A long-term approach is essential to creating value
Today we benefit from the strategic decisions and work delivered by our predecessors over the previous 150 years to provide the North West with good quality water and to reduce the environmental impact of the wastewater we treat. The work we do today will help to ensure customers of the North West continue to enjoy an effective, efficient service for many generations to come.
We can increase long-term value generation through the strategic direction and decisions we take and through the hard work of our employees. It is important that we create and retain an engaged and talented team in order to deliver this and we place a strong emphasis on providing comprehensive training and development opportunities. Management has a range of incentives which focus on performance over a number of years, rather than the current year in isolation, to encourage a longer-term approach.
Regulatory Capital Value (RCV) close to
Average life of our
term-debt of around
Our fixed assets have a replacement cost of around £80 billion i.e. the estimated amount it would cost for another party to build competing assets and networks. This means that we are a natural regional monopoly. However, it is not the replacement cost of our assets upon which we are allowed to earn a return, through our revenues. We earn a return on our Regulatory Capital Value (RCV), which is currently close to £10 billion, so it is this asset value which is more important economically.
Many of our assets are long-term in nature: for example, our impounding reservoirs have a useful economic life of around 200 years with some sewers having a life of up to 300 years. By carefully reviewing our potential capital projects, considering the most efficient long-term solutions, we can save future operating costs, also helping to reduce future customer bills.
Since privatisation in 1989, total capital investment of over £13 billion has provided substantial benefits to our customers and our region's environment. Disciplined investment, along with RPI inflation, also grows our RCV, increasing future revenues.
We need to continue with a substantial investment programme for the foreseeable future in order to meet ever more stringent environmental standards and to maintain and improve the current standards of our assets and services.
However, in deciding on our investment strategy, we also have to be mindful of the impact on our customers' bills, and this is why, for example, we are spreading some of our currently required environmental spend over the next 15 years.
PHOTOGRAPH: Network customer technicians Wes Odel (left) and Adrian Booth, helping customers with issues on the wastewater network.
It is important that we continue to attract equity investors to support a robust and responsible capital structure, which enables us to raise new debt. Capital investment is largely financed through a mix of debt and cash generated from our operations. The average life of our term-debt is around 25 years with our final maturity out as far as 2057. By efficiently raising debt at the best possible rates we can help keep our finance costs as low as possible and potentially outperform the industry allowed cost of debt, set by Ofwat every five years.
Over a long time frame the regulatory environment can change significantly. In the 25 years since the water industry was privatised we have seen substantial improvements in the regional standards of water quality and wastewater treatment and the cleanliness of rivers and bathing waters. We have also recently seen the progressive implementation of competition for business customers, with full market opening expected in 2017.
Maintaining a good reputation is important to enable positive participation in regulatory discussions. By positively engaging and utilising our industry knowledge, we can help influence future policy with the aim of achieving the best outcome for our customers, shareholders and other stakeholders. We can also help ensure we are well prepared for any changes to the regulatory landscape.
Our region's natural environment is also changing. Climate change is bringing more extreme weather patterns and we have a long-term strategy to help ensure we have sufficient water resources and are able to meet increased demand on our sewerage network. A phased, long-term approach ensures that the necessary work can be delivered and does not place too much pressure on customer bills.
Our region has one of the highest concentrations of economically-deprived households in the UK.
This is why we are committed to finding new ways to help our most disadvantaged customers. As well as continuing to financially support an independent trust fund to help those most in need, we link in with many organisations such as Citizens Advice Bureau, housing associations, carers groups, Age UK and credit unions to promote our range of support schemes to their own advisors.
This helps to give us a better understanding of the issues being faced in local communities. It also ensures that people who turn to these organisations for advice around debt-related issues find out about the schemes we have available to help them pay their water bill. It's been an effective strategy to help us get the right support to the right people at a time when they most need it.
Photograph: Carole Quinn (right), outreach manager for United Utilities, meets with Andrea Ratcliffe from Nelson CAB.
Shorter-term (up to five years)
Ofwat, our economic regulator, determines the prices we can charge our customers to provide them with water and wastewater services.
Read more in Regulatory environment
Ofwat sets our regulatory contract following the receipt of our five-year plan proposals.
By submitting a robust, balanced plan, we can help ensure we receive a contract that allows for an optimal outcome for our customers, shareholders and the environment.
Once each five-year regulatory contract is set we create value principally by delivering or outperforming it, by providing the best service to customers, at the lowest sustainable cost and in a responsible manner. Some of the key ways we create value over this shorter time frame are by:
- improving customer service will, in turn, improve efficiency and reduce costs. It will also reduce potential penalties/increase rewards from Ofwat, under its SIM incentive mechanism, maximising future revenues;
- delivering our regulatory commitments helps ensure we meet high customer service and environmental standards and avoid potential financial penalties;
- embracing innovation in our use of technology and work processes helps to make our service better, faster or cheaper;
- raising low cost finance helps us outperform the finance costs allowed in our regulatory contract;
- implementing our hedging strategies, such as fixing medium-term interest rates and power costs, reduce the volatility of our costs, helping us to meet our regulatory contract;
- minimising operating costs on a sustainable basis, such as on power, materials and property rates, helps us to meet or outperform operating costs allowed in our regulatory contract;
- enhancing our debt collection activities will reduce our retail costs. Alongside this, we continue to provide support for customers struggling to pay;
- meeting our economic leakage target provides water resource and customer supply benefits and avoids any unfunded expenditure requirements from our regulators;
- increasing our production of renewable energy from waste helps protect us from rising energy costs and reduces our carbon footprint.
Changes in the economy, such as inflation, interest rates, or unemployment levels, can influence our ability to create value.
Read more in The economic environment
External risk factors
Given the complex legal and regulatory environment in which we operate there are also a range of risks to which we are exposed.
Read more in Principal risks and uncertainties
Over the current 2010–15 regulatory period, outperformance is generated mainly through efficiency savings on operating costs, capital expenditure and financing costs. Ofwat's SIM incentive mechanism also rewards companies who perform well on customer service, or penalises companies who perform badly, relative to other water companies. Our current KPIs are reflective of these potential areas for outperformance.
Read more in Performance
Ofwat is evolving the regulatory framework so that, over the 2015–20 period, the way we can add value is changing. Operating costs and capital investment will no longer be separately assessed as they will be combined into a new 'Totex' methodology. There will be additional rewards or penalties based on performance as measured through a range of Outcome Delivery Incentives (ODIs). Ofwat is intending to continue with its SIM assessment for household customers and this is likely to provide a similar incentive and penalty framework. Companies will still be incentivised to outperform in the area of financing costs. The progressive opening up of the retail market for business customers will also provide additional opportunities to acquire further customers and earn higher returns. We will remain focused on improving our service to business customers to both help us win more out of area customers and, importantly, to retain our existing customers.
We create value principally by delivering or outperforming our regulatory contract.