United Utilities 2015-20 Business Plan Revision
United Utilities Group PLC
27 June 2014
UNITED UTILITIES 2015-20 BUSINESS PLAN REVISIONS
As scheduled, United Utilities Water PLC (UUW) has submitted to Ofwat revisions
to its business plan covering the 2015-20 period. The initial business plan was
submitted on 2 December 2013 and the revisions to the plan follow extensive
discussions with Ofwat, our Customer Challenge Group and our other
stakeholders. Ofwat is expected to publish draft determinations on 29 August
2014.
Overview
* Average household bills fall by a further 0.6% to 2.3% in real terms over
2015-20 period
* Total expenditure of £6.6bn, including capex of £3.75bn, similar to initial
plan
* Comprehensive further evidence provided to support company specific
adjustments
* Proposed exclusions from totex modelling: c£960m wastewater and c£215m
water
* Retail household cost to serve adjustment of £19m p.a. due to high levels
of deprivation
* Plan based on Ofwat's weighted average cost of capital guidance
* Outcome delivery incentives now include rewards as well as penalties
* Revenue adjustments of c£130m relating to the 2010-15 period
Balanced plan
Our business plan for the next five-year period means that customers would
benefit from below inflation growth in average household bills for the decade
to 2020. Our plan reflects the views of customers on service and affordability,
it delivers a paced investment programme to meet our environmental obligations
and it provides an appropriate return for investors.
Customer bills
Extensive stakeholder engagement has highlighted that the principal concern for
customers is affordability. Customers are generally satisfied with the current
high levels of water and wastewater services being provided and are only
prepared to pay for specific targeted areas of improvement, with 86% of
household customers supportive of bill rises no higher than inflation. This has
been a key driver in the formulation of our plan.
Following Ofwat's risk and reward guidance, we are now proposing an average
real terms bill decrease of 2.3% for household customers across the five-year
period (excluding the impact of the previously announced special customer
discount, which is being applied to 2014/15 bills). This compares with an
average real terms bill decrease of 1.7% in our initial plan, reflecting the
combined changes of a lower cost of capital, revised `pay as you go' ratios and
expenditure revisions.
Real change proposed in average household bills
2015/16 2016/17 2017/18 2018/19 2019/20
Annual change -0.5% -0.6% -0.6% -0.4% -0.2%
Cumulative change -0.5% -1.1% -1.7% -2.1% -2.3%
For non-household customers, we are now proposing an average real terms bill
decrease of 0.9% in 2015/16, with a total real terms increase of 2.5% by 2019/
20 which is similar to our initial plan. We tested our initial proposal with
non-household customers and 76% were supportive and our business retail team
continue to engage with customers to help them reduce their overall spend.
Real change proposed in average non-household bills
2015/16 2016/17 2017/18 2018/19 2019/20
Annual change -0.9% +0.5% +1.3% +1.1% +0.3%
Cumulative change -0.9% -0.4% +0.9% +2.1% +2.5%
Total expenditure
Our plan includes total expenditure of £6.6 billion (2012/13 prices), which
overall is similar to the initial plan. Wastewater and water total expenditure
(totex) has reduced by around £150 million and £70 million respectively,
relating to efficiencies and scope reductions, but has been broadly offset by
the acceleration of spend relating to the water service and a revised cost
profile relating to the retail service. The proposed total expenditure of £6.6
billion comprises capital investment (capex), including infrastructure renewals
expenditure of £3.75 billion and operating expenditure (opex) of £2.85 billion.
This mix of opex and capex has been derived from the optimal cost assessment
over the life of our assets. We have set the wholesale business `pay as you go'
(PAYG) ratio at 54% (the PAYG ratio is the proportion of wholesale total
expenditure recovered directly through wholesale revenues). This would result
in real growth in the regulatory capital value of around £600 million over the
2015-20 period (based on an assumed regulatory capital value at 1 April 2015 of
over £9.6 billion, in 2012/13 year-end prices).
The PAYG ratio for the wastewater service is 47%, reflecting the significant
enhancement requirements in this area, largely driven by new environmental
obligations, whereas the PAYG ratio for the water service is 63%, reflecting
the lower level of quality improvement requirements and therefore a greater
proportion of maintenance activity.
Operating expenditure
Total operating expenditure in the plan is £2.85 billion, which is similar to
our initial plan. This is split £1.08 billion opex for the water service, £1.12
billion opex for the wastewater service and £0.65 billion of operating
expenditure for the retail service.
Our plan includes initiatives designed to save around £60 million per annum of
opex by 2019/20, relative to 2012/13, which is similar to our initial plan.
This will largely offset the unavoidable cost increases in areas such as rates
and power, alongside the addition of private pumping stations and enhancement
programme costs.
Capital expenditure
Our proposed £3.75 billion capital investment programme (net of grants and
contributions) comprises £1.39 billion for the water service, £2.3 billion for
the wastewater service and £0.06 billion for the retail service. Overall, our
total capex requirements are similar to our initial plan.
Investment to meet tighter regulatory quality standards, enhance service to
customers and maintain the supply/demand balance is forecast at £1.47 billion,
with the remainder relating to maintenance. We have kept capex constrained at £
3.75 billion by meeting new environmental obligations via a phased approach,
supported by the Environment Agency and the Drinking Water Inspectorate.
Company specific adjustments
Deprivation - reflecting the impact of the extreme levels of deprivation in the
North West on our costs, we are seeking an adjustment to the household retail
average cost to serve of around £19 million per annum. We had already provided
robust evidence to Ofwat in support of this approach and have added to this
evidence base since the submission of our initial plan in December.
Water: Thirlmere totex exclusion - this proposed exclusion from Ofwat's totex
modelling methodology relates to investment required to comply with the
Habitats Directive requirement to revoke our Ennerdale abstraction licence in
the Lake District. The River Ehen, downstream of Ennerdale Water, contains a
declining population of the internationally endangered freshwater mussel.
Revocation of the licence will cause a loss of water resources and customers
would be at risk of loss of supply in the West Cumbria area.
Our preferred plan to address this deficit is to build a pipeline from our
Thirlmere reservoir, with a new water treatment works near Keswick. There is no
modelled spend in Ofwat's totex model for this type of investment. Since our
initial business plan submission, we have reviewed the project timescales to
meet the statutory obligations and have brought forward £165 million of
investment which was originally planned for the 2020-25 period. This has
increased our proposed spend on this initiative for the 2015-20 period to £215
million, which we have asked for Ofwat to exclude from its totex methodology.
Ofwat published its `risk-based review initial thresholds' in March 2014 and
this indicated a totex gap in respect of UUW's water service of around £70
million. Our water totex submission is now £2.48 billion, increasing this gap
to around £170 million. However, we have asked for £215 million, of our £2.48
billion submission, to be assessed separately.
Wastewater totex exclusions - The North West is the only region in the UK with
both large areas of high population density and high rainfall levels and these
factors are significant drivers of wastewater costs. Our region has a very
large industrial base and we treat the highest volume of trade effluent of any
region. We also have the legacy of industrial pollution inherent in the North
West, along with high phosphorus levels and have the largest volume of
wastewater that is required to be treated to the highest standards. Our region
has low dilution capacity of rivers and one third of the poorest quality rivers
in England and Wales, together with two thirds of all of the failing bathing
waters in England and Wales. This will be exacerbated by the Bathing Water
Directive, which will increase the required standards from 2015. In addition,
the North West contains an abundance of internationally and nationally
designated sites of environmental importance that need to be protected and
often improved, with our region containing England's largest area of `Sites of
Special Scientific Interest'. Overall, the North West has significant regional
differences which have a material impact on the cost of providing wastewater
services.
We have worked hard with the Environment Agency to constrain and balance our
expenditure programme. Nonetheless, similar to previous regulatory periods, our
wastewater spend includes a significant environmental programme. In light of
our regional differences and a lack of relevant comparable costs across the
industry, we believe it is necessary to assess several elements of this
programme outside of Ofwat's totex modelling methodology. This reflects our
view that it would be very difficult to capture all of the explanatory factors
relating to certain projects solely through a top-down modelling approach,
especially with regard to complex programmes that deliver multiple outcomes and
/or which are driven by requirements across multiple regulatory periods.
Ofwat's `risk-based review initial thresholds' indicated a totex gap in respect
of UUW's wastewater service of £1.13 billion. After applying around £150
million of scope and efficiency reductions to the December plan, we now propose
that around £960 million be excluded from Ofwat's totex modelling methodology
and assessed separately (as outlined in the following bullets). We have
provided Ofwat with extensive additional evidence and information to support
these model exclusions.
Whilst our assessment of Ofwat's modelled approach is that there are multiple
factors which give rise to this difference, key drivers can be broadly
categorised as follows:
* c£370 million reflecting regional circumstances not reflected in Ofwat's
models, impacting schemes such as those relating to bathing waters and
biodiversity;
* c£330 million in respect of items where requirements are not modelled, or
only partly included, in Ofwat's `risk-based review initial thresholds'.
This includes schemes driven by the future National Environment Programme,
including areas such as those relating to the Water Framework Directive;
and
* c£260 million relating to specific large integrated schemes driven by
requirements across multiple regulatory periods. This includes a major
project at our Davyhulme wastewater treatment works serving the population
of much of Greater Manchester.
Although these key drivers substantially reflect our proposed model exclusions,
we have also raised a number of other matters relating to the application of
the models, company efficiency and the cost exclusions. These could affect
Ofwat's assessment of the wastewater plan and inform its judgement in setting
the wastewater totex baseline.
More information relating to our wastewater totex company specific adjustments
is provided in a presentation pack, which can be accessed via the following
website link:
http://corporate.unitedutilities.com/investors.aspx
Return on capital
Our revised plan is based on the weighted average cost of capital (WACC)
provided by Ofwat in its risk and reward guidance, which was published in
January 2014. This is a real, vanilla WACC of 3.7% for our wholesale business,
plus retail margin. Our initial business plan proposed 4.1%, plus retail
margin.
Outcome delivery incentives (ODIs)
Our initial plan included a range of ODIs where financial incentives were
exclusively penalty-based. Following the publication of Ofwat's revised risk
and reward guidance, we have reviewed our approach and undertaken further
engagement with customers to better understand their preferences. As a result,
we have revised our ODI package so that it is more symmetric, having both
rewards as well as penalties, and now has better alignment of financial returns
to the value delivered to customers. Following further engagement with the
North West Customer Challenge Group we have submitted a total of 17 ODIs as
part of our revised plan.
Eight ODIs relate to the water service and cover performance in areas such as
reliability of supply, water quality, leakage and river quality improvements.
The total reward incentive is around £100 million, with a total penalty risk of
around £190 million, based on potential outcomes covering 80% of the
probability range.
The other nine ODIs relate to the wastewater service and cover performance in
areas such as sewer flooding, bathing waters, private sewers and sludge
disposal. The total reward incentive is around £100 million, with a total
penalty risk of around £190 million, based on potential outcomes covering 80%
of the probability range.
Recognising customers' preference for bill predictability and stability, we
propose to make any performance adjustments relating to our ODIs at the end of
the 2015-20 regulatory period.
Adjustments relating to the 2010-15 period
We have enhanced our supporting evidence and made a number of adjustment claims
in line with Ofwat's methodology. These include areas such as the revenue
correction mechanism, opex incentive allowance, the capital expenditure
incentive scheme and the service incentive mechanism. Overall, these
adjustments amount to a revenue uplift of around £130 million across the
2015-20 period.
Next steps
Ofwat is expected to publish draft determinations on 29 August 2014, when it
will provide its view of our revised plan. Final determinations are due on 12
December 2014.
Investor and analyst conference call
A conference call for investors and analysts starts at 11.00am this morning,
hosted by our Chief Executive, Steve Mogford, and our Chief Financial Officer,
Russ Houlden. The call can be accessed by dialling: +44 (0) 20 3139 4830,
access code 19262851#. A recording of the call will be available for 30 days
following 27 June 2014 on +44 (0) 20 3426 2807, access code 649069#.
United Utilities' contacts
For further information on the day, please contact:
Gaynor Kenyon - Corporate Affairs Director +44 (0) 7753 622282
Darren Jameson - Head of Investor Relations +44 (0) 1925 237033
Peter Hewer / Martin Pengelley - Tulchan +44 (0) 20 7353 4200
Communications
This announcement will be available on the day at: http://
corporate.unitedutilities.com/investors.aspx
Appendix - Expenditure Summary
2015-20 five-year totals Business Plan Initial Business Difference
Plan
£m (presented in 2012/13 prices 27 June 2014
) 2 December 2013
Totex
Water 2,478 2,379 +99
Wastewater 3,414 3,566 -152
Retail 707 665 +42
Total 6,599 6,609 -10
Opex
Water 1,084 1,118 -34
Wastewater 1,116 1,129 -13
Retail 648 606 +42
Total 2,848 2,853 -4
Capex
Water 1,394 1,260 +133
Wastewater 2,298 2,437 -139
Retail 59 59 0
Total 3,750 3,756 -6
Water capex
Infrastructure renewals 380 386 -6
expenditure
Maintenance 603 621 -18
Quality, enhancement, supply & 411 253 +158
demand
Total 1,394 1,260 133
Wastewater capex
Infrastructure renewals 340 355 -16
expenditure
Maintenance 898 887 +11
Quality, enhancement, supply & 1,060 1,194 -134
demand
Total 2,298 2,437 -139
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