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 revisionsto its business plan covering the 2015-20 period. The initial business plan wassubmitted on 2 December 2013 and the revisions to the plan follow extensivediscussions with Ofwat, our Customer Challenge Group and our otherstakeholders. Ofwat is expected to publish draft determinations on 29 August2014. 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 wouldbenefit from below inflation growth in average household bills for the decadeto 2020. Our plan reflects the views of customers on service and affordability,it delivers a paced investment programme to meet our environmental obligationsand it provides an appropriate return for investors. Customer bills Extensive stakeholder engagement has highlighted that the principal concern forcustomers is affordability. Customers are generally satisfied with the currenthigh levels of water and wastewater services being provided and are onlyprepared to pay for specific targeted areas of improvement, with 86% ofhousehold customers supportive of bill rises no higher than inflation. This hasbeen a key driver in the formulation of our plan. Following Ofwat's risk and reward guidance, we are now proposing an averagereal terms bill decrease of 2.3% for household customers across the five-yearperiod (excluding the impact of the previously announced special customerdiscount, which is being applied to 2014/15 bills). This compares with anaverage real terms bill decrease of 1.7% in our initial plan, reflecting thecombined changes of a lower cost of capital, revised `pay as you go' ratios andexpenditure 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 billdecrease 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 withnon-household customers and 76% were supportive and our business retail teamcontinue 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), whichoverall 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 bythe acceleration of spend relating to the water service and a revised costprofile relating to the retail service. The proposed total expenditure of £6.6billion comprises capital investment (capex), including infrastructure renewalsexpenditure 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 assessmentover 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 totalexpenditure recovered directly through wholesale revenues). This would resultin real growth in the regulatory capital value of around £600 million over the2015-20 period (based on an assumed regulatory capital value at 1 April 2015 ofover £9.6 billion, in 2012/13 year-end prices). The PAYG ratio for the wastewater service is 47%, reflecting the significantenhancement requirements in this area, largely driven by new environmentalobligations, whereas the PAYG ratio for the water service is 63%, reflectingthe lower level of quality improvement requirements and therefore a greaterproportion of maintenance activity. Operating expenditure Total operating expenditure in the plan is £2.85 billion, which is similar toour initial plan. This is split £1.08 billion opex for the water service, £1.12billion opex for the wastewater service and £0.65 billion of operatingexpenditure for the retail service. Our plan includes initiatives designed to save around £60 million per annum ofopex 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 ratesand power, alongside the addition of private pumping stations and enhancementprogramme costs. Capital expenditure Our proposed £3.75 billion capital investment programme (net of grants andcontributions) comprises £1.39 billion for the water service, £2.3 billion forthe wastewater service and £0.06 billion for the retail service. Overall, ourtotal capex requirements are similar to our initial plan. Investment to meet tighter regulatory quality standards, enhance service tocustomers 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 theNorth West on our costs, we are seeking an adjustment to the household retailaverage cost to serve of around £19 million per annum. We had already providedrobust evidence to Ofwat in support of this approach and have added to thisevidence base since the submission of our initial plan in December. Water: Thirlmere totex exclusion - this proposed exclusion from Ofwat's totexmodelling methodology relates to investment required to comply with theHabitats Directive requirement to revoke our Ennerdale abstraction licence inthe Lake District. The River Ehen, downstream of Ennerdale Water, contains adeclining population of the internationally endangered freshwater mussel.Revocation of the licence will cause a loss of water resources and customerswould 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 ourThirlmere reservoir, with a new water treatment works near Keswick. There is nomodelled spend in Ofwat's totex model for this type of investment. Since ourinitial business plan submission, we have reviewed the project timescales tomeet the statutory obligations and have brought forward £165 million ofinvestment which was originally planned for the 2020-25 period. This hasincreased our proposed spend on this initiative for the 2015-20 period to £215million, which we have asked for Ofwat to exclude from its totex methodology. Ofwat published its `risk-based review initial thresholds' in March 2014 andthis indicated a totex gap in respect of UUW's water service of around £70million. Our water totex submission is now £2.48 billion, increasing this gapto around £170 million. However, we have asked for £215 million, of our £2.48billion submission, to be assessed separately. Wastewater totex exclusions - The North West is the only region in the UK withboth large areas of high population density and high rainfall levels and thesefactors are significant drivers of wastewater costs. Our region has a verylarge industrial base and we treat the highest volume of trade effluent of anyregion. We also have the legacy of industrial pollution inherent in the NorthWest, along with high phosphorus levels and have the largest volume ofwastewater that is required to be treated to the highest standards. Our regionhas low dilution capacity of rivers and one third of the poorest quality riversin England and Wales, together with two thirds of all of the failing bathingwaters in England and Wales. This will be exacerbated by the Bathing WaterDirective, which will increase the required standards from 2015. In addition,the North West contains an abundance of internationally and nationallydesignated sites of environmental importance that need to be protected andoften improved, with our region containing England's largest area of `Sites ofSpecial Scientific Interest'. Overall, the North West has significant regionaldifferences which have a material impact on the cost of providing wastewaterservices. We have worked hard with the Environment Agency to constrain and balance ourexpenditure programme. Nonetheless, similar to previous regulatory periods, ourwastewater spend includes a significant environmental programme. In light ofour regional differences and a lack of relevant comparable costs across theindustry, we believe it is necessary to assess several elements of thisprogramme outside of Ofwat's totex modelling methodology. This reflects ourview that it would be very difficult to capture all of the explanatory factorsrelating 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 respectof UUW's wastewater service of £1.13 billion. After applying around £150million of scope and efficiency reductions to the December plan, we now proposethat around £960 million be excluded from Ofwat's totex modelling methodologyand assessed separately (as outlined in the following bullets). We haveprovided Ofwat with extensive additional evidence and information to supportthese model exclusions. Whilst our assessment of Ofwat's modelled approach is that there are multiplefactors which give rise to this difference, key drivers can be broadlycategorised 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 ofthe models, company efficiency and the cost exclusions. These could affectOfwat's assessment of the wastewater plan and inform its judgement in settingthe wastewater totex baseline. More information relating to our wastewater totex company specific adjustmentsis provided in a presentation pack, which can be accessed via the followingwebsite 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 inJanuary 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 retailmargin. Outcome delivery incentives (ODIs) Our initial plan included a range of ODIs where financial incentives wereexclusively penalty-based. Following the publication of Ofwat's revised riskand reward guidance, we have reviewed our approach and undertaken furtherengagement with customers to better understand their preferences. As a result,we have revised our ODI package so that it is more symmetric, having bothrewards as well as penalties, and now has better alignment of financial returnsto the value delivered to customers. Following further engagement with theNorth West Customer Challenge Group we have submitted a total of 17 ODIs aspart of our revised plan. Eight ODIs relate to the water service and cover performance in areas such asreliability of supply, water quality, leakage and river quality improvements.The total reward incentive is around £100 million, with a total penalty risk ofaround £190 million, based on potential outcomes covering 80% of theprobability range. The other nine ODIs relate to the wastewater service and cover performance inareas such as sewer flooding, bathing waters, private sewers and sludgedisposal. The total reward incentive is around £100 million, with a totalpenalty risk of around £190 million, based on potential outcomes covering 80%of the probability range. Recognising customers' preference for bill predictability and stability, wepropose to make any performance adjustments relating to our ODIs at the end ofthe 2015-20 regulatory period. Adjustments relating to the 2010-15 period We have enhanced our supporting evidence and made a number of adjustment claimsin line with Ofwat's methodology. These include areas such as the revenuecorrection mechanism, opex incentive allowance, the capital expenditureincentive scheme and the service incentive mechanism. Overall, theseadjustments amount to a revenue uplift of around £130 million across the2015-20 period. Next steps Ofwat is expected to publish draft determinations on 29 August 2014, when itwill provide its view of our revised plan. Final determinations are due on 12December 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 daysfollowing 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 4200Communications 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 -6expenditure Maintenance 603 621 -18 Quality, enhancement, supply & 411 253 +158demand Total 1,394 1,260 133 Wastewater capex Infrastructure renewals 340 355 -16expenditure Maintenance 898 887 +11 Quality, enhancement, supply & 1,060 1,194 -134demand Total 2,298 2,437 -139