Pdf

Our industry and market

Every day, over 50 million household and non-household customers receive water and wastewater services in England and Wales. There are ten licensed water and wastewater companies, which are split regionally based on river catchment areas, and these make up around 95 per cent of the industry, with the remainder being made up of licensed companies which provide water-only services and tend to be smaller in size.

United Utilities Water Limited (UUW) is the second largest based on the size of our asset base, as measured by Regulatory Capital Value (RCV). We are licensed to provide water and wastewater services to a population of approximately seven million people in the North West, and we provide services to approximately three million households, which generates around two-thirds of our total revenue, and approximately 200,000 businesses, ranging in size from large manufacturing companies to small shops.

The privatisation of the industry has delivered a significant contribution to improvements in public health as a result of over £130 billion that has been invested in maintaining and improving assets and services since 1989. It has led to improvements in the quality of services, significantly higher environmental standards, and superior quality drinking water, all at a fair cost to customers that has been estimated to be lower than would be the case if the water sector was still owned by the UK Government, with prices that have declined in real terms over the current and last regulatory periods.

The advancement of technology and innovation makes way for even more improvements in the future, as investment continues to be made in improving the service we provide for the long-term.

Our competitive environment

The other water companies in England and Wales are naturally our main competitors, and we benchmark our performance on a comparative basis with these peers.

In line with our vision to be the best UK water and wastewater company, we also benchmark our customer service performance against other leading service providers in our region.

In addition, as a publicly listed FTSE 100 company, the other UK and worldwide utilities are competitors from an investment perspective.

Our political and regulatory environment

As each company in the water sector operates as a regional monopoly for the majority of its services, we are subject to regulation in terms of price and performance.

At privatisation, in order to protect the interests of both customers and the environment, three separate bodies were set up to regulate the activities of water and wastewater companies under the areas of economic, drinking water quality, and environmental regulation. This has since evolved further to fit with the substantial tightening of laws and regulations that we have seen since privatisation.

Over a long time frame the political and regulatory environment can change significantly. While to some extent these changes are outside of our direct control, we believe in the importance of maintaining good relationships. This enables us to engage positively in regulatory discussions, offering our industry knowledge in order to help influence future policy with the aim of achieving the best outcome for customers, shareholders and other stakeholders.

Environmental and quality regulation

The water and wastewater industry in the UK is subject to substantial domestic and European Union (EU) regulation, placing significant statutory obligations on companies relating to, amongst other factors, the quality of drinking water supplied, wastewater treatment, and the impact of our activities on the environment.

Defra is the UK Government department responsible for water policy and regulations in England and Wales; it sets drinking water quality and environmental standards (many based on European law) which water companies must meet.


The Environment Agency (EA) controls how much water can be drawn from the environment and the quality of water returned to rivers and the sea. The EA produces an assessment of water and wastewater companies' annual performance, and we include this as one of our operational KPIs.


The Drinking Water Inspectorate (DWI) is responsible for ensuring compliance with the drinking water quality regulations.

 


Natural England is responsible for the protection of designated sites for nature conservation, for example Sites of Special Scientific Interest. Companies are required to manage these sites and to protect and enhance biodiversity.

 


The Consumer Council for Water (CCW) represents customers' interests relating to price, service and value for money. It investigates customer complaints. Customers who remain dissatisfied can refer their complaint to be adjudicated by an independent service, WATRS (see below).


The Water Redress Scheme (WATRS) is an independent service designed to adjudicate disputes that have not been resolved through the water company's customer service teams or by referring the matter to the Consumer Council for Water.


Economic regulation

The Water Services Regulation Authority (Ofwat) is the economic regulator of the water and sewerage sectors in England and Wales, responsible for ensuring the companies provide customers with good-quality, efficient service at a fair price.

The water industry plans and operates within five-year regulatory periods known as Asset Management Plan (AMP) periods.

Prior to the start of each regulatory period, Ofwat consults with stakeholders, including companies and sets out its price review methodology, which gives the framework for the forthcoming five-year regulatory period.

As part of the price review process, companies submit their business plans to Ofwat with a projection of the expenditure needed to enhance and maintain their assets over the period, in line with customer priorities, statutory requirements and the regulatory framework. Ofwat scrutinises and challenges these business plans, and ultimately sets the five-year price, service and incentive package – this is the regulatory contract that company performance is measured against over the regulatory period.

Each year all water companies are required to publish an annual performance report (APR). Our APRs, from the beginning of this regulatory period, can be found on our website, where our report for this financial year will also be made available: unitedutilities.com/corporate.

This report covers the third year of the 2015–20 regulatory period (AMP6).

While we are working to perform within the current regulatory period, the industry and its stakeholders, including government and regulators, are constantly looking ahead and planning for the future. The 2014 Water Act paved the way for the extension of competition into certain parts of the wholesale business. The retail market was opened to competition for all non-household customers from 1 April 2017 and Ofwat proposed, in its Water 2020 consultation document in 2015, to open up the areas of water resources and bioresources treatment to future competition.

In December 2017, Ofwat published its final methodology for the price review (PR19) for the 'AMP7' regulatory period, which runs from April 2020 to March 2025. This methodology forms part of Water 2020, which is Ofwat's overall vision for the water sector in England and Wales.

Ofwat has outlined four key themes in its final methodology for the 2020–25 regulatory period:

  • Great customer service;
  • Affordable bills;
  • Resilience in the round; and
  • Innovation.

These are not new for us in the way that we run our business and have been areas of focus for us for some time. We have been actively engaged in the development of Ofwat's approach to PR19, contributing across the full range of working groups and providing detailed proposals in key areas. We have been carrying out extensive customer research and engagement with stakeholders to determine our plans for AMP7. We will be submitting our business plan in September 2018.

Ofwat is introducing a number of changes for the 2020–25 regulatory period.

Price controls

2015–20 regulatory period (AMP6)

Ofwat moved away from one single price control and introduced four separate price controls:

  • Wholesale water – the physical supply of water;
  • Wholesale wastewater – the removal and treatment of wastewater;
  • Household retail – customer-facing activities (principally customer contact, billing, meter reading and cash collection) for households; and
  • Non-household retail – customer-facing activities for businesses (now covered by our joint venture, Water Plus).

Separate retail price controls were introduced to encourage a more efficient service and to promote competition in non-household retail.

2020–25 regulatory period (AMP7)

Ofwat's methodology for AMP7 sets out six separate binding controls:

  • Water resources – the resources from which water is sourced;
  • Water network plus – water treatment and distribution;
  • Wastewater network plus – wastewater collection and treatment;
  • Bioresources – the treatment and sale of energy and nutrient-rich bioresources from recycled organic waste;
  • Residential retail (the equivalent of household retail); and
  • Business retail (the equivalent of non-household retail).

This further separation is intended to promote future competition in water resources and bioresources. As we have transferred our non-household (business) retail business to our joint venture, Water Plus, we will not be covered by the business retail price control.

Operating and capital costs (totex)

2015–20 regulatory period (AMP6)

In order to encourage companies to utilise the most efficient sustainable solutions, Ofwat changed the way companies' operating and capital costs are assessed for AMP6, from separate capex and opex to a combined totex model that treats them both equally.

Ofwat developed wholesale cost assessment totex models as part of the last price review process, which were used to set the allowed costs for companies in AMP6.

Where companies outperform or underperform their totex allowance, this gain or pain is shared between investors and customers, ensuring both receive a share of the impact. We include our performance against our allowed totex expenditure as one of our operational KPIs.

2020–25 regulatory period (AMP7)

Ofwat is developing new cost assessment totex models for AMP7, and we have taken a constructive approach in sharing cost driver analysis from third party experts with Ofwat and our peers in the industry through working groups and other available consultation channels.

Ofwat has introduced a new mechanism for AMP7 that uses cost sharing rates to incentivise companies to submit efficient business plans. Each company will have one cost sharing rate for outperformance and another rate for underperformance, with the rates determined by the ratio of a company's business plan totex to Ofwat's view of efficient totex as determined by its cost assessment models. Business plans that are deemed efficient versus the models used by Ofwat will get more favourable cost sharing rates, and vice versa.

Performance commitments and incentives

2015–20 regulatory period (AMP6)

In a move to a more outcomes-based approach, there was greater emphasis placed on customer engagement to set outcomes for AMP6. Companies' performance is measured through performance commitments covering a wide range of measures assessing operational and environmental performance, with associated rewards or penalties (outcome delivery incentives, or ODIs). We include our performance against our ODIs in our operational KPIs.

Following their introduction in AMP6 there was a wide variety of approaches towards definition, measurement, targets, rewards and penalty payments associated with performance commitment measurements and outcome delivery incentives. There is a cap of +/- 2 per cent of the return on regulated equity in place in AMP6. In part, this reflected a recognition that this was the first period in which these new performance incentives had been applied.

2020–25 regulatory period (AMP7)

Ofwat has set out a clear intention to introduce more powerful ODIs in AMP7, with a drive for companies' returns to be more heavily dependent on their operational performance against stretching targets. It intends to achieve this by removing the cap that is currently in place and also through enhanced outperformance payment rates for significant outperformance and higher underperformance penalty rates for very poor performance.

Alongside the increased scope for outperformance and underperformance payments, company performance commitments and outcome delivery incentives are likely to be subject to significant revision in AMP7, including a set of 14 common performance commitments across the industry, with three of these having common upper quartile performance targets.

Customer satisfaction

2015–20 regulatory period (AMP6)

Ofwat's Service Incentive Mechanism (SIM) assessment is used as a measure of customer satisfaction that rewards companies that perform particularly well on customer service relative to other water companies, and penalises companies that perform particularly poorly.

SIM is split into two components – quantitative SIM is based on the number of customer contacts, and qualitative SIM is based on the satisfaction of customers with the outcomes of those contacts. We include both of these SIM assessments as operational KPIs.

2020–25 regulatory period (AMP7)

A new customer service metric, C-MeX, will replace SIM in AMP7, and will be piloted from 2018/19.

This will be based on two customer surveys, one from customers that have contacted the company, which should be similar to the qualitative SIM in the current period, and one from customers that have not contacted the company. The proposed incentive range will be higher than is currently available for SIM, demonstrating a greater emphasis on customer satisfaction and customer sentiment in AMP7.

In addition, Ofwat plans to introduce a new developer service measure, D-MeX, which will also be piloted from 2018/19.

Household retail

2015–20 regulatory period (AMP6)

Allowed costs within the household retail price control are determined using a water industry average cost to serve approach in AMP6, rewarding companies that are able to achieve costs below the industry average.

Our household retail revenue allowance includes the assumed average cost to serve plus a margin that is intended to cover retail costs not covered through the average cost to serve, such as financing of new retail assets and the retailer's working capital.

We include our performance against our household retail revenue allowance as one of our operational KPIs.

2020–25 regulatory period (AMP7)

Ofwat intends to replace its previous average cost to serve approach with a cost assessment based on econometric models of household retail costs in AMP7. These costs will be benchmarked to an efficient baseline.

We support the decision to use econometric models. This more sophisticated approach has the potential to directly reflect key industry cost drivers such as dual and single billing, meter penetration and the impact of extreme deprivation when estimating of efficient levels for retail cost allowances.

Financing

2015–20 regulatory period (AMP6)

Ofwat estimated a weighted average cost of capital for AMP6 (3.74 per cent, in real terms , based on RPI inflation) in order to provide debt and equity investors with a return that was considered to be commensurate with the level of risk that underpinned their investment.

In setting the cost of capital, Ofwat used a notional capital structure with 62.5 per cent gearing, calculated as net debt as a percentage of regulatory capital value.

We include our performance against Ofwat's industry allowed cost of debt as one of our operational KPIs.

2020–25 regulatory period (AMP7)

Ofwat has been clear that the estimated weighted average cost of capital will be lower in AMP7, recognising that requirements for overall returns are lower now than they have been historically, and reflecting its intention that a higher proportion of companies' returns should come from operational outperformance.

In setting the cost of capital, Ofwat is using a notional capital structure with 60 per cent gearing – this is the midpoint of our target range of 55 to 65 per cent.

Ofwat will apply debt indexation to new debt in order to reduce the risk of forecast errors, and has confirmed that CPIH will be adopted for the indexation of future price controls.

Ofwat has set an indicative figure for its estimate of the cost of capital of 3.4 per cent in real terms (using CPIH as the price index), which is equivalent to 2.4 per cent if RPI had been used as the price index, as in earlier price reviews.