United Utilities bullish about prospects

In a recent investor presentation United Utilities Chief Executive Philip Green said that: “we are well prepared for this next price review period (April 2010-2015) and we are confident of delivering out performance.

This confidence stems from a number of actions United Utilities have undertaken:

•                  Low cost of their debt portfolio of 1.8% real compared to Ofwat’s assumption of 3.6%
•   A reduction in the number of employees in their regulatory business of 7%
•          Streamlining processes and rationalizing IT infrastructure
•   New supplier contracts on improved terms 

United Utilities have secured an increase in their capital expenditure plans of £400m in real terms compared to the previous AMP period 2005-10, with planned expenditure of £3.6bn. United Utilities are particularly pleased that their regulatory capital value (RCV) will grow by 12% in real terms by 2015.

This is worrying for two reasons. Firstly it shows the continuing importance water utilities place on high cost capital schemes – there is in effect an incentive on the water company to promote the highest capital cost scheme that they believe the regulator will support. This mitigates against finding schemes with the lowest whole life cost especially those with higher Opex. Its also worrying as this high level of growth in the RCV has to be paid for by customers – the question is how much longer will customers accept steadily increasing customer bills?

Can the water industry afford major capital schemes?

In the budget Chancellor Alistair Darling announced he is commissioning an investigation into the cost of civil engineering works for major infrastructure projects, building on “existing evidence” of “potentially high costs” of UK schemes compared to the rest of Europe.

Affordability of water bills is likely to become a big issue over the next few years. Already Thames Water is seeing sustained opposition to its Tideway Tunnel proposals from the likes of Hammersmith Borough Council who are concerned about the ability of its residents to afford the bill increases needed to fund the massive investment.

Over the last 20 years, water and sewerage bills have increased by over 40% in real terms. One aspect is that the cost of bad debt is rising and now accounts for about £12 on each customer’s bill. In areas like the far SW water bills are already a major political issue. With the large investment required to meet the challenges posed by Ofwat’s strategy for delivering sustainable water the situation is likely to get worse. It will only increase the incentive for water customers who avoid paying their bills even though they could afford them.

This poses a real challenge for all of us in the water sector. Major capital schemes have often been seen as the preferred option given the way the regulatory and financial framework is tilted in favor of capital schemes. Finding significantly lower cost alternatives perhaps involving more Opex, will require a step change in innovation and that we attract bright young graduates into the industry – neither looks likely at the moment.  

Innovation in the water sector

At a conference run by British Water last week the steps needed to improve innovation (defined as fresh thinking that creates value) in the water sector were discussed. As the Cave Review recognised Innovation is essential for the water sector although the current level of R & D investment in the water sector is extremely small.

The Technology Strategy Board (TSB) established by the current Government with a budget of £1bn over 3 years and 100 staff is the main vehicle for driving business innovation. Groups have already been established by the TSB to look at Low Impact Housing and Sustainable Agriculture and Food. Now Martin Griffiths is leading work to build a case for a new group to stimulate innovation in the water sector. A decision on whether a new group will be formed is not likely til after the election and in the Autumn at the earliest.

Its clear much more needs to be done to encourage innovation. The current situation where the water companies undertake very little true R & D and where the current framework agreements mitigate against innovation is not healthy for the long term future of the industry. A new commercial reality is needed that enables suppliers to be rewarded for investing in innovation that benefits the water sector.       

Northern Ireland Water funding for next three years agreed

The Northern Ireland Utility Regulator has announced the final decision on price limits for Northern Ireland Water (NIW) for the next three years (2010 to 2013). The Final Determination allows over £0.5 bn to be invested over the next three years but it also requires costs to be cut. It delivers a saving of £91m when compared to NIW’s business plan bid.

The Final Determination marks a turning point. The Utility Regulator recognises that operating costs have risen since 2004. He also recognises that there is a large performance gap between NIW and GB water companies. NIW is just beginning its efficiency journey. It is different to the English Water companies in that it’s publically funded but it has the opportunity to learn from others, especially Scottish Water.

Northern Ireland Water Chairman dismissed

Northern Ireland Regional Development Minister, Colin Murphy, today announced that he had dismissed the Chairman and a number of non-executive Directors of the Board of NI Water (NIW).

The dismissals came after the publication of a recently completed Review of Procurement Governance. This identified that there had been a serious breakdown in the governance and control framework of NIW in relation to contract approvals.   In particular a number of contracts each worth over £250k had been let with out shareholder (Government) or NI Water’s Board approval. There was also a breakdown in the relationship between the CEO and Chairman.

In hindsight these problems may have been an inevitable consequence of the political chaos and lack of a clear strategy purpose for Northern Ireland Water.

When Northern Ireland Water was formed in 2007 it had been expected that it would be funded through the introduction of water charges. It let, for example,  a contract to build a new customer billing and contact centre. When the politicians lost their nerve this had to be cancelled. This meant that NIW could no longer be a Government Company (GoCo) but instead became a Non Departmental Public Body (NDPB). This resulted in increased public accountability and a very complex goverance model that is a half-way house between GoCo and NDPB.

There is no doubt that the confusion in identity and strategic purpose combined with the excessively complex business operating context were major factors in the chaos that is now evident. There is an important lesson here.

Summer/winter dual charging for water

Photo: Southern Water Durrington HQ

Southern Water has announced plans to start charging its customers more for water in summer than winter. The plans only affect customers with new dual charging meters. But is this likely to make a real difference to water consumption?

While there is good evidence that, at least in the short term, installing a water meter reduces consumption, it is less clear that long term having a meter makes any real difference to consumer behaviour. Is water demand really in economists jargon elastic to price? Apart from water usage by hose pipe, which is often banned in water stressed areas, how can a customer change demand between summer and winter? Can customers really use the toilet and shower, less in summer? 

Surely a more effective way to reduce usage is through changes to the building regulations, such as the installation of low flow taps.  The concern has to be that this new dual charging scheme will just antagonise customers and achieve no real reduction in demand.   

Water competition - a pipe dream?

The issue of market reform continues to be on the agenda and was debated at the Water UK City Conference. But is it likely to happen or just a good talking point? The key will be the attitude of the next government. Certainly the Conservatives are ideologically wedded to competition but speeches by the Shadow Secretary of State for the Environment, Nick Herbert MP have been much more cautious.

Nick Herbert is more concerned about whether the water industry is sufficiently sensitive to consumer demands and the growing issue of affordability. Secondly in the electricity market where competition was seen to have been successful growing concerns are emerging. There is growing consumer anger over the failure of competition to close the gap between wholesale and retail electricity prices. Even Ofgem has expressed 'reasonable doubt' that the UK energy market is capable of providing the £200bn investment required to deliver guaranteed supplies in the period to 2020.

   

Market reform was the subject of debate at Ofwat recently. The idea of separating out retail activities into a separate legal entity as suggested in the Cave review was discussed. One of the big problems of this idea is the concern that the legal separation of retail activities would breach covenants for the securitised water utilities and therefore require consent from lenders.

So while competition and the need for change may be promoted by industry, government and the regulator. There is recognition that nothing must be done that will undermine the confidence of investors. This means slow evolution not revolution. There is too much to lose, so expect a lot more talking but little action!

Welsh Water restructures to meet efficiency challenge

Photo: Mogden sewage treatment works courtesy of Thames Water

Welsh Water is to undertake the biggest re-structuring of the company since it was bought by Glas Cymru and became a “not-for-profit” company – to meet Ofwat’s demand that water bills be cut by £30 per household over the next five years. The move is expected to lead to 300 jobs being cut.

The company has torn up a fifteen year £1.5 billion outsourcing contract with United Utilities. It is also in negotiations with Kelda over the future of its £450m contract for water services.

“We aim to achieve a reduction of 20 per cent in our day-to-day running costs. We will do this by exploiting our recent large investment in new technology, by eliminating duplication in management and by investing in ‘green energy’ to reduce power costs ,” Mr Annett said.

The move marks a radical change of strategy for Welsh Water, the company that pioneered the outsourcing model. It means it will revert to managing a large number of staff with almost a ten-fold increase in the number of employees on Welsh Water’s books.

Meanwhile South West Water and Thames Water are going down very a very different route to Welsh Water to reduce costs. SWW with its Puros project is looking to centralise control of its sites and move to pro-active management of staff. Thames also has a major automation project underway. These type of projects do not have a good success record in the chemical industry. If they are to work they do require an excellent understanding of the process technology and key control points prior to implementation – not something that most water companies are traditionally good at.

What is clear is that water companies feel under tremendous pressure after the Ofwat final determination to reduce costs. Becoming more efficiency is a laudable objective but will it really be in the best long term interest of consumers?