A long-term approach is essential to creating value
Today we benefit from the strategic decisions and work delivered by our predecessors over the last 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 create value for our stakeholders principally by agreeing and then delivering, or outperforming, our regulatory contract. The way we use our key resources and interact with our ever-evolving external environment, influenced by our long-term strategic approach, helps to achieve value creation. This also facilitates the delivery of our five customer outcomes alongside ensuring investors receive an appropriate return.
We create value for our stakeholders principally by agreeing and then delivering, or outperforming, our regulatory contract.
Pictured: The £100 million Davyhulme sludge recycling centre treats the wastewater sludge from half the North West’s population, with the potential to generate up to 80GWh of electricity each year.
How we create value
Changes in the economy, such as inflation, interest rates, or unemployment levels, can influence our ability to create value. Whilst outside of our direct control, we can mitigate some of the potential adverse impact associated with market movements, such as on inflation and interest rates, through our hedging strategies. More details about the economic environment are described here.
Political and regulatory
Over a long time frame the political and regulatory environment can change significantly. In the 26 years since the water industry was privatised by the UK Government, we have seen substantial tightening of laws and regulations. Whilst to some extent, changes to the regulatory environment are outside of our direct control, maintaining a good reputation is important to enable positive participation in regulatory discussions. By positively engaging and using our industry knowledge, we can help influence future policy with the aim of achieving the best outcome for our customers, shareholders and other stakeholders.
Planning far into the future ensures that we are prepared for the changing natural environment, most notably the effects of climate change. We have a responsibility to return water to the environment safely and we are focused on reducing pollution incidents, caused by spills from our network. We can make an important contribution to protecting and enhancing the natural environment by using fewer natural resources and we are reducing our carbon footprint as well as increasing renewable energy production. More detail across each of these areas is provided in Our natural environment.
Advances in technology can be used to help deliver improvements in the quality or cost of our service. Embracing innovation, using modern technology or techniques, is at the heart of how we do business. For example, our Davyhulme sludge recycling centre which employed a ground-breaking configuration of thermal hydrolysis to maximise energy generation from sludge, won an Annual Institute of Chemical Engineers award for innovation in 2013/14. We also have to be mindful of our customers’ ever increasing use of technology and we have been improving our website and using text messages and social media to expand communication options with customers. More information on how we are embracing innovation is shown in Our performance 2014/15.
We see some significant societal trends that we plan to address in our long-term strategy. The North West remains the most socially and economically deprived region in England and so we can anticipate continued hardship for a number of communities and difficulties for some customers in paying their bills. We will remain committed to supporting these customers through a suite of payment assistance schemes and looking at new ways to help, like the introduction of our social tariff in 2015. We anticipate an increase in the North West population of around 600,000 by 2040 (more than the population of a large city such as Liverpool). We are planning to ensure our services and supporting infrastructure meet the needs of this growing population, which will include a higher proportion of older people.
Our employees play a critical role in increasing long-term value generation. Fundamental to the decisions we take and operational performance we deliver is a skilled, engaged and motivated team. We place a strong emphasis on providing comprehensive training and development opportunities. Our latest engagement score is reported in Our performance 2014/15. Management has a range of incentives which focus on performance over a number of years, rather than just the current year, to encourage the delivery of benefits over the longer term.
Our suppliers and contractors provide us with essential services which we rely on to deliver our strategy. It is vital that we work closely with them, for example on large capital projects where the delivery of projects on time, to budget and with minimal customer impact has economic, societal and environmental benefits. Close collaboration is important to help support the delivery of these benefits and, for example, our suppliers contributed significantly towards our c£7 billion estimated contribution to the regional economy over the 2010–15 period. Our responsible approach to doing business outlines the standards we expect of our suppliers.
Our employees play a critical role in increasing long-term value generation
The average life of our term debt is over 20 years
We aim to maintain a robust and responsible capital structure, balancing both equity and debt to achieve a strong investment grade credit rating. Our proactive equity and credit investor programmes allow us to engage effectively with investors. Issuing new debt is particularly important as our capital investment is largely financed through a mix of debt and cash generated from our operations. We maintain access to a broad range of sources of finance in a number of markets across which best relative value is sought when issuing new debt. The European Investment Bank is our largest lender with c£1.9 billion of debt and undrawn facilites.
Locking in long-term debt at good relative value can help keep our finance costs low and enables us potentially to outperform the industry-allowed cost of debt. Sustained low-cost finance across the industry benefits customer bills. The average life of our term debt is over 20 years. Our prudent financial risk management policies covering credit, liquidity, interest rate, inflation and currency risk help reduce the group’s exposure to the economic and regulatory environment.
Our fixed assets (including all our reservoirs, treatment works and pipes) have a replacement cost of around £80 billion which is the estimated amount it would cost for another company to build similar assets and networks. 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), a regulatory measure of our capital base, which is currently just over £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. 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. Embracing innovation in our asset configuration and work processes can help to make our future service better, faster or cheaper.
Since privatisation in 1989, total capital investment of over £14 billion has provided substantial benefits to our customers and our region’s environment as well as contributing to the North West economy through job creation, both within our company and in our supply chain. 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 have to be mindful of the impact on our customers’ bills, and this is why, for example, we are spreading some of the environmental spend required by European legislation over the next 15 years.
Whilst rainfall in the North West of England is greater than other parts of the country, and thus supply is not as constrained, it is still in everyone’s interest to make the most of this precious resource. We have encouraged customers to use water more efficiently and have increased the number of households fitted with meters. We also have a regulatory annual leakage target which we aim to meet each year.
We own over 55,000 hectares of land around our reservoirs. Through our sustainable catchment management programme (SCAMP), we can effectively manage these catchments to protect and enhance water quality and to provide other benefits such as an improved natural environment. Over the past five years we have invested £12 million through this programme. Our new Catchment Wise project is looking at working with others to improve the lakes, rivers and coastal waters where we return wastewater.
As well as water and our catchment land, another key resource is waste. Sludge from wastewater can be processed to generate renewable energy, helping to save power costs and protect the environment. Our advanced digestion facility at Davyhulme is one of the largest works of its type in the world. We also recycle waste by supplying treated biosolids to agriculture, which provides a valuable resource to farmers.
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.
Ofwat sets our regulatory contract following the receipt of our five-year plan proposals (see the ‘Regulatory environment’ section for further details).
By submitting a robust, balanced plan, we can help ensure we receive a regulatory contract that allows for the best overall 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. Investing in our people to ensure a committed, capable and motivated workforce is a major contributor to delivering high performance. Some of the key ways we create value over this shorter time frame are by:
- improving customer service – which will improve efficiency, reduce costs and reduce potential penalties/increase rewards from Ofwat, under its service incentive mechanism (SIM);
- enhancing our debt collection activities – which will reduce our retail costs. Alongside this, we continue to provide comprehensive support for customers struggling to pay;
- raising low-cost finance – which 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, to reduce the volatility of these costs, helping us meet our regulatory contract;
- minimising total costs on a sustainable basis, such as on power, materials and property rates – which helps us meet or outperform totex costs allowed in our regulatory contract;
- delivering our operational and regulatory commitments – which helps ensure we achieve high levels of customer service and meet environmental standards. Our performance can also result in potential financial rewards or penalties such as those linked to our outcome delivery incentives (ODIs), which include reliably delivered high-quality water and reducing pollution and sewer flooding incidents;
- meeting our regulatory leakage target – which provides water resource and customer supply benefits and avoids any unfunded expenditure requirements from our regulators; and
- increasing our production of renewable energy from waste – which helps protect us from rising energy costs and reduces our carbon footprint.
Over the 2010–15 regulatory period, outperformance was generated mainly through efficiency savings on operating costs, capital expenditure and financing costs. Ofwat’s SIM assessment also rewarded companies who performed well on customer service, or penalised companies who performed badly, relative to other water companies.
Our KPIs over this period, including for 2014/15, were reflective of these potential areas for outperformance, and how we performed is described within the ‘Our performance 2014/15’ section. ‘Key achievements 2010-15’ also outlines our progress over the last five years, particularly in the important area of customer service.
Ofwat has evolved the regulatory framework so that, over the 2015–20 period, the way we can add value has changed. Operating costs and capital investment are no longer separately assessed as they are now combined into a new ‘totex’ methodology. There will be additional rewards or penalties based on performance as measured through a range of ODIs. Ofwat is continuing with its SIM assessment for household customers with a similar incentive and penalty framework. Companies are still incentivised to outperform in the area of financing costs. The progressive opening up of the retail market for business customers will also encourage companies to improve service. We will continue to improve our service to help us win more out of area customers and, importantly, to retain our existing customers.
Our KPIs for 2015–20 have evolved to reflect the changes in the regulatory framework and further details of these are shown here.