United Utilities has submitted its representations in response to Ofwat's Draft Determination (DD) - the regulator will publish final determinations on 12 December 2014.
The response addresses the gap between Ofwat’s totex assessment and the AMP6 business plan revision the company submitted on 27 June 2014.
On performance and efficiency improvements, United Utilities said it had challenged its efficiency plans further and set, where practical, more stretching targets beyond those contained in its original business plan submission. The revised plan would result in average household bills falling by 4.1% in real terms over the 2015-20 period, compared with a 2.3% reduction in its June plan
On plan expenditure (totex), United Utilities had a totex gap between the June business plan submission and the DD of around £1 billion, comprising just under £800 million for wastewater and just over £200 million for water. The response to the DD reflects adjustments to the business plan which reduce planned totex by around £370 million.This includes reduced activity of around £90 million primarily associated with 2020-25 early start projects under the National Environment Programme (NEP5) and trunk mains resilience activity. The remaining proposed reduction of around £280 million relates to cost efficiencies which bring the overall proposed wholesale totex, for the 2015-20 period, down to £5.52 billion from £5.89 billion in June.
Following the plan revisions set out above, United Utilities is now proposing that Ofwat allows £628 million of totex, in addition to the £156 million already included in the DD. This comprises the following items:
Water
£143 million for the major Thirlmere project to address supply and demand issues in West Cumbria, which will arise from the revocation of abstraction licence at Ennerdale Water. The amount sought is £72 million lower than in the June plan, following an independent assessment.
Wastewater
£191 million of NEP5 wastewater projects, which are driven by environmental legislation, such as the Water Framework Directive. £188 million of wastewater base totex adjustments to reflect the particular characteristics of the North West region (outlined in detail with our June business plan), not captured in Ofwat’s totex modelling; and
£106 million relating to specific large integrated schemes, driven by legislation and customer demand, and other activity, after reductions to account for implicit allowances and the upper quartile efficiency challenge.
In the DD, Ofwat asked the company to provide further evidence and assurance to support its claim for additional costs above Ofwat’s assessed totex baseline. United Utilities said it had provided Ofwat with a comprehensive response comprising further independent evidence and information. The information covers need, cost benefit analysis and robust support for United Utilities costs, as required, on a project-by-project basis.
Household Retail
Ofwat has accepted an adjustment to the household retail average cost to serve of around £19 million per annum.
Non-household retail
United Utilities said that having already separated its household and non-household retail businesses, it believes its costs are accurately represented. The DD response proposes that, in a competitive environment, the charges need to be cost reflective. In United Utilities view the company should have greater flexibility in setting customer charges to help ensure that it can recover its costs and earn the allowed margin through the default tariffs.
Given the uncertainty relating to the market fully opening to competition, the firm has also proposed that an annual re-assessment is undertaken to enable any cost and margin implications to be periodically reviewed.
Return on capital
United Utilities revised proposals are based on the weighted average cost of capital (WACC) provided by Ofwat in its risk and reward guidance and assumed in the DD in August. This is a real, vanilla WACC of 3.7% for the wholesale business, plus retail margin.
United Utilities said:
"We believe it is important that this level of WACC is maintained to support the financeability of our plan."
Outcome Delivery Incentives
On outcome delivery incentives (ODIs), United Utilities has nine ODIs which relate to the water service and cover performance in areas such as reliability of supply, water quality, leakage and river quality improvements. The firm has proposed that the total reward incentive is retained at around £100 million, with a total penalty risk of around £190 million (similar to the June plan), based on potential outcomes covering 80% of the probability range.
In particular, United Utilities believes that the parameters relating to the water quality ODI in the DD need to be changed to provide a suitable incentive mechanism to reflect the regional differences in the North West.There are nine ODIs which relate to the wastewater service and cover performance in areas such as sewer flooding, bathing waters, private sewers and sludge disposal. United Utilities is now proposing that the total reward incentive is reduced to around £60 million (from around £100 million in the June plan), with an increase in the total penalty risk to around £250 million (from around £190 million in the June plan), based on potential outcomes covering 80% of the probability range.
The firm also believes that the parameters relating to the sewer flooding ODI in the DD need to be changed to provide a suitable incentive mechanism to reflect regional differences and deliver a performance level in line with customer preferences. United Utilities plans to make any performance adjustments relating to the ODIs at the end of the 2015-20 regulatory period.
Adjustments relating to the 2010-15 period
In the DD, Ofwat largely accepted United Utilities proposed adjustments (relating to areas such as the opex incentive allowance and the revenue correction mechanism) and allowed £123 million. United Utilities said it is seeking amendments to a small number of relatively minor specific issues.
Next steps
The water company said it will continue to engage with Ofwat and other regulators and stakeholders between now and publication of final determinations on 12 December 2014.