 Other tax payables 28 394,182 461,925 Other current liabilities 1,335,555 1,796,449 14,079,587 13,979,274 TOTAL EQUITY AND LIABILITIES 96,816,375 97,016,529 (*) The Consolidated statement of financial position at 31 December 2011 is presented for comparative purposes only The accompanying Notes 1 to 53 and the Appendix are an integral part of the Consolidated statements of financial position at 31 December 2012 and 2011

14 Annual consolidated financial statements 2012 Financial statements Translation of Consolidated financial statements originally issued in Spanish and prepared in accordance with IFRS, as adopted by the European Union (Note 53). In the event of a discrepancy, the Spanish-language version prevails. IBERDROLA, S.A. AND SUBSIDIARIAS Consolidated income statements for the years ended 31 December 2012 and 2011 Note 31 December 2012 Thousands of euros 31 December 2011 (*) Net revenue 31 34,201,193 31,648,035 Procurements 33 (21,623,130) (19,622,228) 12,578,063 12,025,807 Staff costs 34 (2,390,936) (2,151,463) Capitalised staff costs 34 551,318 508,111 Outside services (2,377,763) (2,274,956) Other operating income 548,852 650,064 (3,668,529) (3,268,244) Taxes other than income tax (1,182,943) (1,107,093) 7,726,591 7,650,470 Amortisation and provisions 36 (3,349,701) (3,145,377) OPERATING PROFIT 4,376,890 4,505,093 Result of companies accounted for using the equity method - net of taxes 11.a (187,542) (34,543) Finance income 38 1,336,961 1,468,787 Finance cost 39 (2,437,298) (2,530,708) Gains on disposal of non-current assets 37 74,481 61,730 Losses on disposal of non-current assets (88,414) (15,948) PROFIT BEFORE TAX 3,075,078 3,454,411 Income tax 27 (206,539) (549,182) NET PROFIT FOR THE YEAR 2,868,539 2,905,229 Non-controlling interests (27,854) (100,684) NET PROFIT FOR THE YEAR ATTRIBUTABLE TO THE PARENT 2,840,685 2,804,545 EARNINGS PER SHARE IN EUROS (BASIC AND DILUTED) 51 0.459 0.458 (*) The Consolidated statement of financial position at 31 December 2011 is presented for comparative purposes only The accompanying Notes 1 to 53 and the Appendix are an integral part of the Consolidated income statements for the years ended 31 December 2012 and 2011.

15 IBERDROLA, S.A. AND SUBSIDIARIES Consolidated statements of comprehensive income for the years ended 31 December 2012 and 2011 Thousands of euros 2012 2011 (*) Of the Parent Of noncontrolling interests Total Of the Parent Of noncontrolling interests NET PROFIT RECOGNISED DIRECTLY IN EQUITY In other reserves (484,725) - (484,725) (276,987) - (276,987) Actuarial gains and losses on pension schemes (Note 22) (649,468) - (649,468) (417,543) - (417,543) Spain (electricity for employees) (49,903) - (49,903) 2,657-2,657 United Kingdom (433,703) - (433,703) (164,706) - (164,706) U.S.A. (129,605) - (129,605) (227,876) - (227,876) Brazil (26,059) - (26,059) (46,777) - (46,777) Others (10,198) - (10,198) 19,159-19,159 Tax effect 164,743-164,743 140,556-140,556 In unrealised asset and liability revaluation reserves (Note 19) (106,941) 831 (106,110) (25,515) 1,655 (23,860) Change in the value of available-for-sale investments (29,381) - (29,381) (11,974) 511 (11,463) Change in the value of cash flow hedges (110,978) 1,187 (109,791) (31,241) 1,882 (29,359) Tax effect 33,418 (356) 33,062 17,700 (738) 16,962 In translation differences (157,030) (2,416) (159,446) 527,870 (77,581) 450,289 NET PROFIT RECOGNISED DIRECTLY IN EQUITY (748,696) (1,585) (750,281) 225,368 (75,926) 149,442 NET PROFIT FOR THE YEAR 2,840,685 27,854 2,868,539 2,804,545 100,684 2,905,229 TOTAL INCOME AND EXPENSES RECOGNISED IN THE YEAR 2,091,989 26,269 2,118,258 3,029,913 24,758 3,054,671 (*) The Consolidated statement of comprehensive income for 2011 is presented for comparative purposes only The accompanying Notes 1 to 53 and the Appendix are an integral part of the Consolidated statements of comprehensive income for the years ended 31 December 2012 and 2011 Total

16 Annual consolidated financial statements 2012 Financial statements Translation of Consolidated financial statements originally issued in Spanish and prepared in accordance with IFRS, as adopted by the European Union (Note 53). In the event of a discrepancy, the Spanish-language version prevails. IBERDROLA, S.A. AND SUBSIDIARIES Consolidated statements of changes in equity for the years ended 31 December 2012 and 2011 Issued capital (Note 19) Treasury shares (Note 19) Legal reserve (Note 19) Revaluation reserves (Note 19) Other reserves Share Premium (Note 19) Other restricted reserves (Note 19) Retained earnings (Note 19) Unrealised assets and liabilities revaluation reserve Translation (Note 19) differences Net profit for the year Thousands of euros Noncontrolling interests As at 1 January 2012 4,411,868 (383,762) 838,286 1,170,548 14,667,676 86,270 10,885,338 (385,758) (1,207,138) 2,804,545 319,927 33,207,800 Comprehensive income for the period - - - - - - (484,725) (106,941) (157,030) 2,840,685 26,269 2,118,258 Operations with partners or owners Profit distribution - - 21,998 - - - 2,604,901 - - (2,804,545) - (177,646) Transactions with treasury shares (Note 19) - (116,362) - - - - (10,089) - - - - (126,451) Free capital increase (Note 19) 192,302 - - (192,302) - - (1,003) - - - - (1,003) Acquisition of bonus issue rights (Note 19) - - - - - - (834,416) - - - - (834,416) Other changes in equity Share-based payment transactions (Note 19) - - - - - - 9,289 - - - - 9,289 Other changes - - - - - - (89,653) - - - (21,377) (111,030) As at 31 December 2012 4,604,170 (500,124) 860,284 978,246 14,667,676 86,270 12,079,642 (492,699) (1,364,168) 2,840,685 324,819 34,084,801 Total Thousands of euros Issued capital (Note 19) Treasury shares (Note 19) Legal reserve (Note 19) Revaluation reserves (Note 19) Other reserves Share Premium (Note 19) Other restricted reserves (Note 19) Retained earnings (Note 19) Unrealised assets and liabilities revaluation reserve (Note 19) Translation differences Net profit for the year Noncontrolling interests Total As at 1 January 2011 4,112,882 (284,332) 787,848 1,215,769 13,015,498 86,270 9,369,191 (360,243) (1,735,008) 2,870,924 2,584,271 31,663,070 Comprehensive income for the period - - - - - - (276,987) (25,515) 527,870 2,804,545 24,758 3,054,671 Operations with partners or owners Profit distribution - - 50,438 - - - 2,645,819 - - (2,870,924) - (174,667) Transactions with treasury shares (Note 19) - (1,621,231) - - - - (15,852) - - - - (1,637,083) Capital increase (Note 19) 253,765 - - - 1,652,178 - (2,911) - - - - 1,903,032 Iberdrola Renovables, S,A, dividends (Note 19) - - - - - - - - - - (1,014,927) (1,014,927) Acquisition non-controlling interest Iberdrola Renovables, S,A, (Note 19) - 1,521,801 - - - - (269,659) - - - (1,252,142) - Free capital increase (Note 19) 45,221 - - (45,221) - - (856) - - - - (856) Free allowance acquisition (Note 19) - - - - - - (550,840) - - - - (550,840) Other changes in equity Share-based payment transactions (Note 19) - - - - - - (2,830) - - - - (2,830) Other changes - - - - - - (9,737) - - - (22,033) (31,770) As at 31 December 2011(*) 4,411,868 (383,762) 838,286 1,170,548 14,667,676 86,270 10,885,338 (385,758) (1,207,138) 2,804,545 319,927 33,207,800 (*) The Consolidated statement of changes in equity for 2011 is presented for comparative purposes only The accompanying Notes 1 to 53 and the Appendix are an integral part of the Consolidated statements of changes in equity for the years ended 31 December 2012 and 2011

17 IBERDROLA, S.A. AND SUBSIDIARIES Consolidated statements of cash flow for the years ended 31 December 2012 and 2011 31 December 2012 Thousands of euros 31 December 2011 (*) Note Cash flows from operating activities: Profit before tax 3,075,078 3,454,411 Adjustments for Amortisation charge, provisions and staff costs for pensions 22,34,36 3,662,083 3,259,564 Results of companies accounted for using the equity method net of taxes 11 187,542 34,543 Grants credited to income 36 (68,634) (72,450) Finance income and costs 38,39 1,100,337 1,061,921 Gains from disposal of non-current assets 13,933 (45,782) Changes in working capital Change in trade and other receivables (313,164) 454,447 Change in inventories 233,498 (188,862) Change in trade and other payables (569,502) (1,302,241) Effect of translation differences on working capital of foreign companies 21,261 (8,508) Change in non-current receivables and other payables 191,146 38,538 Provisions paid (337,451) (339,797) Income taxes paid (685,665) (744,543) Interests received 400,400 459,384 Dividends received 69,040 51,052 Net cash flows from operating activities 6,979,902 6,111,677 Cash flows from investing activities: Subsidiary acquisition 41 - (1,672,211) Change in cash due to changes in consolidation method and/or scope 18, 41-166,757 Investments in intangible assets 8 (582,733) (501,799) Investments in associates 11 (22,188) (32,698) Equity instruments 11 17,002 (29,921) Other investments 11 35,523 (73,539) Investments in investment property 9 (2,695) (33,645) Investments in property, plant and equipment 10 (3,896,475) (4,043,359) Changes in working capital due to current financial assets 784,570 1,870,247 Income taxes paid (5,904) - Proceeds from disposals of non-financial assets 6,004 3,055 Proceeds from disposals of financial assets 258,166 144,147 Net cash flows from investing activities (3,408,730) (4,202,966) Cash flows from financing activities: Free allowances acquisition 19 (834,416) (550,840) Dividends paid 19 (177,646) (174,667) Ordinary dividends paid Iberdrola Renovables - (20,713) Non-controlling shareholders acquisition of Iberdrola Renovables Treasury shares acquisition - (1,521,801) Extraordinary dividend Iberdrola Renovables - (994,214) Issues and disposal from borrowings 7,049,257 11,971,224 Repayment of borrowings (7,233,655) (11,316,954) Grants related to assets 447,869 535,590 Interest paid including capitalised interest (1,628,160) (1,609,309) Proceeds from capital increase 19 (1,003) 1,902,176 Treasury shares acquisition 19 (300,002) (759,203) Proceeds from disposals of treasury shares 19 173,551 643,921 Net cash flows from financing activities (2,504,205) (1,894,790) Effect of exchange rate changes on cash and cash equivalents (114,073) (24,771) Net increase in cash and cash equivalents 952,894 (10,850) Cash and cash equivalents at the beginning of the year 2,091,007 2,101,857 Cash and cash equivalents at the end of the period 3,043,901 2,091,007 (*) The Consolidated cash flow statement for 2011 is presented for comparative purposes only The accompanying Notes 1 to 53 and the Appendix are an integral part of the Consolidated cash flow statements for the years ended 31 December 2012 and 2011

18 Annual consolidated financial statements 2012 Financial statements NOTICE. This document is a translation of a duly approved Spanish-language document, and is provided for informational purposes only. In the event of any discrepancy between the text of this translation and the text of the original Spanish-language document that this translation is intended to reflect, the text of the original Spanish-language document shall prevail. IBERDROLA, S.A. AND SUBSIDIARIES Notes to the Consolidated financial statements for the year ended 31 December 2012 1. GROUP ACTIVITIES Pursuant to article 2 of its By-laws, the corporate purpose of Iberdrola, S.A., incorporated in Spain with limited liability (Sociedad Anónima) (hereinafter, IBERDROLA) is as follows: To carry out all manner of activities and construction work and provide services required for, or related to, the production, transmission, switching and distribution or retailing of electric power or electricity by-products and their applications, and involving the raw materials or primary energies required for electric power generation, energy services, engineering, computer and telecommunication services, services relating to the Internet, the treatment and distribution of water, the integral provision of urban and gas retailing services, and other gas storage, regasification, transmission or distribution activities, which will be provided indirectly through the ownership of shares or other equity investments in companies that do not engage in the retailing of gas. The distribution, representation and marketing of all manner of goods and services, products, articles, merchandise, computer programs, industrial equipment, machinery, machine and hand tools, spare parts and accessories. To engage in the research, study and planning of investment and corporate organisation projects, and to promote, set up and develop industrial, commercial and service companies. To provide assistance and support services to the group companies and other investees, providing for them the guarantees and collateral required for this purpose. The aforementioned activities may be performed in Spain and abroad, and may be performed totally or partially either directly by IBERDROLA or through the ownership of shares or other equity investments in other companies, subject in all cases to the legislation applicable at any given time and, in particular, to the legislation applicable to the electricity industry (Note 3). In general, the corporate purpose of the subsidiaries consists of the production, switching, distribution and retailing of electricity and gas, the provision of telecommunication services and the performance of real estate and other related activities in Spain and abroad. IBERDROLA s registered address is at Plaza Euskadi 5, in Bilbao. 2. BASIS OF PRESENTATION OF THE CONSOLIDATED FINANCIAL STATEMENTS a) Applicable accounting legislation The IBERDROLA Group s 2012 Consolidated financial statements were prepared by the Directors on 13 February 2013, in accordance with International Financial Reporting Standards (hereinafter, IFRS), as adopted by the European Union, in conformity with Regulation (EC) no. 1606/2002 of the European Parliament and of the European Council. The Directors of IBERDROLA expect these Consolidated financial statements to be approved at the General Shareholders Meeting without modification. The IBERDROLA Group s 2011 Consolidated financial statements were approved at the General Shareholders Meeting on 22 June 2012.

19 These Consolidated financial statements have been prepared on a historical cost basis, except for available-for-sale financial assets and derivative financial instruments, which have been measured at fair value. The carrying amounts of assets and liabilities hedged by fair value hedges are restated to reflect variations in their fair value as a result of the risk hedged. The accounting policies used in the preparation of these Consolidated financial statements coincide with those used for the year ended 31 December 2011. For the IBERDROLA Group, that prepares its Consolidated financial statements in accordance with the IFRS as adopted by the European Union, application becomes mandatory in 2014 of the new IAS 19: Employee benefits. In the IBERDROLA Group, the main impact of this standard is that the actual return on assets during the year will now be recognised in the Consolidated Income Statement, and not the expected return, as mandated in the IAS 19 currently in force. The following standards will be applicable to the IBERDROLA Group this year: IFRS 10: Consolidated financial statements, IFRS 11: Joint arrangements and IFRS 12: Disclosure of interests in other entities. IFRS 11 requires using the equity method for joint ventures, which are defined as those with joint control, and where the parties have a right to, only to, their net assets (Note 43). Finally, in 2013 IBERDROLA must apply IFRS 13: Fair value measurement, although this standard is not expected to have a significant impact. The standards approved by the European Union which application has not been mandatory for 2012 would not have entailed significant changes in these Consolidated financial statements. In addition, the IFRS provide certain alternatives for their application, including most notably the following: As indicated in Note 4.c, IAS 31: Interests in joint ventures, applied in the preparation of these Consolidated Financial Statements, defines a joint venture as one whose authority is subject to joint control, independently of whether parties have a right to their assets and liabilities separately or they simply have a right to their net assets, unlike the IFRS 11 described above. Interests in joint ventures may be proportionately consolidated or accounted for by the equity method. The same method must be applied to all the group s interests in joint ventures. The IBERDROLA Group proportionately consolidates all its investments in companies over which it shares control with the shareholders. Both intangible assets and assets recorded under Property, plant and equipment and Investment property may be measured at fair value or acquisition cost, less any accumulated amortisation and any accumulated impairment losses, if any. The IBERDROLA Group decided to measure these assets at adjusted acquisition cost. Under IFRS, actuarial differences exceeding the higher of 10% of the actuarial present value of guaranteed benefit or 10% of the reasonable value of the pension plan assets, may be allocated to income and differed over the average remaining life of the employees covered by the pension plan. Alternatively, the actuarial differences that arise in relation to its defined benefit obligations may be allocated to reserves. The IBERDROLA Group decided to recognise the full amount of the actuarial deviations charged or credited, as appropriate, to reserves. In this sense, according to IAS 19: Employee benefits only allows, in relation to actuarial deviations, the IBERDROLA Group s criteria. Under IFRS, grants related to assets can be treated in two ways: the amount of the grants related to assets received for the acquisition of the assets can be deducted from the carrying amount of the assets or they can be set up as deferred income on the liability side of the Consolidated statement of financial position. The IBERDROLA Group opted for the latter treatment.

20 Annual consolidated financial statements 2012 Financial statements b) Basis of consolidation The subsidiaries over which the IBERDROLA Group exercises control are fully consolidated, except when they are scantly material with respect to presenting fairly the accounts of the IBERDROLA Group. The IBERDROLA Group considers that it has control over a company when it has the power to apply its financial and operating policies so as to obtain benefits from its activities. The entities that the IBERDROLA Group manages jointly with other companies are proportionately consolidated. The associates over which the IBERDROLA Group does not exercise control but does have a significant influence on were accounted for in the Consolidated statement of financial position by the equity method. For the purposes of these Consolidated financial statements, it is considered that a significant influence is exercised over companies in which the Group has an ownership of over 20% and it can be proven that such significant influence exists. In addition, there are specific cases that, despite having a lower ownership percentage, a significant influence can be demonstrated and, therefore, the equity method is applied. In the specific case of Gamesa Corporación Tecnológica, S.A. (hereinafter GAMESA, Note 11.a), this significant influence is demonstrated, inter alia, by IBERDROLA being the main shareholder, having two representatives on GAMESA S Board of Directors, which has ten members, and by the fact that there are significant transactions between both companies. The Appendix to these Consolidated financial statements contains a detail of the subsidiaries, jointly controlled entities and associates of IBERDROLA, together with the consolidation or measurement basis used and other disclosures relating thereto. The closing date of the financial statements of subsidiaries, jointly controlled entities and associates is 31 December. These companies accounting policies are the same as or have been conformed to those used by the IBERDROLA Group. The financial statements of each of the foreign companies have been prepared in their respective functional currencies, defined as the currency of the economy environment in which each company operates and in which it generates and uses cash. The operations of IBERDROLA Group are consolidated in accordance with the following basic principles: 1. On acquisition, the assets, liabilities and contingent liabilities of a subsidiary are recognised at fair value. Any excess of the subsidiary s acquisition cost over the market value of its assets and liabilities is recognised as goodwill, as it corresponds to assets that cannot be separately identified and measured. If the difference is negative, it is recognised via a credit to income in the Consolidated income statement. The results of the subsidiaries acquired or disposed of during the year are included in the Consolidated income statement from the effective date of acquisition or until the effective date of disposal. 2. Goodwill arising from business combinations has not been amortised since 1 January 2004, the date of transition to IFRS, although it is reviewed once a year to ascertain whether any impairment loss should be recognised. 3. The result of accounting for investments using the equity method (after eliminating the results on transactions between group companies) is classified under Other reserves and Result of companies accounted for using the equity method-net of taxes in the Consolidated statement of financial position and in the Consolidated income statement, respectively. 4. The interest of minority shareholders in the equity and the results of the fully consolidated subsidiaries and of the subsidiaries of proportionately consolidated jointly owned entities is presented under Equity of non-controlling interests on the liability side of the Consolidated statement of financial position and Non-controlling interests in the Consolidated income statement, respectively.

21 5. Gain or losses on acquisitions from non-controlling interests in companies over which the Group exercises control and sales transactions without loss of control are recognised against or credited to reserves. 6. The financial statements of foreign companies were translated to euros using the year-end exchange rate method. This method consists of translating to euros all the assets, rights and obligations at the exchange rates prevailing at the date of the Consolidated financial statements; the Consolidated income statement items at the average exchange rates for the year; and equity at the historical exchange rates at the date of acquisition (or in the case of retained earnings at the average exchange rates for the year in which they were generated provided that there are no significant transactions that make the use of the average exchange rate inappropriate), as appropriate. The resulting translation differences are taken directly to reserves. 7. All balances and transactions between the fully and proportionately consolidated companies have been eliminated on consolidation. c) Comparability of information On 19 January 2011, the IBERDROLA Group entered into a purchase agreement with Ashmore Energy International, Ltd. (hereinafter, AEI) to acquire 99.68% of the share capital of Elektro Electricidade e Serviços, S.A. (hereinafter, ELEKTRO), a Brazilian company that provides electricity distribution services in the state of Sao Paulo and Mato Grosso do Sul. The fulfilment of the purchase agreement was contingent upon compliance with certain conditions precedent, the last of which was fulfilled on 27 April 2011, the date on which the IBERDROLA Group acquired control over ELEKTRO (Note 41). This transaction should be taken into account when comparing figures included in these 2012 Consolidated financial statements with those relating to 2011, since the Consolidated income statement, the Consolidated statement of comprehensive income, the Consolidated statement of changes in equity and the Consolidated statement of cash flow for the year ended 31 December 2011 include the operations of ELEKTRO from 27 April 2011 but those for the year ended 31 December 2012 include transactions from 1 January until the end of the year. As from 1 January 2012, the United States gas storage and trading business, which had hitherto formed part of the Renewables segment, and the Canadian gas storage and trading business, which had hitherto formed part of the Other Businesses segment, were reclassified for organizational and financial reporting purposes to the Deregulated segment. Also as from 1 January 2012, the South America operating segment, which covered the operations carried out in Brazil, has been reclassified for organizational and financial reporting purposes to the Networks segment. The IBERDROLA Group has accordingly modified the segmentation figures for the year ended 31 December 2011 (Note 7), included in these Consolidated Financial Statements, which differ from those in the Consolidated Financial Statements of 2011. 3. INDUSTRY REGULATION AND FUNCTIONING OF THE ELECTRICITY AND GAS SYSTEM Both IBERDROLA and some of the fully or proportionately consolidated subsidiaries engage in electricity business activities in Spain and abroad (see the Appendix to these Consolidated financial statements) that are heavily affected by the respective regulatory frameworks. Following is a description of the main regulations affecting the IBERDROLA Group.

22 Annual consolidated financial statements 2012 Financial statements a) Industry regulation and functioning of the electricity system in Spain The electricity sector is currently regulated by the Electricity Industry Law 54/1997, of 27 November 1997. This law and its subsequent updates have transposed the provisions contained in Directives 96/92/CE, 2003/54/CE and 2009/72/CE. Electricity Industry Law 54/1997, of 27 November, and the subsequent implementing legislation established, inter alia, the following principles: 1) Separation of activities: It prescribes a separation between the activities carried out in the competitive sector and others that are considered to be regulated activities. Companies that carry out any activities defined by the law as regulated (economic and technical management of the system, transmission and distribution) must have these as their sole corporate purpose and cannot, therefore, engage in unregulated activities (generation, supply, to either eligible or last resort customers, other activities unrelated to electricity or activities abroad). In addition, it prescribes a separation between regulated and deregulated activities for accounting purposes. However, a group of companies may carry out incompatible activities provided that these are done by different companies within it. In addition, Law 17/2007, which transposed European Directive 2003/54/CE, introduced the functional separation of regulated activities. 2) Introduction of competition in the power generation activity through the following measures: Since 1 January 1998, the producers of electricity, other than the special cases and exceptions provided for in the law, have tendered hourly bids for the selling price of electricity of each of the production units owned by them. The operating order of the production units is established on the basis of the lowest bids made until demand is satisfied in each programming period as a result of matched supply and demand. There is also the option of recourse to the intraday markets (six every day), where operators can adjust their positions in respect of their daily programs. Meanwhile, the production facilities contribute to the provision of whatever additional services may be necessary to guarantee adequate supply, obtaining additional remuneration for such services. The organisation and regulation of the electricity production market was defined and implemented by Royal Decree 2019/1997, of 26 December. In addition to the market remuneration, the Ministry of Industry, Energy and Tourism may establish remuneration entailing payment for capacity. In this regard, orders ITC 2794/2007, ITC 3860/2007 and ITC 3127/2011 regulate said payments for capacity, which consist of an investment incentive, an environmental incentive and an availability service. Royal Decree-Law 13/2012 temporarily modifies the investment incentive and the environmental incentive during the year 2012. In 2007, the regulation of auctions to buy energy that would then be supplied at the regulated tariff (CESUR) was instituted. Since 1 July 2009, the last resort suppliers have acquired energy for supply to customers signed up for the last resort tariff. The outcome of the auctions feeds into the calculation of the additive rate for last resort tariffs. The installation of new generating facilities is deemed to be liberalised, without prejudice to the obtainment of the necessary authorisations. Producers are entitled to use in their generating facilities the primary energy sources that they deem most appropriate, subject to such restrictions in respect of the environment, etc. as might be provided for in current legislation. An option is being considered to prioritize the dispatch to facilities that use domestic fuel (e.g. domestic coal) as their primary energy, provided that it does not represent more than 15% of the total primary energy required for the production needed to satisfy domestic demand and that the necessary measures are adopted to avoid distorting the market price. In this respect, Royal Decree 134/2010 introduced a Security of Supply Restriction procedure which established an obligation on certain owners of coal-fired thermal units to acquire set amounts

23 of this domestic coal at set prices each year according to a Secretary of State for Energy ruling. Furthermore, this Royal Decree gives priority in the dispatch to said coal-fired thermal units over the other thermal units in the system, up to a certain maximum annual amount of electricity production, which is also set in the aforementioned Secretary of State for Energy ruling and which must comply with the 15% limit at all times. In addition, regulated remuneration is established for these thermal units designed to reflect the full costs relating to their production associated with the aforementioned maximum annual amount of domestic coal-based electricity production. The Security of Supply Restriction procedure was applied for the first time on 26 February 2011. A maximum annual amount of domestic coal-based electricity production of 24.7 TWh was established for 2012. At the end of the year, the actual amount produced was 22.2 TWh. Plants not exceeding 50 MW of installed capacity that qualify as co-generation facilities under Law 54/1997 or plants whose primary energy source is renewable can come under the special regime, with a separate regulatory system and remuneration that is different from the market price. On May 28, 2007, the Royal Decree 661/2007 was published. It regulates the Production of Electricity under the Special Regime, replacing the previous Royal Decree 436/2004. The main implications of this royal decree for the economic framework for electricity generation by the IBERDROLA Group are the following: a) Owners of facilities commissioned after 31 December 2007 must have selected, for periods of one year or more, between the following two options: - To supply the electricity through the transmission or distribution network in exchange for a regulated tariff. - To sell electricity on the spot electricity generation market either at the applicable sales price on the organised market or at the price freely negotiated between the facility owner, plus, where appropriate, a premium. In this instance, there are minimum and maximum prices in place. b) Facilities commissioned prior to 31 December 2007 (except photovoltaic solar farms) must have elected, before 1 January 2009, whether to remain within the regime provided for in Royal Decree 436/2004 or to switch to the new one. This Royal Decree 436/2004 established two remuneration schemes. The first consisted of supplying electricity to the electricity distributor at the pre-existing price set for this modality, without scope for future resetting. The second option consisted of selling electricity onto the wholesale generation market at the prevailing price plus the incentive and premium provided for in said royal decree when the new legislation was published, also without update and ending on December 2012. c) On 26 September 2008 the government published Royal Decree 1578/2008, on Remuneration for Electricity Generation via Solar Photovoltaic Technology for installations brought into service after the date for continued application of the remuneration system set out in Royal Decree 661/2007, of 25 May, for this technology. This royal decree established premiums of between 32 and 34 euro cents per kwh generated and sets a calls system for the allocation of pre-established quotas and feed-in tariffs, such that only those projects submitted that fall within the pre-defined quotas are eligible to receive the feed-in tariff. Allocations are based on chronological order of the applications received. The feed-in tariff declines as the pre-defined quotas are met. d) Royal Decree Law 6/2009 established a register for pre-allocation of remuneration covering all technologies included under the special regime except photovoltaic energy, requiring registration of a project before it is eligible to receive remuneration in accordance with Royal Decree 661/2007. Projects were registered in chronological order, and must have met some administrative requirements and guarantees must have been provided. All registered facilities have the right to be remunerated in accordance with Royal Decree 661/2007, although the total amount surpass the limit established in this legislation. If the total amount of capacity registered in a single category is below the established limit, the subsequent projects will be entitled to this remuneration up to the limit.

24 Annual consolidated financial statements 2012 Financial statements e) Towards the end of 2010, a number of regulations affecting the special regime were published: Royal Decree 1565/2010, Royal Decree 1614/2010 and Royal Decree-Law 14/2010. These amend the remuneration of the various technologies as follows: - Wind power: the benchmark premiums for 2011 and 2012 are reduced for wind farms accessing the market under Royal Decree 661/2007 by 35%. A limit is placed on equivalent hours of operation of the wind farms, whereby hours that exceed the limit are not eligible for the related premium. For the individual wind farm limit to be triggered, the national level must also exceed the overall limit. - Solar thermal: the regulations state that during the first year of either the life of the plant or from enactment of Royal Decree 1614/2010, these plants may only choose the regulated tariff option (the market option disappears). Limits are also placed on equivalent hours in accordance with the technology of each plant. - Photovoltaic: the number of years of eligibility to obtain the premium is limited to 28 (previously there was no limit). Limits are also placed on equivalent hours of operation according to the technology and the climate area after which the plants no longer receive the premium (tentatively for installations under Royal Decree 661 and until 2013, more restrictive equivalent hours than those established in general). The number of years with premium is extended for which are under Royal Decree 661 to 30 years according to Sustainable Economy Law (Law 2/2011, of 4 March). On 28 January 2012, Royal Decree-Law 1/2012 has been published, cancelling the procedure of registration in the pre-allocation register, and hence the economic incentives for all facilities under the special regime not listed in said registry. 3) Guarantee of the proper functioning of the system, by using the following measures: System operation: - Red Eléctrica de España, S.A. carries on the transmission management and system operation activities which, pursuant to the law, have been unbundled for accounting purposes. As system operator, it is responsible for managing the adjustment markets to guarantee a balance between energy demand and generation. Market operation: - In 1998, OMEL, S.A (hereinafter, OMEL) was created for managing the Spanish electricity peninsular market. The offshore system was run following its own rules. - Iberian Electricity Market (hereinafter, MIBEL). On 1 October 2004, Spain and Portugal agreed the International Convention setting up an Iberian Market for Electric Power between the Kingdom of Spain and the Republic of Portugal. In January 2008, this agreement was revised at the Braga Summit to comply with the March 2007 Regulatory Compatibility Plan. - Since July 2006 the Portuguese and Spanish forward markets have operated together and since July 2007 so have the short-term markets. Several of the measures described above are designed to implement a single Iberian market for electricity. - Currently, the operation of the Iberian market is split between two companies: OMIE (OMI-Polo Español) which is responsible for managing the daily and intraday markets for MIBEL and futures auctions for last resort demand in the Spanish system (CESUR), and OMIP (OMI-Polo Portugués) which runs the overall MIBEL futures markets. - The International Convention between the Portuguese Republic and the Kingdom of Spain, setting up a single Iberian Market for Electricity Power, revised according to Braga Agreement on 18 January 2008, envisaged the creation of the Iberian Market Operator (Operador del Mercado Ibérico, OMI) by merging OMIE and OMIP, via two shareholding companies with head offices in Spain and Portugal, 10% cross-

25 shareholdings and a corporate structure comprising the current two market operating companies. This reorganisation process was completed as of 31 December 2011. 4) Legislation applying to regulated activities: The Electricity Industry Law establishes that distribution and transport are classified as regulated activities that are not subject to the free competition and market regime. On 1 December 2000, Royal Decree 1955/2000, regulating the transmission, distribution, retailing and supply activities and electricity facility authorisation procedures, was approved. The basic aim of this royal decree was to establish the measures required to guarantee the supply of power and the authorisation procedures relating to all electricity facilities that are the responsibility of the Spanish Government. On 15 February 2008, the government approved Royal Decree 222/2008, establishing the prevailing remuneration framework for the electricity distribution business. Pursuant to this Royal Decree, the remuneration paid for distribution activities will be set for regulatory periods of four years and will be calculated using a reference network model as a technical comparison tool. A reference network model is a model that maps out, for all Spanish territory, the areas in which each distributor is active and determines the reference distribution network needed in order to supply the final customers under the established quality levels. The reference remuneration of each distribution company will be calculated by summing together three components: remuneration for investment, remuneration for operating and maintenance, and remuneration for all other costs necessary to the exercise of activities which include commercial management, network planning and energy management. Within each period, the annual remuneration is calculated by updating the base remuneration of the previous year, in line with the CPI and IPRI, and adding the remuneration for the new investments made. Annual incentives are also set for enhancing quality and reducing losses. The quality incentive is established in Appendix I of Royal Decree 222/2008. In general, the incentive consists of comparing quality indicators reached by the companies with target indicators, resulting in penalties or bonuses. The limits of the incentive/bonus are `+ 3% of the remuneration. Legislation for the incentives for losses is Order ITC 2524/2009, of 8 September. This incentive is calculated as the product of a) the difference between the actual loss percentage and a target, b) a loss price and c) the power flowing through the networks of distribution companies. The limits of the incentive/bonus are `+ 2% of the remuneration. Order IET/3586/2011, of 30 December, which establishes the electricity tolls applicable from 1 January 2012, made some technical corrections in the calculation of the incentive. Order ITC 3353/2010, of 28 December establishes the final distribution remuneration for 2009 and 2010. Order IET 3586/2011, of 30 December established provisional remuneration for 2011 and 2012, and made a slight adjustment to the final remuneration of 2010 for certain companies (Note 4.y). Royal Decree-Law 13/2012, of 30 March, which transposes directives on internal electricity and gas markets and on electronic communications, and which adopts measures to correct the deviations arising from imbalances between costs and revenue in the electricity and gas sectors has, reduced the remuneration for distribution activities indicated in the preceding order for 2012, and has modified the remuneration system, mandating that new facilities commissioned in a given year (which were remunerated as new investments in the following year) are to be remunerated two years later. It also provides that financial remuneration must be made for net assets. With regard to the electricity transmission business, Royal Decree 325/2008 established the new remuneration regime for facilities brought into service after 1 January 2008. It provided that the remuneration of each transmission facility commissioned after 1 January 2008 will consist of two components: a remuneration for investment and a remuneration for operating and maintenance costs. Order ITC 368/2011, of 21 February approves the new reference unit values for investment costs and operating and maintenance costs for these facilities. Transmission facilities prior to 1 January 2008 continue

26 Annual consolidated financial statements 2012 Financial statements to be governed by the model and standard costs established in Royal Decree 2819/1998. The aforementioned Royal Decree-Law 13/2012, jointly with Royal Decree-Law 20/2012, of 13 July, of measures to guarantee budgetary stability and to stimulate competition, reduce remuneration of transport in application of the aforementioned criteria applied for the reduction in remuneration of distribution activities. Royal Decree- Law 13/2012 also suspends the granting of new administrative authorisations for transmission facilities until a new planning regime has been approved. In addition to the discussed measures on remuneration, Royal Decree-Law 13/2012 has included the transposition of Directive 2009/72/CE, amending Law 54/1009 of the Electricity Sector. Hence, new provisions are introduced to attain an effective separation between the activities of supply and generation and grid activities, and to bolster the role of national regulatory authorities and public service obligations. 5) Access tariffs or tolls: Royal Decree-Law 14/2010, of 23 December, which amended Law 54/1997, extended the application of access tolls to electricity producers of both the ordinary and the special regime, and established that the producers would be regulated taking into consideration the energy fed into the grid. In addition, as from 1 January 2011, provided the tolls to be paid by the electricity producers have not been implemented, this royal decree-law establishes that an access toll of EUR 0.5 per MWh fed into the grid will be applied to producers that are connected to the grid. Subsequently, Royal Decree 1544/2011, of 31 October implemented the aforementioned regulation of access tolls for electricity producers. Also, it included an order for the National Energy Commission (hereinafter, CNE) to send to the Ministry of Industry, Energy and Tourism, within six months, a proposed methodology for calculating said access tolls, while temporarily maintaining the toll set in Royal Decree- Law 14/2010 and establishing a specific toll for pumping facilities. In June 2012, the CNE has approved the holding of a public consultation on the methodology of assigning costs to electricity access tolls, after which the issuance of its proposed methodology remains pending. In 2012, Royal Decree-Law 20/2012 was enacted, which, amongst other measures, amends the Electricity Sector Act as follows: for activities or facilities used in electricity supply that are directly or indirectly subject to regional taxes or surcharges on national taxes, the law makes it mandatory to exact the territorial supplement in access tolls and last resort tariffs covering the totality of the overcost caused by such taxes and which must be paid by consumers within the territory of the given region. Hence, the Ministry of Industry, Energy and Tourism is empowered to determine, following a resolution of the Executive Committee for Economic Affairs, the specific taxes and surcharges to be included in the application of this territorial supplement to access tolls and last resort tariffs, and the necessary mechanisms for their management and settlement. The same Royal Decree-Law empowered the Ministry of Industry, Energy and Tourism to establish progressive tolls and to levy territorial supplements in the same. This royal decree also eliminates quarterly reviews of tolls by repealing Article 2.2 of Royal Decree 1202/2010, while maintaining annual reviews. 6) Progressive liberalization of the electricity supply and introduction of the retailing activity: Law 54/1997 established a the gradual deregulation of the electricity supply, progressively giving each of the different types of customer segments the possibility of choosing their supplier. All electricity consumption has been deregulated since 1 January 2003. This means that consumers who wish to, can freely contract their energy with the supplier of their choice, paying an access tariff for the right to use the networks. The new regime gives qualifying customers and suppliers the right to use the transmission and distribution networks, setting a single toll applicable nationwide for use of the networks, without prejudice to any specialised services provided due to voltage and/or network usage requirements, or to the type of energy supplied, depending whether transmission or distribution networks are involved. Royal Decree 1164/2001,