OFWAT CITY BRIEFING

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OFWAT CITY BRIEFING

• Philip Fletcher
• 29 November 2002

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• Whats been happening?
• Water Bill
• Competition Commission report
• Approach to the next price review

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Whats been happening?

• Legislation
• Enterprise Act
• Water Bill
• Mergers / Restructuring
• ANG restructuring completed
• Small-scale refinancings e.g. Dee Valley
• CC report on Vivendi / First Aqua
• YTL / Wessex

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Whats been happening? (2)

• Regulation
• Continue to work towards minimising unnecessary
  regulatory uncertainty
• Modified licences to provide 25-year notice
  period in line with electricity
• Release of our new financial model
• Interim determinations
• Licence consistency review

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Whats been happening? (3)

• ...and,
• formally kicked off the 2004 periodic review
  with publication in October of our Framework
  paper

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WATER BILL
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Water Bill

• Confirmed in Queens speech
• Likely key provisions for economic regulation
• competition proposals
• changes to Ofwat
• Board structure
• Enhanced duties
• Consumer council for water
• abstraction licensing

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Water Bill Competition

• To achieve benefits
• Framework and rules must be simple
• must avoid uncertainty and regulatory complexity
• Potential market must be large enough to
• encourage entry
• create spur to improve undertakers performance

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COMPETITION COMMISSION REPORT
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Competition Commission report

• Outcome so far
• Welcome recognition of comparator principle
• Will work with Vivendi Water to explore remedies
• Tight timescale - Ofwat advice to DGFT by end of
  January 2003

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Merger Regime

• Comparators remain key plank of water regulation
• Yet to be persuaded that significant operating
  economies of scale would be achieved by mergers
• But, do not wish to lock the industry into a
  particular structure
• Will continue to look with an open mind at
  individual propositions

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SETTING PRICE LIMITS 2005-10 FRAMEWORK AND
APPROACH-consultation runs from October
02-January 03
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Achievements to date
Compliance
At
privatisation
Now
Sewage
99
90
treatment works
Bathing Waters
66
97
Rivers
83
94
Drinking Water
1 in 100
1 in 700
failures
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We aim to set price limits which provide best
value to customers now and in the future. We
intend to

• enable well managed companies to finance the
  delivery of services in line with relevant
  standards and requirements and
• provide incentives for companies to improve
  efficiency and service delivery
• We will adopt an efficient and transparent
• process in conducting the review

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Approach to Periodic Review 2004

• Build on lessons learned from
• Our own review of the 1999 Periodic Review
• Environmental Audit Committees Report
• Competition Commission reports
• NAO Pipes and Wires report

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Approach

• Retain RPI-X
• Reviewed alternatives
• RPI-X is the preferred option as gives strong
  incentives to improve efficiency

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Bills from 2005

• Too soon to predict the outcome
• Bills will be what they need to be to finance
  functions
• We need to examine scope for efficiency and
  likely pressures for improvements in
  environmental and drinking water quality

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Timetable

• Oct 02 Framework consultation
• Mar 03 Consultation Conclusions
• Aug 03 Draft Business Plans
• Jan 04 Final Ministerial input
• Apr 04 Final Business Plans
• June 04 Draft Determination
• Nov 04 Final determinations

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Our priorities in setting price limits will allow
companies to

• 1. Run businesses day to day
• 2. Maintain asset systems-now and in the future
• 3. Balance supply and demand
• 4. Meet drinking water quality and service
  improvements for public health
• 5. Meet obligations on environmental improvements
  decided by Ministers
• 6. Make other improvements e.g. sewer flooding

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Incentives and efficiency

• RPI-X incentive based regulation
• Benefits investors and customers
• Will our approach provide sufficient incentive
  for companies to seek to outperform our
  assumptions?

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Maintaining services

• Maintaining day to day services accounts for 85
  of bills
• Companies need to do more to understand their
  assets
• Where companies want to spend more we will expect
  robust evidence

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Capital programme

• Ministerial guidance - 3 Stages
• initial guidance Dec 02/Jan 03
• final guidance Jan 04
• Ministers fine-tune guidance
• Early confirmation of 2005-06 programme

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Roller coaster of investment
First review period
Second review period
Third review period
5000
4000
3000
millions
2000
1000
0
Price limit assumptions
Actual capex
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Cost of capital

• Water industry is relatively low risk
• OXERA report into capital structures
• Joint study with other regulators
• Single cost of capital
• Need to maintain stable credit quality

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Future uncertainties

• We will not include contingencies for
  uncertainties
• Logging up and logging down
• Interim determinations

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Beyond 2009

• The next review will be in 2009
• What do we need to consider when deciding whether
  to extend the next review period?
• How long should it be 5, 6, 7 or more years?

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OFWAT CITY BRIEFING

• 29 November 2002