Utility Week

UTILITY WEEK | 14TH - 20TH SEPTEMBER 2018 | 13 Policy & Regulation Analysis W ith a thump on its doormat or via a bulging inbox, Ofwat has taken delivery of 17 water company busi- ness plans. They are chunky documents; medium-sized Anglian's is almost 300 pages. As part of the regulator's 2019 price review, PR19, all water firms must set out how they will meet the needs of their cus- tomers from 2020 to 2025 and beyond. Inevi- tably, there are many differences and varying priorities, but some key themes apply across the sector. Not surprisingly, some very hey invest- ment is proposed, although there is a distinct regional element to the expenditure profiles. In Thames's case, its business plan reveals a profound change of policy mar- shalled by new chairman Ian Marchant, whose utility expertise dates right back to the 1980s. Thames has been savagely criticised for its excessive dividends, its soaring net debt, its minimal corporation tax payments and its woeful record on leakage reduction. For the 2020-25 period, Thames's planned total expenditure (totex) is circa £11.7 billion; capital enhancement represents £3.3 billion – more than a quarter of this figure. Impor- tantly, Thames is seeking to resurrect the Abingdon reservoir project, a controversial scheme that has been debated for decades. Given the high level of house-building locally, both Anglian and Wessex are plan- ning a circa 30 per cent upli in investment. Similar criteria apply to Southern, where a 25 per cent upli in investment is planned – from £3.2 billion to £4 billion over the five-year period. Impressively, Southern's long-standing metering programme is now bearing fruit – 87 per cent of customers are now metered, with a claimed 16 per cent cut in consumption being achieved. Severn Trent, too, operates in a region where new-build levels are high. Of its forecast £6.6 billion of totex, £1.7 billion is earmarked for enhancement expenditure. Cutting bills By contrast, United Utilities is projecting a £1 billion-plus cut in expenditure, when compared with 2010-15, as it focuses on cutting average bills. It envisages price cuts of more than 10 per cent in real terms between 2020 and 2025; only Northumbrian, with its front-loaded cut proposals, plans to exceed this figure. Other companies are less aggressive in reducing customer bills, with most work- ing on single-digit cuts over the five years: Severn Trent, for example, is focusing on a 5 per cent cut in real terms. In Thames's case, it expects its average bills to be flat – in real terms – throughout the 2020-25 regulatory period. Dividend policy For investors, future dividend policy is key. While Thames is unquoted, its new policy limits dividend payments to about £20 mil- lion per year. Under Thames's old regime, annual dividends regularly cost more than £100 mil- lion per year – and, in 2009/10, topped £300 million. Quoted water companies will seek to avoid a dividend cut. Until the final determi- nations are announced in December 2019, the quoted trio – Severn Trent, United Utilities and Pennon – are unlikely to be over-specific on their future dividend-paying intentions. However, Pennon has confirmed its plans for approximately £20 million of accrued benefits to be passed on to customers via a share option – an arrangement Pennon describes as unique. A harbinger for UK utilities in the future? Reducing leakage For politicians, leakage levels are a key parameter. Since privatisation in 1989, it has to be said that – £150 billion of indus- try expenditure later – the sector record on reducing leakage, with a few exceptions, remains dire. Thames admits that "currently, 25 per cent of all the water that it treats and puts into the system is lost…". Water companies are now according a far higher priority to reducing leakage levels. Yorkshire is particularly aggressive in stating: "Our leakage will reduce by 40 per cent between 2018 and 2025." Investment focus Ofwat will not lack reading material. John Russell, director for strategy and planning, stated: "From now until January 2019, we'll pore over each business plan and we'll be looking for evidence that they are robust, ambitious and, crucially, that they have been shaped by customers." While Ofwat will no doubt trawl for its favoured buzzword – innovation – which appears in virtually every business plan, it will focus on the investment programmes and whether there is any evidence that "lilies have been gilded". Aer all, under the water regulatory regime, higher investment means higher earnings – much welcomed by investors. And Ofwat will have noted United Utilities' comparatively conservative expenditure proposals. Ofwat may even disqualify some schemes from being eligible for a regulated return. Bristol's experience in the last periodic review over the Cheddar Reservoir/Seabank Power scheme is a salutary lesson. Wacc acceptance Ofwat itself will be pleased that some water companies, such as United Utilities, seem implicitly to have accepted its aggressive 2.4 per cent weighted average cost of capital (Wacc). Indeed, United Utilities has adopted "an RPI-stripped appointed cost of capital of 2.4 per cent consistent with Ofwat's early view". Of course, the pivotal Wacc figure may be adjusted before December 2019. Publication of the business plans saw shares in the three quoted water firms edge down. But for Ofwat, a massive reading and financial modelling exercise has begun. And, early next year, there will be the eagerly awaited – and price-sensitive – announcement of the "exceptional" and "fast trackers" among the 17 water companies. Nigel Hawkins is an investment analyst specialising in the utilities sector How will water splash cash? The business plans are in and Ofwat must now rate 17 water firms on how they intend to spend their income in 2020-25 to meet the needs of customers and the environment. Nigel Hawkins reports.

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