2 Final Business Plan PR09

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2 Northumbrian Water Limited: North East operating area North East operating area Northumbrian Water provides water and sewerage services to 2.6 million people in the North East of England. The major population centres of Tyneside, Wearside and Teesside are in our area but we also serve large rural areas in Northumberland and County Durham. Northumbrian Water also provides water services to 1.8 million people in its Essex & Suffolk operating area. Northumbrian Water Operating areas 2

3 Foreword Northumbrian Water is proud of the service it provides in the North East of England. The quality of our drinking water is the best it has ever been and we have contributed to significant improvements in river and bathing water quality. For the third year running we scored highest of all water and sewerage companies for customer satisfaction in research undertaken by the Consumer Council for Water. We are now planning the services we will deliver in and have used extensive customer research to find out what customers think about our current services and their priorities for improvements. In these times of economic difficulty it is especially important to ensure customers are willing to pay for improvements and we have, therefore, taken care to understand their views in this respect. This document describes the services we plan to provide, taking on board the results of the customer research and the views of regulators and other stakeholders. Our plan, which includes important programmes to reduce flooding from sewers and alleviate discoloured water complaints, received high levels of customer support in the research undertaken after our draft plan was published. There have been a number of significant and unavoidable changes since we published our draft plan, including increased tax liability and business rates. The economic recession is also having an impact, with reduced water use resulting in the requirement for higher charges to recover our costs. Given these changes, it is inevitable that water and sewerage bills will be higher than we proposed in our draft plan. Whilst this will be unwelcome news for customers, we have done all we can to manage the impact of increased costs. We have used central estimates to ensure risk is shared fairly. We have also phased prices to avoid a large increase in , which we believe would have been unacceptable. Our bills in the North East will remain amongst the lowest in England and Wales. We believe our plan represents excellent value for money and will allow the company to continue to deliver top class services. John Cuthbert Managing Director 7th April 2009 Business plan Foreword 3

4 Company strategy Summary INTRODUCTION This is a summary of Part A of our Final Business Plan, which sets out our plans for water and sewerage services in the North East for the period A separate document describes plans for water services in our Essex & Suffolk operating area. The Final Business Plan is an important document in the water industry price review 2009 (PR09). PR09 is the process by which Ofwat will set limits on the prices companies can charge their customers for the five years from 1 April The final business plan will be used by Ofwat as the basis for setting draft price limits in July Customers and other stakeholders will have the opportunity to comment on draft price limits before they are finalised in November DEVELOPING OUR PLANS Our aim is to provide the services our customers want at a price they find acceptable. To understand our customers needs, we carried out extensive customer research which established priorities for service improvement and willingness to pay for them. As well as meeting the needs expressed by customers, our plan addresses a number of specific challenges: investing in services whilst also keeping bills at affordable levels responding to the impacts of the economic recession reducing carbon emissions to help prevent the damaging effects of climate change ensuring our assets are protected from sea and river flooding resolving significant flooding of properties from overflowing sewers maintaining a stable financial position We have also liaised closely and effectively with the Consumer Council for Water (CCWater), the Drinking Water Inspectorate, the Environment Agency, Natural England and other stakeholders in producing our plans. Our plans take us a significant step towards the goals and aspirations for the longer term set out in our Strategic Direction Statement published in November 2007, which can be found on our website RESPONDING TO CUSTOMERS VIEWS There are few areas where customers have indicated they want improvements to service. We believe this is because satisfaction with service is already very high. This was confirmed by the results of research by CCWater (the water industry watchdog) where, for the third year running, we scored the highest of all water and sewerage companies for customer satisfaction. After publication of our draft plan, customer research was undertaken to establish the degree of support for our proposals. We found there was a high level of support for all aspects of our service offering, confirming that we had interpreted our customers views appropriately. Our proposals for future services, therefore, remain substantially unchanged in the Final Business Plan. Business plan Summary 4

5 Company strategy Summary SUMMARY OF WHAT WE WILL DELIVER IN THE NORTH EAST Customer satisfaction Further improvements to satisfaction with service and value for money A significant reduction in billing and operational complaints Further development of payment methods including online payment facilities Water Quality Reliable, safe water supplies, addressing risks through the Water Safety Plan approach New standard for lead in drinking water achieved Further reductions in the risk of discoloured water Improvements in the taste and odour of drinking water Improved liaison with farmers and land managers to protect sources used to supply drinking water Meeting future water needs Encouragement to customers to save water Manage leakage to achieve the revised, lower sustainable economic level of leakage Increases in water system capacity required to meet population growth and relocation Keeping the water flowing Reductions to planned interruptions Maintain current level of unplanned interruptions of over six hours duration Maintain current low levels of properties at risk of low water pressure Dealing with increasing flows in the sewerage system Develop an integrated long term drainage plan Major programme to address flooding from sewers Additional cleaning of sewers to reduce flooding from blockages Increases to sewerage system capacity to cope with new development and population movement Levels of sewer replacement increased to sustainable levels Increased real time monitoring and management of the sewerage system to aid planning Improving the water environment Achieve as near as possible to 100% discharge consent compliance by 2015 Further significant reduction in pollution incidents by 2015 Reduce sewage litter by customer campaigns and reducing system spills Further improvements to river & bathing water quality Undertake investigations into the impact of certain water abstractions on the environment Encouraging biodiversity and catchment management Continue to encourage biodiversity on all our sites Development of our partnership initiative Branch Out to help build habitat resilience Continuation of our involvement with the Tees Colour Peatscapes project Sustainable operation and resilience Development and implementation of a carbon reduction plan covering all our operations Production of 20% of our energy from self-generated renewable resources by 2015 Aspiration to achieve a 50% reduction in operational carbon from levels by 2020 Investment to protect our assets from flooding risk Update our assessment of operational resilience in the light of changing circumstances Business plan Summary 5

6 Company strategy Summary COSTS OF DELIVERY Note: Operating costs and capital expenditure in this section reflect company-wide requirements (North East plus Essex & Suffolk). Efficiency proposals We aim to deliver the objectives in our plan efficiently and effectively, to ensure customers bills are no higher than they need to be. We intend to reduce base operating costs over the 2010 to 2015 period by 1% per annum for the water service and 2% per annum for the sewerage service. These challenging efficiency savings are in addition to major reductions made over the last 20 years and will help offset above inflation increases in some of our costs. Changes since our draft plan Since we submitted our draft plan, there have been a number of changes to forecast expenditure from factors mainly outside our control. Whilst there are movements in both directions, the net impact is a large increase in expenditure pushing bills upwards. The main changes are shown below. Changes since our draft plan Government driven changes Tax increases (removal of Industrial Building Allowances) Increased business rates Increasing customer debt as a result of the new Tribunals, Courts and Enforcement Act Cost of permits to work in highways from the new Traffic Management Act Changes as a result of the Economic recession Reduced demand for services (our fixed costs have to be recovered from lower sales) Pensions deficit resulting from falling stock market prices Other changes Energy price reductions (but still an increase on assumptions made at the last review) Revaluation of assets completed higher Current Cost Depreciation Reduction in capital investment (some as a result of the recession) Reduced volume related costs due to lower demand Lower capital cost inflation (COPI) Overall, the net effect of cost increases and efficiency savings result in a 9% increase in total operating costs from to , excluding inflation. Business plan Summary 6

7 Company strategy Summary In line with Ofwat s guidance, we have not included either operating costs or capital investment in our plan resulting from the Government s decision to transfer certain private drains and sewers to company ownership in This is because of uncertainty over the costs that will be incurred. It is important to note, however, that is likely to bring a significant increase to sewerage bills in the future through an interim price review. Capital investment To meet our objectives we will need to invest a total of 1.27 billion (net of contributions) over the next five years, nearly 20% more than allowed at the last review but slightly less than our draft programme. Whilst investment in mandatory improvements to drinking water and environmental quality have continued to reduce, increases are required to deliver appropriate levels of asset maintenance and reduce sewer flooding. Our proposed asset maintenance programme has been subject to rigorous internal challenge and reflects the minimum sustainable level required to maintain services. It is well founded on robust asset planning processes in line with the framework agreed with regulators. The company s proposals for future levels of capital maintenance investment at previous periodic reviews have been found to be appropriate and, as a result, we have considerable confidence in our planning capability. We were concerned, therefore, to find that Ofwat had adjusted the scope of our capital maintenance proposals significantly downwards in its draft baseline document. We have carefully reviewed and refined our proposals since we submitted our draft plan and remain convinced that we have identified the right level of capital maintenance investment. Financing the capital programme It is essential that the company is able to raise the funds it requires to finance the future investment. A key financial assumption in this respect is the cost of capital and the current volatile financial climate makes it more problematic than usual to assess what this should be. In our Draft Business Plan, we assumed a cost of capital of 4.7% real, post tax, significantly lower than at the last price review (5.1% real, post tax), partially offsetting the impact on bills of increased investment and higher operating costs. We have reviewed this assumption and have decided to retain 4.7% for our final plan. This is at the lower end of the possible range identified by NERA in a recent report on the cost of capital. Our approach will help keep bills down. IMPACT ON PRICES AND CUSTOMERS BILLS Overall prices We have modelled the impact of our proposals for on prices and customers bills. Price limits are expressed as a percentage above or below inflation. This is called the K factor. Ofwat sets separate indicative price limits for the water and sewerage services. The water price limit applies to both the North East and Essex & Suffolk. The overall average annual price limit required by our plan is +3.4% comprising +4.3% for the water service and +2.1% for the sewerage service. This is higher than proposed in our draft plan because of the changes described above. We have phased price limits in AMP5 to avoid an overall K of +11% in , which we believe customers would have found unacceptable. Business plan Summary 7

8 Company strategy Summary We considered spreading the price increases equally across the five years. However, we were unable to reduce the price increase in the early years whilst maintaining a satisfactory financial position. In any case, to maintain the same overall cashflow on this basis would have resulted in bills rising by over 4% more than with our proposed phasing by This would have meant bills in the North East rising by a further 6.50 and 7.60 for the water and sewerage services respectively. Our policy of charging customers no more than is necessary was demonstrated by our decision not to use the full price limit allowed by Ofwat for , and This has resulted in bills overall being around 2% lower than they otherwise would have been in but has the effect of making the price increases in AMP5 appear larger. Application of price limits The overall price limit for the water service denotes the average increase to prices in the North East and Essex & Suffolk. When setting tariffs, it is necessary to consider whether there are reasons why the price limit should be applied differentially to reflect any significant variations in costs in each charging area. This is to ensure customers bills continue to reflect broadly the cost of providing the services they receive. For example, it would not be fair to expect customers in the North East to pay for improvements to service benefiting customers in Essex & Suffolk only. Our plans include significantly more investment and other costs (per property) in Essex & Suffolk than in the North East. This includes investment in mains renewal to manage leakage and the Abberton water resource scheme. Other cost drivers, particularly EA abstraction charges, are also greater in Essex & Suffolk. We are, therefore, proposing to apply the water K factors to reflect differences in investment and costs between the two areas. This results in the following average annual increases in prices (not including inflation), phased to avoid a large first year increase. Average price increases, not including inflation (%) North East 2010/ / / / /15 Average Water Sewerage Total Essex & Suffolk Water Business plan Summary 8

9 Company strategy Summary Customers bills Our proposals result in average household bills as shown in the table below. Average household bills ( prices) Actual Actual Forecast North East (water and sewerage) Despite investing some 4 billion in improving our assets, forecast bills in the North East for are only around 6% higher, in real terms, than those in CONCLUSION THE OVERALL OUTCOME FOR CUSTOMERS We have produced an integrated, well founded plan which has been endorsed by our Board of Directors. We have placed our customers at the heart of the process and believe that our plan delivers the benefits they want. The foundation of our plan is maintaining compliance with drinking water and environmental standards, maintaining high levels of customer service and ensuring our customers have sufficient water. In addition to this we will deliver a relatively small programme of quality improvements and a small number of carefully justified service enhancements. Since we submitted our draft plan, a number of factors outside our control have pushed bills upwards. These include increases in taxation and rates and the impacts of the economic recession. In assessing the costs arising from these changes, we have taken a balanced view, incorporating in our plan central estimates of the costs we will incur. We believe we have taken a balanced view of risk throughout our plan, ensuring bills are no higher than they need to be. As well as always including central estimates, there are a number of assumptions we have made with significant risk. These include our assumption about the impact of the economic recession on revenue, where reductions in industrial demand could easily be much greater than we have forecast, and our decision to use a cost of capital towards the lower end of the potential range. Despite the increases, our bills in the North East will remain amongst the lowest in England and Wales. We believe our plan represents excellent value for money and will allow the company to continue to deliver top class services. By households will pay on average (2007/08 prices): 41p per day for water services in the North East 48p per day for sewerage services in the North East Business plan Summary 9

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11 Contents PART A COMPANY STRATEGY CONTENTS Introduction 12 The starting position 13 Key challenges 16 Developing our plans 20 Taking account of the economic recession 29 Our plans 33 Improving customer satisfaction 34 Maintaining our assets 38 Providing safe and clean drinking water 41 Meeting future water needs 50 Keeping the water flowing 56 Dealing with increasing sewerage system flows 58 Maintaining the sewerage system 68 Improving the water environment 69 Catchment management and encouraging biodiversity 72 Sustainable operation and resilience 75 Costs of achieving our plans 79 Financing our plans 97 The outcome for customers 104 Annex A Board endorsement and statement 113 Annex B Glossary of terms 117 Annex C Tables and table commentaries 123 Business plan Contents 11

12 Introduction The water industry price review 2009 (PR09) is the process through which Ofwat sets limits on the prices companies can charge their customers for water and sewerage services for the period There are three main submissions water companies must make as part of PR09 to help Ofwat, customers and other stakeholders understand their plans for the future. 1. The Strategic Direction Statement (SDS) We published two versions of our SDS in November 2007, covering our North East and Essex & Suffolk regions. The documents described the challenges to be overcome in the future and our goals and aspirations for the longer term. 2. The Draft Business Plan (the draft plan ) Published in August 2008, this document described the company s plans for future services and the impact on prices of implementing our strategy for the five years It provided the basis for discussion with industry regulators, the Consumer Council for Water (CCWater), customers and other stakeholders. 3. The Final Business Plan (the final plan ) The final business plan, of which this document is a part, is the third and final submission in the process. Views of stakeholders on our draft plan have been taken into account in our final plan. THIS DOCUMENT This document is Part A of our final plan covering Northumbrian Water Limited in the North East. It provides a summary for all stakeholders of our plans for the period , set in the context of the longer term goals and aspirations in our SDS. The final plan reflects our customers priorities and willingness to pay for service improvements. It delivers drinking water and environmental requirements required by government and regulators. We have considered the impact of the recession on our plans and also, of necessity, taken into account significant increases to company taxation and business rates which are outside the company s control. We have identified an optimum programme of actions to meet our objectives and a sustainable financing plan. Whilst the increases in bills are higher than we would have liked due to unavoidable cost increases and the impacts of the recession, we believe the package proposed provides an appropriate balance for all stakeholders. Ofwat will use our final plan in its production of draft price limits in July There will be an opportunity for customers and other stakeholders to comment on draft price limits before they are finalised in November Business plan Introduction 12

13 The starting position The need for improvements to service and to the environment in the future depends upon current levels of customer satisfaction and environmental performance. In this section we describe the starting position. MAIN THEMES High levels of customer satisfaction Major improvements to customer service and the environment already delivered Very low combined water and sewerage average bill in the North East NWL is a company with high values and integrity High levels of customer satisfaction Customers are at the heart of our strategy and our overriding aim is to provide excellent service and value for money. In our latest independent survey, 92.3% of customers said they were satisfied with overall service and 89.8% with value for money. These levels of satisfaction have been consistently high for a number of years. Our findings are consistent with the results of the CCWater Annual Tracking Survey for This is the third year CCWater has commissioned this research and, once again, Northumbrian Water is top for customer satisfaction. Our success as a customer focussed business has been reflected in two awards Utility Company of the Year 2008 In recognition of its achievements, Northumbrian Water was named Utility Company of the Year 2008 in the face of competition from the water, gas and telecom industries. Steve Hobson, Editor of Utility Week, said: Northumbrian Water was a worthy winner for the way it builds its business around customers and the community, principles that usually do not make headlines but show that a successful utility really does put customers at the heart of its business. NWL receives the Utility Company of the year award 2008 The starting position North East Customer Centre of the Year Award We were also delighted to receive the North East Customer Centre of the Year award in Business plan 13

14 The starting position Major improvements to services and the environment It is now nearly 20 years since water industry privatisation and substantial improvements to drinking water quality, customer service levels and to the environment have been delivered over that period. By 2010 we will have invested nearly 4 billion in the North East resulting in the major improvements illustrated in the charts below. Performance in the North East Water Quality Compliance North East Water Pressure Performance North East % samples compliant / /8 Year Properties below reference level / /8 Year 3000 Water Supply Interruptions North East 170 Leakage Performance North East Properties with interruptions > 12hrs / /8 Year Leakage l/prop/d / /8 Year % bathing waters failing mandatory standard No of pollution incidents Bathing Water Non-compliance North East 1992/ /8 Year Pollution Performance North East 1992/ /8 Year Sewage Treatment Works Non-compliance North East / /8 It should be noted that each chart should be viewed individually as they use different performance measures and scales. % non-compliant No of properties on 2 in 10 register Year Sewer Flooding Performance North East 1992/ /8 Year Business plan The starting position 14

15 The starting position It can be seen from the charts opposite that there have been major improvements in performance in each area, apart from sewer flooding. The increase in sewer flooding, as a consequence of more frequent and severe summer storms, is a challenge for the company and we have included measures to address this in our plan. The investment we have made has brought tangible benefits to customers and the environment in the North East including: a high level of confidence in drinking water quality sufficient supplies of water with leakage at the lowest level ever very high performance against customer service measures almost all bathing waters now pass the EU s most stringent standard salmon, trout and seals returning to the rivers Tyne, Wear and Tees The high levels of performance, together with the excellent levels of satisfaction with service described above, have undoubtedly influenced customers views about the need for further improvements in the future. Competitive bills Our aim is to charge our customers no more than is necessary. We have made significant reductions in the costs of providing services over many years. These savings are passed on to customers, resulting in bills being lower than they otherwise would have been. We deliver excellent service at competitive prices. The average household bill in the North East of 297 in for water and sewerage services is amongst the lowest in England and Wales. Our decision not to increase prices by the full amount allowed by Ofwat in , and demonstrates our continuing commitment to fairness and has contributed to our strong comparative position. A company with high values and integrity Our internal document Building our Future sets out, for employees, our company values and aspirations. Central to our approach is acting with integrity which we bring to all areas of corporate activity. This includes our relationship with customers, our regulatory reporting and our PR09 business planning. In our SDS we highlighted our aim to be recognised as more than just a water company and stressed our partnership approach to achieving sustainable change in health, environment, education and the communities in the regions we serve. The success of our partnership approach has been reflected in the following achievements: 2008 Sunday Times Business in the Community (BITC) survey We were ranked the multi-utilities sector national leader in the BITC Corporate Responsibility Index - the UK s leading benchmark of responsible business practice. BITC s Big Tick We were one of only eight companies to be awarded BITC s prestigious platinum rating and impact on society Big Tick for work done in the marketplace, workplace, environment and community. Business plan The starting position 15

16 Key challenges Planning for the future requires the identification, assessment and prioritisation of issues that need to be addressed. In this section we describe the challenges for the period and beyond. MAIN THEMES Ensuring bills remain affordable and value for money whilst Investing in services Forecasting the impacts of the recession Helping to tackle climate change by reducing carbon emissions Future proofing our operations against climate change Addressing flooding from sewers Maintaining a stable financial position Affordability of water bills Water bills are much lower than other utility bills such as gas and electricity and are a small proportion of household outgoings. Despite this, paying water bills is already difficult for some customers, particularly those with low household income. The current economic downturn is likely to worsen this situation. Affordability of bills is of particular concern in the North East as this region has the highest percentage of population considered by government to be income deprived. It is clear that we cannot maintain and improve services if plans are based exclusively on the ability of the poorest to pay. As a minimum we must continue to: invest in sustainable levels of asset maintenance plan to manage and meet the demand for water and sewerage services deliver properly justified drinking water and environmental obligations There are also substantial pressures on bills from a number of areas we cannot control. Government tax changes (abolition of Industrial Building Allowances) rates revaluation by the Valuation Office energy price rises increasing our operating costs increased costs resulting from the new Traffic Management Act All of the pressures listed, except energy prices, represent an increase to bills since we published our draft plan. We also note that Government has decided, in principle, to transfer certain private drains and sewers to water company ownership in Business plan Key challenges 16

17 Key challenges At this stage, the actual details of the transfer are uncertain and, in line with Ofwat guidance, the costs are not included in our final plan. Should transfer of private drains and sewers go ahead this will lead to significant increases to sewerage bills not reflected in our plan. Given these pressures, a key challenge of our final plan is to manage operating costs and investment to keep water bills as affordable as possible whilst still providing excellent and sustainable water services. However, we believe customers who do not have sufficient income to pay their bills should be helped through the tax and benefits system. Forecasting the impacts of the recession The state of the economy of the United Kingdom (UK) has changed significantly over the last two years. At the time of our draft plan, in early summer 2008, we wrote that the relative stability of the last decade appears to be over and the UK is entering a period of higher interest rates, increasing inflation and lower growth. Since then, the UK has entered a recession. The recession affects many aspects of water company operations and, therefore, our plans for the future. The main areas affected are shown below. Impacts of the recession: reduction in demand for water and sewerage services from industrial and commercial customers affecting demand forecasts, revenues and costs reduction in numbers of new houses built and house moves affecting demand forecasts, meter numbers, revenues and costs impacts of the credit crunch and increasing unemployment on customers income leading to higher numbers of customers unable to pay their bills impact of the credit crunch on the cost to water companies of borrowing pensions deficit resulting from falling stock market prices deflation assumed in price limits will not be fully reflected in our manpower costs It is extremely difficult to forecast the extent and length of a recession. This raises a number of challenges for business planning. We have used the additional information on the economic situation available to us since writing the draft plan to review our assumptions and forecasts. We have produced balanced, central forecasts for our final plan and have been careful to include impacts that will reduce bills as well as those that will increase them. We describe the changes we have made to our plan as a result of the recession in the section entitled Taking account of the economic recession. Business plan Key challenges 17

18 Key challenges Reducing carbon emissions The control of carbon emissions and other greenhouse gases by businesses is considered essential to help limit the damaging effects of climate change. This is a particular challenge for water companies as they use a large amount of energy to pump and treat both water and sewage. Carbon impacts have been taken into account in developing our plans and we have set a challenging target for carbon reduction in Responding to climate change It is difficult to predict precisely the impact of climate change. In the UK the scientific consensus is that we are likely to have hotter, drier summers and greater, more extreme changes in our weather. This means more droughts and more frequent intense storms. Some scientists also forecast that sea levels will rise as glaciers melt. We must ensure that we can continue to supply the water our customers need when there are drought conditions. We have, also, evaluated the risk to our assets from both rises in sea levels and river flooding and included actions in our plan to address the risks identified. Addressing flooding from sewers Addressing flooding from sewers is a key challenge Business plan Key challenges 18

19 Key challenges Addressing flooding from sewers Recent changes to rainfall patterns in the North East have increased the number of properties flooding from overloaded sewers. Climate change predictions point to the likelihood of more frequent storms of greater intensity and it will be important to take action to manage the consequential impacts. Flooding is one of the worst service failures our customers can suffer. As well as planning to address existing problems we aim to work with other agencies responsible for flooding to understand the underlying causes and develop solutions so that the risk of flooding from all causes can be reduced in the future. We fully support the recommendations of the Pitt Review ( Lessons learned from the 2007 floods ) and have included proposals in our plan in line with the report recommendations. Maintaining a stable financial position It is important to all stakeholders that we can continue to invest to both maintain and improve services. Like most water companies, we need to borrow money to finance the investment programme. The money we borrow is paid back over time, rather like a mortgage. We aim to borrow money on reasonable terms to avoid passing on unnecessary costs to customers. We must, therefore, have a business plan that is financeable. It must ensure the company has a strong financial position consistent with a solid investment grade credit rating, representing good creditworthiness, so that the company is attractive to financial institutions willing to lend to water companies. The plan we have set out meets this objective. Business plan Key challenges 19

20 Developing our plans In this section we describe our approach to developing our plans for the future. We also describe how we identified the activities and costs required to deliver the objectives. Our plans for customer service and environmental performance address the challenges described in the previous section and reflect the views of our customers and other stakeholders. MAIN THEMES Setting objectives for customer services We have undertaken a thorough evaluation of stakeholder views including - extensive customer research pre and post draft plan - meetings and events to seek the views of key stakeholder groups - regular meetings with CCWater, DWI and EA to discuss proposals Objectives are based on a comprehensive cost benefit assessment (CBA) Drinking water and environmental quality improvements are well justified Our objectives represent a step towards the aims in our Strategic Direction Statement Objectives have been approved by senior management and the NWL Board Overview of outcome of stakeholder engagement Customers are generally very satisfied with current service There is limited willingness to pay for further improvements Post draft plan validation research demonstrates that a large majority of customers strongly support our proposed water and sewerage service packages and their associated costs of delivery Customers strongly support proposals to reduce discoloured water complaints and alleviate flooding from sewers Drinking water and environmental quality enhancements are well justified and supported by customers Stakeholders generally support the objectives we have identified Business plan Developing our plans 20

21 Developing our plans SETTING OBJECTIVES FOR CUSTOMER SERVICES Stakeholder engagement There are a number of groups that have a valid and important interest in our plans for water and sewerage services. We refer to these as stakeholders. While customers and regulators views are perhaps the most important consideration, we also take into account what other stakeholders tell us, such as those with consumer, local community, environmental and regional interests. Over the last two and half years our planning process has engaged closely and effectively with stakeholder groups. The table below summarises what we have done to establish the need and priority for improvements and, importantly, the willingness to pay for them. Company Stakeholder Engagement PR09 Customer research Groups involved Timing Focus Group research Household customers February 2007 Willingness to pay research Household customers July 2007 Qualitative and quantitative Commercial and industrial telephone survey customers July 2007 Post DBP validation research Household customers November 2008 Customer communication Groups involved Timing Source magazine articles All customers Pre SDS and pre draft plan Letters Regional stakeholders Post draft plan Website draft plan posted All Aug onwards Website final plan posted All April 2009 onwards E Mail addresses for stakeholder responses All Post SDS and post draft plan Stakeholder meetings Groups involved Number of meetings held NWL meeting with specific group CCWater (Eastern) 2 NWL meeting with specific group CCWater (Northern) 5 NWL meeting with specific group DWI 4 NWL meeting with specific group EA 9 NWL meeting with specific group Natural England 2 Meeting with environmental Northern environmental 1 groups in the North East groups including Natural England, RSPB, Wildlife Trust, Peatscapes Meeting with environmental Environmental groups 1 groups in Essex & Suffolk covering Essex & Suffolk including EA, Natural England, RSPB, Wildlife Trust Quadripartite meetings CCWater, EA, DWI 7 Stakeholder events Groups involved Number of events Chairman s post DBP events Regional stakeholders 8 PR09 workshop, Durham CCWater, DWI, EA, Ofwat, 1 Regional stakeholders, Environmental groups The comprehensive programme of engagement outlined above demonstrates the importance we place on responding to the views of stakeholders. Business plan Developing our plans 21

22 Developing our plans Process to develop objectives The main elements of the process we used to develop proposals are shown in the diagram below. Objective setting process 1. Strategic Direction Statement (providing the longer term context) 2. Willingness to pay customer research (establishing priorities and willingness to pay for improvements) 3. Strategic and specific cost benefit assessments (establishing areas where improvements are cost beneficial) 4. Assessment and challenge of quality enhancements (working with DWI & EA to identify statutory quality requirements) 5. Draft business plan (water and sewerage proposals, published for consultation) 6. Draft business plan validation research (establishing that customers agree with water and sewerage packages and improvements to service proposed) Stakeholder liaison throughout process 7. Final business plan (water and sewerage proposals) The NWL Board was involved throughout this process, providing strategic leadership and ensuring our plan delivers best value to customers. Details of each element of the process are described below. 1. Strategic Direction Statements The objectives in our plans for have been set in the context of our longer term aims. Our longer term aims, for 25 to 30 years into the future, are published in our Strategic Direction Statements available on our websites. The goals and aspirations in our SDS took into account: customer complaints (to identify areas requiring improvement) our regular customer tracking research our domestic and business customer research undertaken for PR09 opportunities to harness innovation and new technology what we believe a good company should aspire to deliver Business plan Developing our plans 22

23 Developing our plans The views of a number of external stakeholders were also sought regarding the content and format of the SDS. This included Ofwat, CCWater, the Drinking Water Inspectorate (DWI), the Environment Agency (EA), Natural England (NE) and the Royal Society for the Protection of Birds (RSPB). The strategy and final documents were agreed and endorsed by the NWL Board of Directors. Following publication of the SDS we provided extensive opportunities for customers and other stakeholders to provide their comments. There was limited feedback from customers, which possibly reflects the high level of satisfaction with service. Views from wider stakeholders were extremely supportive of our goals and aspirations. Reflecting the SDS in our final plan We aim to manage the pace of delivery of the long term objectives in the SDS over time to ensure customer bills, within discrete price review periods, remain within acceptable bounds. This is important considering the affordability issues described under key challenges in the previous section. The objectives for in our plan have been set in accordance with the willingness to pay information from our customer research. They are a significant and, we believe, satisfactory step towards the long term goals in our SDS. Our plan also embraces the strategic themes in our SDS. Strategic themes transferred from our SDS to our final plan striving to satisfy our customers and deliver affordable services safeguarding and improving drinking water quality, environmental performance and customer services aiming to reconcile social, environmental and economic priorities contributing to regional development by providing top class, competitive water services factoring sustainability into all that we do, including minimising our carbon emissions and enhancing habitats for wildlife on land under our control. 2. Establishing priorities and willingness to pay for improvements Accent and RAND Europe, specialist consultants with proven track-records in this area, were commissioned to undertake our domestic customer research in spring/summer Professor Willis of the University of Newcastle was asked to peer review the research to ensure it was appropriate and robust. We also carried out non-domestic customer research covering our commercial and industrial customers. The outcome of both the domestic and non domestic research was used to develop the service packages offered in our plan. Business plan Developing our plans 23

24 Developing our plans Our domestic customer research started in early 2007 with eight focus group sessions. This qualitative research, undertaken in a number of locations with people from different socioeconomic groups helped identify areas where service is already acceptable and our customers priorities for improvement. This information helped determine the questions for the willingness to pay research. Our willingness to pay quantitative customer research took place in summer This used a stated preference methodology, which is considered to be one of the best methods for this type of benefit assessment. Customers were asked how much they would be willing to pay for service and environmental improvements in a number of areas. A total of 1,014 respondents were interviewed in their own homes. This was a very large sample designed to ensure the results were statistically representative both by socio-economic group and geographic area. Professor Willis commented on both the pilot research and the draft report, which resulted in important improvements to the research outputs. Commenting on our research, Professor Willis wrote: Both the reports [from Accent and RAND Europe] are professional pieces of research, and provide good information on customer demand for improvements across water service factors in the Northumbria Water (NW) and Essex and Suffolk Water (E&SW) areas. 3. Cost benefit assessment We undertook a comprehensive cost benefit analysis (CBA) to determine objectives for services in the period Our approach was based on Ofwat s guidance to the industry on CBA and was in accordance with the cost benefit planning objective of the Capital Maintenance Planning Common Framework (CMPCF). Our CBA was used to determine where improvements to service are cost beneficial and also where it is not cost beneficial to improve service. This enabled objectives to be set for each investment area, with the need to maintain current service levels a minimum requirement. The benefits element of the assessment was taken from the willingness to pay customer research described above. The cost element was established from the activities required to achieve the service improvements, on a least cost basis. The benefits and costs were then modelled to identify cost beneficial improvements to service. A sensitivity analysis was undertaken where there was uncertainty about any of the material assumptions. The impact of the cost of carbon was considered where this could have affected the outcome. We established that using willingness to pay from different income groups did not change any of the findings. In addition to the strategic CBA described above, specific assessments were also undertaken for sewer flooding (involving further customer research), river water quality improvements, Howdon advanced sludge digestion (on Tyneside), Information Services investment and sewage odour schemes. Business plan Developing our plans 24

25 Developing our plans 4. Assessment and challenge of quality enhancements We have worked closely and productively with DWI and EA to identify requirements to improve drinking water and environmental quality, respectively. In developing these programmes, we took into account the Government s Statement of Obligations, the Government s strategy Future Water and Ministers Environmental and Social Guidance to Ofwat. We have liaised closely with the DWI throughout the PR09 process concerning actions required to meet statutory drinking water quality regulations. The proposals in our final plan reflect the final letters of support received from DWI. We have also worked with the EA in the development of the National Environment Programme (NEP) for The aim of both EA and NWL was to identify a well justified programme to improve the environment. We carried out investigations, including river water quality modelling, to identify which of our sewage treatment works may require improvement under environmental drivers, including the Water Framework Directive (WFD). This work enabled us to review the EA s proposals and any that appeared not to provide an appropriate benefit were challenged. Identifying the right environmental programme Our approach has enabled non cost beneficial investments to be identified and excluded from the NEP. The original candidate list of 29 schemes and 28 investigations for improvements to river water quality has been reduced to 13 schemes and 11 investigations. The proposals in our plan reflect the final NEP, which we believe to be well founded. 5. Draft business plan Our draft plan described our proposals for customer service and environmental performance based on customers priorities and willingness to pay for improvements, CBA and the identification of statutory quality enhancements. The plan was published in August last year for all stakeholders to review and consider. 6. Post draft business plan validation research In November 2008 we undertook further customer research in the North East to validate the proposals in our draft plan. This research was designed to establish the level of support for our draft water and sewerage packages and, particularly, proposals for substantial investment to alleviate discoloured water complaints and flooding from sewers. It also had the added advantage of establishing customers views after the start of the economic recession. A total of 502 customers were interviewed face to face in venues around the region. Those interviewed broadly represented our customer base in terms of gender, socio economic group and age. Interviews were conducted in the following geographic areas: 25 Business plan Developing our plans

26 Developing our plans Post DBP research: geographic areas Alnwick Easington Bishop Auckland Berwick Sedgefield Sunderland Blyth Valley Gateshead Darlington Castle Morpeth Newcastle Middlesbrough Durham North Tyneside Redcar and Cleveland This research was complementary to that undertaken post draft plan by the PR09 Water Industry Stakeholder Steering Group. However, we were able to ask additional, and more specific questions, in our own research. 7. Final Business Plan Our final plan reflects final guidance from DWI and EA on the statutory drinking water and environmental quality enhancements we must deliver. Service objectives have been determined by stakeholder engagement and the cost benefit assessment described above. OVERVIEW OF OUTCOME OF STAKEHOLDER ENGAGEMENT Interpretation of the willingness to pay research and CBA results The results of our customer research, CBA assessments and stakeholder dialogue were discussed internally by senior management and the Board of Directors alongside other evidence, including customer research undertaken on behalf of the PR09 Water Industry Stakeholder Steering Group. Objectives for our final plan were developed for discussion with key stakeholders, taking into account this information. Proposed objectives were discussed with CCWater, DWI and EA both individually and as a group (the Quadripartite Group). We believe our approach to setting objectives has provided a robust picture of the services customers want in the period Any material changes in service levels proposed are supported by CBA and the objectives chosen are fully consistent with customers priorities and willingness to pay. Overview of willingness to pay research and CBA results Our customer research, research undertaken by CCWater and research carried out for the PR09 Water Industry Stakeholder Steering Group all point to very high levels of satisfaction with the current service we provide. Our PR09 customer research in 2007 identified limited willingness to pay for improvements to service. Based on the weighted average willingness to pay, customers were willing to pay an additional on their annual bills to receive all of the improvements offered. The overall limited willingness to pay for improvements is not surprising given the high levels of customer satisfaction and the drinking water and environmental improvements already delivered. 26 Business plan Developing our plans

27 Developing our plans Our CBA based on this customer research indicated that only one service enhancement, a small scheme to improve taste and odour of drinking water, was cost beneficial, again reflecting the limited willingness to pay for improvements. The packages proposed for the draft plan are outlined below together with an overview of the results of the validation research. Overview of objectives As a result of our customer research and CBA assessments, the proposals in our draft plan for the North East were primarily based on maintaining current levels of service, addressing flooding from sewers and delivering statutory drinking water and environmental quality enhancement schemes. The main elements of the water and sewerage package are shown below. Main elements of the package further improve customer satisfaction (at no cost to customers) maintain current levels of service address properties subject to internal flooding where cost beneficial reduce complaints about the taste and odour of drinking water meet the new standard for lead in drinking water further reduce discoloured water complaints deliver further improvements to river and bathing water quality address risk of water supply and sewerage assets flooding implement measures to manage risks to water supplies in catchments continue to support biodiversity and access to nature The package described above was strongly supported by customers in the post draft plan research undertaken by NWL. For each element of the package, customers were given information about the benefits and the impact on bills of the proposals to inform their responses. Results are as shown below for the water and sewerage services. Support for our plans water service (source: independent research for NWL, post draft plan) Elements of the package Quite or Strongly Not at all or Not in favour (%) really in favour (%) Further improve customer satisfaction 85 2 Maintain water supply system 84 9 Improvements to taste and odour of drinking water 81 7 Meet new standard for lead in drinking water 90 3 Further reduce discoloured water complaints 79 8 Address risk of water supply assets flooding 91 3 Maintain adequate water supplies 87 7 Our research also indicated that 70% of customers judged the overall water package to be value for money. It is noteworthy that the major scheme to further address discoloured water complaints received support from a large percentage of respondents (79%). 27 Business plan Developing our plans

28 Developing our plans Support for our plans sewerage service (source: independent research for NWL, post draft plan) Elements of the package Quite or Strongly Not at all or Not in favour (%) really in favour (%) Further improve customer satisfaction 85 2 Maintain sewerage assets 90 5 Reduce no. of properties at risk of internal flooding 92 3 Improve river water quality 90 3 Improve bathing water quality 92 2 Address risk of sewerage supply assets flooding 95 1 Maintain adequate sewerage system capacity 90 5 Our research also indicated that 86% of customers judged the overall sewerage package to be value for money. It is noteworthy that the major programme to address internal flooding from sewers received support from over 90% of respondents. The results of the research undertaken on our behalf are consistent with the results from the PR09 Water Industry Stakeholder Steering Group customer research, also undertaken post draft plan. Customer endorsement of our plans (source: PR09 Water Industry Stakeholder Steering Group customer research, post draft plan) 78% of customers felt that our plans for the North East and the associated impacts on customers bills were acceptable (water plus sewerage as a whole). each element of the package was considered either very good or good value for money by a sizeable majority of customers. the significant investment proposed to address discoloured water complaints and internal flooding from sewers was considered very good or good value for money by 71% and 68% of customers respectively. These results give us confidence that we have interpreted our customers views appropriately and our plans have the support of a large majority of our customers. The objectives in our final plan received the approval of the Quadripartite Group. Further details can the found in the section of this document entitled Our Plans. Business plan Developing our plans 28

29 Taking account of the economic recession The current economic recession is having a significant impact on the company s operations and will continue to do so in the period for which water and sewerage prices are being set. In this section we describe the impacts we are experiencing now and how we have factored the recession into our forecasts. MAIN THEMES Impacts of the recession We are experiencing reductions in demand for water and sewerage services from industrial and commercial customers resulting in reduced revenue and costs Reductions in the numbers of new houses built is affecting demand, revenues and costs The credit crunch is affecting the cost to water companies of borrowing for capital investment Falling stock market prices reduce pension funds Above inflation cost increases for certain materials and services used by the company Factoring the recession into our forecasts We have reviewed all of our forecasts for our final plan We have adjusted forecasts where necessary to reflect the effects of the recession Whilst the length and duration of the recession is unclear, we have taken a balanced view based on the available evidence We have not assumed the future loss of specific large customers, apart from one that has already announced closure there is a risk of much larger revenue losses than predicted We have reduced operating costs and capital investment in line with assumptions about reducing demand and revenues Although customer debt is almost certain to rise because of the impacts of the recession, we have not included an increase in this regard in our forecasts Because the majority of water company costs are relatively fixed (that is not directly volume related), the overall impact of reduced revenues and increased borrowing costs is to increase bills We have included for partial pensions deficit recovery from 2012 The company has sought to manage the impact of the recession on customers bills Industrial and commercial demand In the second half of we are seeing significant reductions in the demand for water and sewerage services from industrial and commercial (non-household) customers. This is affecting potable water, industrial water and sewerage income from both our small and large user customers. We are continuing to see businesses close (temporarily or potentially permanently) or move to part time working. Some of these are major customers with significant impacts on revenue. Business plan Taking account of the economic recession 29

30 Taking account of the economic recession NERA, an economic consultant, produced a non household demand forecast for our draft plan using economic projections by industrial or commercial sector. These forecasts were refreshed towards the end of 2008 for the final plan using latest economic forecasts. This has resulted in a reduction in the forecast demand for water and sewerage services. This is demonstrated in the graph below showing the forecast for potable water use for non-household customers in our final plan compared to that in our draft plan. 200 North East Non-Household Demand Forecast 180 Volume Mld / / / / / / / / /15 Draft Plan Final Plan We have not assumed the future loss of specific large customers apart from one that has already announced its closure. However, there is a potential risk that large customers will close, resulting in lower demand and revenues than anticipated in our plan. This is perhaps best illustrated by reference to the chemical industry on Teesside where current temporary closures of key companies could become permanent. It is also important to note that many companies are dependent on one another and the closure of one could have a knock on effect on others in the area resulting in a major reduction in our revenue. It would be premature to forecast closures such as this at this point but they are a significant business risk. Overall, we believe we have adopted a central position albeit with the risk of much larger revenue losses than predicted. The losses in revenue described above are, to an extent, offset by reductions in variable costs in our plan, such as those to pump and treat water. Reductions in costs are low because the majority of our operating costs are relatively fixed. For example, it would take much greater reductions in demand than we are predicting to result in the closure of a treatment works with the associated significant reduction in cost. When the fixed costs are spread over a smaller customer base this results in an increase in customer bills. The reductions in revenue predicted are significant and, therefore, result in significant increases to bills. Reductions in new build houses The lack of buyer confidence and difficulty in obtaining mortgages has affected the demand for new housing. As a consequence, developers are reducing housing new builds. We have reviewed our projections of new properties, taking a view of the impact of the recession. Business plan Taking account of the economic recession 30

31 Taking account of the economic recession We have based figures for this year ( ) on actual numbers for the year to date and then assumed a slight worsening of the situation for and Thereafter, numbers gradually recover to pre-recession forecast levels over the two years to We assume that, in time, the properties not built during the recession will still be needed and, by 2020, the overall number of house builds will be the same as forecast pre-recession. A reduction in new houses results in reduced demand, lower revenue, lower investment to service new development and lower operating costs. These are all reflected in our final plan. The investment to service new development is financed through developer contributions and so the decrease does not have an impact on bills. Customer debt As the credit crunch takes its effect on households and unemployment increases, this is likely to result in more customers unable to pay their water bills. This is worsened by the fact that paying water bills is a low priority compared to other bills because legislation prevents disconnection for non-payment. We have efficient and effective debt collection operations and will continue to improve these where possible. Despite this, we think it likely that customer debt will rise as a result of the recession. The extent is difficult to predict and we have decided not to include increased costs in this regard in our final plan. However, we propose that the Notified Item for customer debt is retained. However, we have included an estimated increase in costs arising from the new Tribunals, Courts and Enforcement Act but this is not as a result of the recession see Costs of achieving our plans for more details. Cost of borrowing The company does not receive sufficient revenue in any one year to cover the cost of the capital investment required in that year to maintain and improve services. Therefore, we borrow money over a period of time to pay for the investment. The cost of borrowing (or debt) is an important assumption in the price review, affecting the level of future bills. The credit crunch has increased the current cost of debt. Business plan Taking account of the economic recession 31

32 Taking account of the economic recession In this respect, we have taken a cost lower than prevailing at the current time. This assumes that markets will recover by the time we have to borrow again and that the cost of borrowing will be lower. There is some risk for the company if the cost of corporate finance does not decrease as we have predicted. However, we believe our view of the cost of new debt to be balanced and appropriate. Our cost of capital for the final plan, of which the cost of debt is part, is the same as that assumed in our draft plan. Further details can be found in the section entitled Financing our plans. Costs of materials and services The recession has impacts on the costs of materials and services used by the company. Generally, we expect that these cost changes will be taken into account by appropriate indexation used in price setting. There are, however, a number of specialist chemicals used by the water industry (eg. ferrous sulphate and chlorine) where the loss of a manufacturer could result in major increases in costs for importing the products or for researching and adapting to alternatives. Such increases for specialist chemicals are not included in our plan and are not reflected in indices such as RPI. Should they arise, they represent a significant risk for the company and affect our ability to match Ofwat s efficiency assumptions. Impact on pension funds Falling stock market prices have created a significant pension deficit that needs to be managed. Although we have taken action to mitigate further cost increases (including closing the scheme to new employees, changing the benefit structure and increasing member contributions), we have had to include an increase in the employer contribution of 6m per annum with effect from January 2012 (see Costs of delivering our plans for more details). Managing the impact of the recession on customers bills We have used the additional information on the economic situation available to us since writing the draft plan to review our assumptions and forecasts. We have produced balanced, central forecasts for our final plan and have been careful to include impacts that will reduce bills as well as those that will increase them. Forecasting the impacts of a recession is extremely difficult and the outcome could be significantly different to our forecast. Our assumptions about non household demand, customer debt and the cost of borrowing could turn out to be wrong, with the potential of a significant adverse impact on our financial position being one of the possible outcomes. We have sought to manage the impact of the recession on customers bills by assuming a balanced risk profile. It is important the cost of capital assumed at price setting takes this risk into account and that the safeguard of the substantial effects clause remains in place. Business plan Taking account of the economic recession 32

33 Our plans OUR PLANS In this section we provide details of the services we will deliver for customers in the period , set in the context of the longer term goals and aspirations in our SDS. Our plans are described under the following headings: Improving customer satisfaction 34 Maintaining our assets 38 Providing safe and clean drinking water 41 Meeting future water needs 50 Keeping the water flowing 56 Dealing with increasing sewerage system flows 58 Maintaining the sewerage system 68 Improving the water environment 69 Encouraging biodiversity and access 72 Sustainable operation and resilience 75 Business plan Our plans 33

34 Our plans OUR PLANS: IMPROVING CUSTOMER SATISFACTION MAIN THEMES Our overall goal is to ensure every customer experience is first class We will improve on our high levels of satisfaction with service and value for money For all customer contact we will aim to get things right first time, every time We will achieve a significant reduction in complaints We will make it easy for customers to deal with us, using technology where appropriate. We will continually improve the efficiency and effectiveness of our income collection and debt recovery We will work collaboratively with customer related stakeholders Improving satisfaction with service and value for money Whilst proud of our already high levels of customer satisfaction, we believe we can make further improvements throughout that will move us closer to the aspirations we have set out in our SDS. By 2015 we aim to: increase overall customer satisfaction with our service from 8.1 to 8.3 out of 10.0 increase customer satisfaction with value for money of our service from 7.8 to 8.0 out of 10.0 Delivering a first class customer experience is at the heart of what we do and is essential to our aim of providing world class service. This requires an approach that ensures every aspect of what we do meets customer expectations. It requires all employees to be completely focused on delivering excellent customer service. We will continue to undertake extensive customer research. As well as measuring the overall customer experience, we will assess customer satisfaction across billing, metering, water and sewerage operations and customer contact handling. Seeking customers views, and listening to their feedback about our performance and the service we provide will help us develop prioritised action plans to deliver greater satisfaction levels. Getting things right first time and reducing complaints By concentrating our efforts on a right first time, every time approach, we believe we can improve customer satisfaction and become more efficient and effective at managing customer contact and complaints. Since the submission of our draft plan, Ofwat has worked closely with the industry to develop new consumer experience measures. We have revised our key objectives to reflect this and to reinforce our commitment to our right first time every time philosophy. Business plan Our plans 34

35 Our plans By 2015 we aim to: achieve a year on year reduction in avoidable operational telephone contacts achieve a year on year reduction in avoidable billing telephone contacts reduce written customer complaints about billing and charging issues from 38 (2007/08) to 25 per 10,000 properties connected reduce written customer complaints about operational issues from 22 (2007/08) to 15 per 10,000 properties connected reduce the number of complaints being escalated by 30% to 3.8 per 10,000 properties Our performance regarding timeliness of response to customer complaints is excellent. However, our aim is to prevent these complaints happening in the first place and we will take a proactive approach to reduce the number of customer complaints. Performance improvement techniques will be used to identify areas for customer service and business process improvements. Our aim will be to reduce repeat, avoidable and unnecessary contacts. Our ongoing analysis of the root causes of complaints will continue across all billing and operational issues. This will help us identify measures to prevent customer complaints in the future. We will review the appropriateness of our Customer Charter standards and enhancements to Guaranteed Standards of Service regularly. We will ensure they reflect customers expectations of excellent service and our commitment to getting things right first time every time. We expect individuals and teams across our business to take responsibility for customer issues. To encourage this approach, we will be increasing the use of customer focused key result areas for all frontline teams. Keeping promises, treating customers with respect and dealing with issues quickly and professionally will all be essential components of our internal customer service standards and performance frameworks. We will ensure all customer facing employees receive the appropriate training and development to ensure they have the skills and information to achieve high levels of performance and customer satisfaction. Communicating with customers Communicating effectively with our customers is essential and we aim to make dealing with Northumbrian Water a pleasure for them. We want it be as easy as possible for customers to get in touch with us, regardless of the reason for making contact. We recognise our customers have different communication preferences and for this reason we will continue to offer a variety of contact channels. Business plan Our plans 35

36 Our plans By 2015 we aim to: provide a range of online services in addition to conventional service channels extend our offering of paperless services to all of our customers Where appropriate, we will use technology to enhance customer service and improve our cost effectiveness. Online offerings are becoming more widely used and will provide customers with access to services and information through a growing range of channels, at their convenience. We expect our web based customer service offering to expand significantly. Whilst the internet and telephony based communication advances will allow us to reduce customer contact costs longer-term, their development will require significant investment. However, we do not expect such technology to completely replace conventional methods of communication, such as the telephone or face to face. We remain committed to our long-standing principle that customers should always be able to talk to us should they wish to do so. Our research consistently shows that many customers prefer to speak to a person about their issues and enquiries. Moving forward, field to office technology and mobile communications will allow us to optimise resources across our areas of operation and enable real-time information to be shared more readily and quickly between teams. This will enable customer services staff to keep customers informed about our work, especially where our activities will cause disruption. We will also continue to forge links with organisations and groups who can help promote our special assistance services to those customers most likely to benefit from them, for example community nurses, social housing providers and local authorities. Information on a pc about supply interruptions Managing income collection and customer debt By , average household bills in the North East will be amongst the lowest in England and Wales. Nevertheless, affordability is an issue for our customers. Income deprivation levels in the North East are the highest of all water and sewerage companies. The economic recession will make paying bills more difficult for customers on low incomes or for those who lose their jobs. The new Tribunals, Courts and Enforcement Act will also make debt collection more difficult. Further details of this Act and its impact on debt collection can be found in the section entitled Costs of achieving our plan. Despite our continuing best efforts to collect debt, we anticipate the combined impacts of the recession and the Tribunals, Courts and Enforcement Act will result in an increase in customer debt. However, it is difficult to predict the amount. All of this places even more emphasis on the importance of debt collection measures. Business plan Our plans 36

37 Our plans During AMP5 we will: continue to promote metering where it will benefit customers with affordability issues work with social landlords to promote metering to reduce charges extend our debt help lines via the use of free phone numbers and dedicated lines for customers in debt, manned by specialist advisors further promote the WaterSure tariff, ensuring employees are fully aware of the benefits for relevant customers help customers apply for direct payment from benefits via the Water Direct Scheme, building positively on our relationship with the DWP to promote and encourage effective use of the scheme promote and support debt advice agencies, nurturing relationships with them to ensure each understands the other s point of view and working closely with them to understand affordability issues. ensure we work in conjunction with the good practice guidelines issued by the Money Advice Liaison Group (MALG) for debt management and collection in relation to people with mental health problems. Providing our customers with a range of payment facilities and frequencies that suit their individual circumstances is a critical element of successful income collection and debt prevention. We will regularly review the range of payment options we offer. We will always be understanding with those customers experiencing financial hardship. We will help distressed and vulnerable customers and those struggling manage their financial problems. We will support the Saving for Poverty study to consider the feasibility of establishing a weekly electronic jam jar. We are committed to ensuring that customers are aware of options which help them pay or reduce charges. We will continue to enhance the data available about different types of customer so we can target communication and ensure that payment options and debt recovery action is appropriate for each customer. We will continue to review our methods of communication with customers about debt. New methods will be deployed, where appropriate, such as text messaging and automated voice messaging. We will also extend the use of outbound calling to try to establish effective dialogue with customers in debt. Where appropriate, visiting customers at their homes to gain information about their circumstances and establish long term payment arrangements will continue to form part of our debt collection strategy. Our employees will receive training to ensure they are familiar, comfortable and proficient with discussing and promoting the options to pay and reduce debt. Our approach towards those customers who deliberately avoid paying charges will remain assertive and they will be actively pursued. We do not believe it is fair for customers who pay their bills promptly to subsidise those who do not. CCWater research confirms our belief that this is unfair and customers generally share that view. 37 Business plan Our plans

38 Our plans During AMP5 we will: extend our use of charging orders, attachment of earnings orders and insolvency orders our principle will remain to use the County Court only where we believe that court action will lead to a payment from a customer who has the ability to pay We will collect data about the relative effectiveness of methods of enforcement and keep abreast of legislative changes which may affect the options available to us. We will continue to work with Ofwat and Defra to seek changes to legislation to clarify who is responsible for the payment of charges and to require customers to provide the information required to enable the industry to raise and collect charges. The ability to collect information from newly occupied properties early in the customer s occupation would avoid the build up of debt and enable customers to budget effectively. It is hoped that these changes can help to reduce the debt burden on the company and on the majority of customers who pay their charges. We will also work with our colleagues across the water industry to establish best practice in debt collection. We will look beyond our own industry to understand techniques which could also be applied to our own circumstances. Working collaboratively with customer related stakeholders Our approach to customer issues has always been a collaborative one and we routinely involve relevant stakeholders in our work. In particular, we will continue to actively involve CCWater in our customer related activities. We value their views as a water consumer champion and have seen through experience how their input can enhance the customer experience in many areas. We will also liaise with organisations such as Citizens Advice, Age Concern and DWP as we believe they will make a valuable contribution to our services. OUR PLANS: MAINTAINING OUR ASSETS MAIN THEMES We have set clear objectives for capital maintenance Our predictions for capital maintenance investment requirements at previous price reviews have been found to be accurate We have significantly improved our asset management planning approach We use robust processes and tools for day to day and strategic planning in line with the agreed Common Framework Our approach is risk based and forward looking Business plan Our plans 38

39 Our plans Introduction Providing water and sewerage services requires the use of many assets. Company-wide our assets include over 25,000km of water pipes, 16,000km of sewers, 450 water and sewage treatment works, nearly 250 treated water service reservoirs and over 900 pumping stations. As these assets deteriorate, their performance suffers and they require refurbishment or replacement so we can continue to deliver safe and reliable water services and deal with waste water effectively. The work to renovate or renew assets is called capital maintenance. In the section on Developing our plans we explained that customers were broadly satisfied with our current performance levels and only limited improvements to service during are required. A major part of our plans, therefore, concentrates on maintaining our assets to continue to safeguard drinking water quality, environmental performance and customer service. We describe here our high level objectives for capital maintenance and our approach to developing our capital maintenance investment requirements. Overall objectives for capital maintenance Our overriding objectives for capital maintenance are as follows. During AMP5 we will: safeguard drinking water and environmental quality maintain current service levels as a minimum invest at sustainable levels consistent with meeting our objectives and to avoid the build up of a backlog of work to be paid for by customers in the future ensure we undertake least cost options to operate and maintain the asset base We have based our objectives for service on a cost benefit approach, with benefits based on customers willingness to pay for improvements. This has helped us identify where service levels need to be maintained and where they should be improved. Our approach is in line with the cost benefit planning objective of the Capital Maintenance Planning Common Framework ( common framework ), which is recognised as best practice by both regulators and water companies. Our plan incorporates the minimum level of capital maintenance required to meet the objectives we have identified. Investing at lower levels would have significant adverse consequences. Consequences of lower than planned capital maintenance levels Our analysis shows that lower levels of maintenance would result in deteriorating service levels and reduced compliance with drinking water and environmental standards. Investment in improvements delivered over the last 20 years would be put in jeopardy. Increased investment would be required in AMP6 ( ) to restore stable serviceability, resulting in disproportionate increases to bills for customers in that period. We have proposed a minimum sustainable level of capital maintenance and investing less than this would not be in the best interests of customers or the environment. It is important to note that our predictions of capital maintenance investment requirements at previous price reviews have been found to be reliable. We have confidence in our asset management planning and are committed to maintaining our assets properly. 39 Business plan Our plans

40 Our plans Improved asset planning processes Since the last price review, we have significantly improved our asset management planning processes, tools and data. The main stages of our asset planning process are fully documented and cover strategic planning, performance analysis, system planning and asset management. We have identified clear roles and responsibilities for groups and individuals, starting at Board level. This is of paramount importance to ensure efficient implementation on a day by day basis and decision-making at an appropriate level. Good asset management requires good information. A dedicated Asset Information Department was established in 2005 to ensure the data required is collected, recorded and made available in appropriate formats. Processes are in place to ensure data is reliable. Our approaches to asset management are embedded in the business and are being continually improved. They are in line with the principles of the common framework and, more broadly, the widely accepted PAS 55 asset management standard. They provide a sound foundation on which our capital maintenance plans are based. Capital maintenance investment tools and decision-making Our decision-making methodologies and tools for capital maintenance have been designed to provide appropriate and practical approaches, tailored to each asset type. For non-infrastructure (above ground) operational assets, risk based and forward looking methodologies were adopted to understand the asset base and potential activities required to meet the objectives. These best practice approaches included the use of Deterioration Curves, Failure Modes and Effects Analysis (FMEA) and analysis of serviceability trends for main and sub indicators. This information was supplemented with information from our ongoing asset management processes, including details of asset issues identified by operational personnel. The mix of activities required to manage risk and achieve objectives was then chosen from a range of possible interventions based on achieving the best risk reduction per pound invested. For water and sewerage infrastructure assets the main tool used to identify activities was the WILCO modelling approach. Again this is a risk based, forward looking approach in-line with the common framework. WILCO is an optimisation tool which identifies a programme of activities that provide the best benefit (attainment of service objectives) for the investment made. We believe that our CBA, plus the approaches described above, ensure the right objectives are being targeted and that we are planning to deliver these optimally in terms of risk reduction (benefits delivery) at the least whole life cost. Thus, as well as meeting the common framework cost benefit planning objective, the cost effectiveness objective is also met. Business plan Our plans 40

41 Our plans OUR PLANS: PROVIDING SAFE AND CLEAN DRINKING WATER MAIN THEMES Our overall goal is to continue to provide a reliable, safe water supply Further improvements are planned to the already high levels of quality compliance We will continue to address risks through our Water Safety Plan approach Quality investment is significantly lower than in AMP3 and AMP4 We will invest sustainable levels of capital maintenance Our plans for providing safe, clean drinking water have been developed under five headings and form a comprehensive, integrated package. A summary for the North East is provided below. Continuing to provide safe clean drinking water: summary 1. New standards meeting the new standard for lead in drinking water 2. Water Safety Plan approach further reductions in discoloured water complaints identify and address risks to raw water quality catchment management 3. Maintaining drinking water quality sustainable levels of capital maintenance 4. Quality compliance further improvements to the already high levels 5. Enhancing service improving the taste and odour of drinking water We describe below our proposals for drinking water quality under each of the five headings. 1. Meeting the new standard for lead in drinking water (DWI scheme NWL 077) Lead can get into drinking water from lead pipes laid many years ago. Both communication pipes (CPs) and supply pipes can be lead. The CP is a water company asset and connects the water main to the boundary of the customer s property. The supply pipe, which is owned by the property owner, connects the CP to the customer s home. The new standard for the level of lead in drinking water (10 µg/litre), comes into force in Compliance against the new standard is already high following the installation of water treatment to reduce the take-up of lead from pipes into the water (plumbosolvency control). Given this position, we agree with the DWI that a blanket lead CP replacement strategy is inappropriate and would not represent value for money. Building on the assessment we carried out for our draft plan we have identified an integrated package of measures arising from risk assessments of all of the company s water supply zones, but prioritising work in high risk water supply zones. This package has a final letter of support from the DWI. Schemes that receive DWI support are considered necessary to meet statutory requirements. 41 Business plan Our plans

42 Our plans During AMP5 we will: continue with plumbosolvency control undertake targeted lead CP replacement in high risk areas undertake lead CP replacement on failure of 10ug/l from April 2010 undertake lead CP replacement on request from customers regardless of whether a sample exceeds 10µg/l undertake lead CP replacement as part of planned work on the distribution system work with health protection teams and primary care trusts to address risk to vulnerable groups work with local authorities and housing associations to identify opportunities for replacement of lead pipes offer a rechargeable service to customers for their lead supply pipe replacement when the company replaces its CPs. These policy strands are also part of our long term SDS strategy to reduce the number of lead CPs over time in a cost effective manner. 2. Managing risks to drinking water quality We are implementing a Water Safety Plan approach to identify and manage risks to the drinking water supply system, from source to tap. This approach identifies and documents the potential hazards that can occur in the water supply chain that could put drinking water quality at risk. Once these hazards are identified, assessments are undertaken to identify the likelihood and consequence of the hazards occurring. Where it is established that a risk exists, appropriate control measures are identified and put into place to reduce or eliminate the risk. Control measures can take various forms including advice to farmers in catchment areas, an operational improvement at a treatment works or capital investment. We will also ensure that adequate monitoring is carried out to confirm that the control measures adopted are effective. Our Water Safety Plan approach has been welcomed by the DWI The risk assessment reports were very comprehensive providing an excellent interpretation of the requirements Risk assessments carried out as part of the Water Safety Plan approach have identified a number of areas where we propose to take action requiring investment or additional operational expenditure. We proposed these to DWI as Quality enhancements and have received final letters of support for the scheme described below. Business plan Our plans 42

43 Our plans North East: discoloured water alleviation (DWI schemes NWL 076 and 075) In the North East we have a relatively high level of customer complaint about discoloured tap water. This can be caused by sediment in the mains, which is stirred up by unusually high flows. It can also lead to failure against the standards for iron and manganese. Although discoloured water can be unpleasant to drink and can discolour washing, there is no health risk. We have set out a long term strategy in our SDS to alleviate discoloured tap water and have already started to address the problem. In 2005 we began a major programme, embodied in a formal Undertaking, to clean substantial parts of the mains system. This programme was designed to reduce complaints from over 14,500 (prior to 2004) to 5,000 per annum by This work has already achieved a substantial reduction in complaints, to 7,440 in This is shown in the graph below. Graph showing discoloured water contacts in the North East Number of contacts Discoloured Water Contacts in the North East Year No of discoloured water cells The Undertaking also required the company to investigate the risks of discoloured water in the rest of the trunk mains system. This demonstrated that there are significant levels of sediment in the system supplying parts of Newcastle and Gateshead. The number of discoloured water complaints from customers supplied from this system averages around 1,300 per year but the impact of a major incident could be much higher. The cost of managing this risk is 27.8m. The source to tap approach we will employ includes the preparation and cleaning of 165 km of trunk mains and flushing of more than 1,300km of distribution mains. This has been identified as the most cost beneficial scheme to reduce the risk of discoloured water and has been included in our plan as the next stage of our longer term strategy. In doing this we have responded to the following evidence and views. Business plan Our plans 43

44 Our plans Reasons supporting the scheme to reduce discoloured water complaints in AMP5 DWI have provided a final letter of support, designating the scheme as a statutory requirement The scheme has strong customer support: - in our draft plan validation research, 79% of respondents supported the scheme, taking into account its impact on bills - in the PR09 Water Industry Stakeholder Steering Group post draft plan research, 71% of respondents regarded the scheme as good or very good value for money The scheme is supported by CCWater Complaints about discoloured water in the North East are higher than those for other companies and we generally have lower compliance against the standards for iron and manganese Discoloured water can affect customers confidence in the safety of drinking water The scheme will move the company towards its SDS goal of reducing discoloured water complaints to 2,500 by Our investigation also identified that the water mains supplying parts of Teesside and Teesdale have the next highest risk of causing discoloured water. However, the solution required is not clear at this stage. It is proposed that a feasibility study be undertaken in AMP5 to determine possible solutions and their cost. This will enable a decision to be made regarding whether to proceed with this scheme at the next price review in During AMP5 we propose to: complete the current AMP4 scheme to reduce discoloured water (completion in 2011) undertake a major, one-off, scheme to reduce the risk of discoloured water in Newcastle and Gateshead (DWI scheme NWL 076) investigate the viability of addressing discoloured water on Teesside and in Teesdale in AMP6 (DWI scheme NWL 075) We believe that our phased approach to dealing with the discoloured water problem is an appropriate strategy. Spreading investment over AMP4, AMP5 and potentially AMP6, provides a practical programme with progressive benefits and also minimises the impact on bills. Business plan Our plans 44

45 Our plans Identifying and addressing risks to raw water quality catchment management Our Water Safety Plan approach involves the identification and control of risks to water sources. The Water Framework Directive also requires the protection of waters used for drinking water supply (Article 7). We do not generally own the catchments supplying our water resources. The control of risk, therefore, includes working proactively with land managers and farmers to ensure their actions do not result in pollution of water sources that then require expensive treatment solutions to resolve. Emerging issues, such as that relating to pesticides emphasise the fact that it is important to maintain contact with land managers and work with them to help them avoid contaminating drinking water sources. In AMP5 we will: increase our catchment liaison activity in the North East to address existing and emerging risks and to reduce the potential need for expensive treatment solutions continue with our contribution to the Peatscapes project to help control colour in the River Tees We have identified the need for a Catchment Liaison Officer who will work with regulators (eg. the EA and NE), relevant organisations (eg. National Farmers Union and the Country Land Owners Association), spray contractors, farmers and land managers to promote good practice and coordinate actions to address problems. Further information on this and the Peatscapes project can be found in the section in Our plans entitled Encouraging biodiversity and access. This work often has several benefits, including those to land managers and to biodiversity, as well as protecting drinking water sources. The Catchment Liaison Officer will work in partnership to maximise the benefits of the work. We have included these proposals under the Water Framework Directive, Article 7. Whilst they do not qualify as statutory drinking water quality schemes or for the National Environment Programme, they have the support of the DWI, EA and NE. This is also part of our Branch Out approach see Encouraging biodiversity and access later in this section for further details. 3. Maintaining drinking water quality capital maintenance Carefully targeted and timely asset maintenance is required as part of our overall approach to manage drinking water quality. Business plan Our plans 45

46 Our plans In AMP5 we will: deliver sustainable levels of capital maintenance to ensure we continue to provide a safe and reliable water supply Our proposals regarding non infrastructure and infrastructure assets are as set out below. Non-infrastructure assets Our asset management processes, described earlier in this section, indicate that we need to increase investment in the maintenance of water treatment works and treated water storage reservoirs. The main schemes in this regard are shown below. Key contributors to capital maintenance for water quality reasons Granular Activated Carbon (GAC) regeneration required for the first time for filters installed at four major water treatment works in AMP4 new sludge treatment and disposal facilities required for Lumley water treatment works (in County Durham) where continued use of current facilities is no longer possible higher (but optimum) levels of mechanical, electrical and ICA (instrumentation, control and automation) asset replacement major service reservoir replacements required at Hebron (serving Ashington) and Stoneygate and Mill Hill (serving Sunderland) major replacement of filters at Horsley water treatment works (serving Newcastle) due to severe concrete and steel degradation Business plan Our plans 46

47 Our plans Infrastructure assets The main driver of change in investment in this area follows on from the completion of the Section 19 mains renovation programme. In AMP4 and previously, the major Section 19 Distribution programme required water mains to be replaced to improve water quality. As well as improving compliance with the standard for iron and manganese, this investment also contributed significantly to maintaining the structural condition of the water mains network. This meant that renewals required under the capital maintenance investment heading were lower than otherwise would have been required. The Section 19 renewal programme was completed in AMP4 and our analysis shows that water mains renewal undertaken as part of our capital maintenance programme needs to increase in the future to manage structural condition. However, it should be noted that the overall length of mains renewal proposed in AMP5, for all purposes, is only 60% of that in AMP3 and 15% less than that in AMP4 (see chart below for mains renewals in AMP3, 4 and 5). Total length of water main renewal company-wide for AMP3, 4 and 5 Total length of water main renewal km AMP3 AMP4 AMP5 We have also introduced a policy to replace metallic (including lead) communication pipes on an opportunistic basis to support leakage control and avoid the additional costs of returning to the site more than once, also reducing disruption to the public. 4. Further improving drinking water quality compliance We described above how we will reduce risks to drinking water quality through our Water Safety Plan approach. This approach covers all of the activities required to collect, treat and distribute water and we believe its use day to day will help improve compliance with drinking water quality standards even further. This will be supported by our improved processes to plan and target capital maintenance investment. Business plan Our plans 47

48 Our plans 5. Addressing the taste and odour of drinking water enhanced service level Our SDS aspiration is that all customers find drinking water pleasant to drink. Drinking water can have a taste or smell. Sometimes this is due to chlorine added to the water to make it safe to drink. Occasionally we also have to change the source of water supplying a particular area from season to season to manage resource availability. New sources can have differences in taste or smell that some customers detect and find less acceptable. These tastes and odours do not make the water unsafe to drink. This is a particularly difficult issue to deal with as customers, even when they receive exactly the same water supply, often have different views about the taste. In many cases, simply cooling the water in the fridge before drinking can give it a more pleasant taste but, because taste and odour is of concern to some of our customers, we want to make sustainable improvements. Contacts from customers about this issue are relatively low. However, significant numbers of customers tell us through our customer research that they would like improvements to the taste or smell of drinking water. Our Strategic CBA, based on customers willingness to pay for improvements, confirmed that a modest approach to addressing taste and odour complaints is cost beneficial and this was confirmed by post draft plan validation research. We propose to set up a dedicated team with the aim of understanding the causes and solutions of taste and odour problems, trouble-shooting discoloured water complaints and providing advice to customers. We also intend to increase monitoring to provide more data on water in the network which may help to identify why complaints arise and help us to develop strategies to reduce complaints. Whilst we anticipate our proactive management approach will achieve a small reduction in taste and odour complaints, a key thrust of our work will be to identify actions we can take in the future to make a more significant difference. We will produce an improvement plan in time to inform the periodic review in 2014, in line with our SDS. In AMP5 we will: work with customers to understand and address taste and odour problems develop an improvement plan for PR14 The cost of this enhancement to service in AMP5 is small. Business plan Our plans 48

49 Our plans OUR PLANS: MEETING FUTURE WATER NEEDS Water companies must ensure there is an appropriate balance between the water resources it has available (supply capability) and the demand for water from its customers. This is called managing the supply/demand balance. Managing the supply/demand needs to address pressures on the environment from abstracting water, changes to the demand for water in the future and what the effects of climate change may be. The tools that companies can use to ensure there is sufficient water include demand management (through metering, tariff development and encouraging customers to use water wisely), leakage control and resource development. Our planning is undertaken in accordance with the EA s Water Resource Management Plan guidance using the UKWIR Economics of Balancing Supply and Demand methodology. Our proposals to pilot automatic meter reading and smart meters are described at the end of Meeting future water needs together with our change of meter replacement policy. Business plan Our plans 49

50 Our plans MEETING FUTURE WATER NEEDS MAIN THEMES Water availability is generally not an issue in the North East Continuation of current policies for metering and water efficiency Sustainable level of leakage recalculated A small scheme required to enable optimum resource use in the Berwick and Fowberry supply zone Some increases to system capacity are required to service new development as a result of growth in property numbers Introduction In the North East we generally have sufficient water for our customers needs. We have two main supply zones, one very large and the other relatively small. Each has its own characteristics. Kielder supported supply zone Around 99% of the population we serve in the North East resides in this zone. It covers the majority of our supply area including the main population centres of Tyneside, Wearside and Teesside. As water can be transferred to all parts of the zone from Kielder reservoir to supplement our other sources, it is called the Kielder supported supply zone. Business plan Our plans 50

51 Our plans Over the next 25 years demand in the Kielder zone is forecast to increase by 3.2%, taking into account demand management, leakage control and the impact of the economic recession. Water delivered to households is forecast to decrease by about 1.6%. While population is forecast to increase by around 9% and the number of properties by 18%, this will be offset by a reduction of about 9% in per capita consumption. Non-household demand, which accounts for about 31% of total consumption in the Kielder zone, is forecast to increase by 14%. In these circumstances Kielder reservoir guarantees that there will be sufficient water available for the foreseeable future. Our approach is, therefore, to manage leakage and encourage our customers to use water wisely so that current resources continue to be sufficient to meet customers needs. There is a need, also, to ensure there is sufficient treated water and strategic transport capacity to satisfy new development. Berwick and Fowberry supply zone This small zone is centred on the towns of Berwick and Wooler in north Northumberland. Apart from these towns, the area is largely rural and sparsely populated. Overall, taking into account demand management, leakage control and the impact of the economic recession, demand is forecast to increase by 7.5% over the next 25 years. Water delivered to households is forecast to increase by 2.5%. While population is forecast to increase by around 13% and the number of properties by 18%, this will be offset by a reduction of about 9% in per capita consumption. Non-household demand is forecast to increase by 14%. Development in the zone will require system reinforcement to convey existing resources to the areas where it is needed. Metering and tariffs Most customers feel that metering is the fairest basis for charging for water. However, most customers are not in favour of compulsory metering of existing properties. In areas where water is scarce, metering has a key role to play in reducing demand. This issue is less acute in the North East, where we have adequate water resources. Our ultimate aim is to achieve as near to universal metering as practicable, as this is the fairest basis of charging. As our customers do not support compulsory metering, and there is no need to install meters to control demand, we intend to continue with our current metering policy for AMP5. Business plan Our plans 51

52 Our plans In AMP5 we will: install meters in all new properties and actively promote the option of installing a meter free of charge to existing customers. We forecast this will move meter penetration from 18% at the end of to around 43% by 2020, in line with the goal in our SDS. We have revised our forecasts for meter numbers since the draft plan taking into account the impacts of the economic recession. These are shown in the table below. Meters installed each year in the North East (actual and forecast) AMP4 AMP New 8,297 9,017 9,230 7,842 6,215 5,902 7,202 9,614 11,267 11,768 Optants 16,149 19,692 17,701 16,000 15,000 14,000 14,000 14,000 14,000 14,000 Total 24,446 28,709 26,931 23,842 21,215 19,902 21,202 23,614 25,267 25,768 Encouraging water efficiency Although the North East has sufficient supplies of water and is not water stressed, we believe it is important to encourage the efficient use of water. This will help to protect the environment by taking less water from it and saving water also lowers carbon emissions. Ofwat has recently introduced a new requirement for water companies to meet formal water efficiency targets. We have used Ofwat s required methodology to define targets for the future and included these in our demand forecasts. The target for the North East is 1.12 Ml/d, cumulative. We will: undertake activities to promote water efficiency at a level consistent with meeting the formal targets Our activity levels in our two resource zones will reflect the water resource position in each. We will draw on the wealth of expertise and experience developed in Essex & Suffolk Water in planning our activities. In the past we have actively discharged our duty to promote water efficiency at a level of activity consistent with our ample water resource position. Our level of activity has never been questioned or challenged by Ofwat as being insufficient to meet our formal duty. The new targets Ofwat has introduced require increased activity and expenditure ( 1.6m per annum opex). We have, therefore, included the increased costs in our plan and expect Ofwat to take these into account in price limits. Business plan Our plans 52

53 Our plans Managing leakage Setting leakage targets It makes good sense to manage leakage to the sustainable economic level (SELL), even if there are ample resources in the North East and no environmental pressures from water abstraction. This ensures that costs are minimised. It also reduces energy used in treatment and pumping and, therefore, carbon emissions. Our goal is to manage leakage at the long term sustainable level in both of our supply zones using best available technologies and taking into account social and environmental costs. We have produced a new, improved estimate of the SELL for our final plan that shows current targets are higher than the revised sustainable level. The graph below shows leakage targets and actual leakage for AMP4. It also shows the SELL and proposed leakage targets for AMP5. North East past and proposed future leakage levels / / /5 2005/6 2006/7 2007/8 2008/9 2009/ / / / /15 The SELL set at PR04 was 153 Ml/d. Formal targets required this to be met by on a reducing profile. Our revised estimate of the SELL is Ml/d (some 12 Ml/d less than the current target). We propose to achieve this by on a reducing profile, starting at 150 Ml/d in In actual leakage was 136 Ml/d, significantly lower than expected because of the combination of improved reporting and a benign winter. Although 136 Ml/d is significantly below the targets for and , it would be uneconomic to let leakage rise to these target levels just to have to drive it down again in AMP5. We will manage leakage in the last two years of AMP4 consistent with the start point of AMP5. 53 Business plan Our plans

54 Our plans In AMP5 we will: meet the revised sustainable economic level of leakage of Ml/d by Activities to meet leakage targets We will manage leakage by improving the effectiveness and efficiency of our activities to find and fix leaks, by introducing further enhanced pressure management and through opportunistic communication pipe replacement. Developing water resources Kielder supported zone Kielder reservoir currently has significant surplus capacity. There is enough water from this reservoir to meet the demand for water in the area it supplies now and into the foreseeable future, even taking climate change into account. Our plan includes for an investigation into the impact of abstraction from the River Coquet (for our Warkworth water treatment works) on river flows and ecology. The need for this has been identified by the EA as part of the final NEP programme. Berwick and Fowberry zone Water for this zone is supplied from local underground water sources. At the moment these resources can meet the communities needs, but there is limited surplus capacity to meet any future growth. In AMP5 we aim to improve management of existing resources in the zone to maximise the use of available water without exceeding our licensed abstraction. We will: implement a scheme to increase our ability to move water from one part of the zone to another. The investigation into the impact of abstraction of groundwater from the fell sandstone in the River Till area has been removed from the NEP and, therefore, is not included in our final plan. Dealing with development and growth As mentioned above, the number of properties is predicted to grow significantly in the North East in the future. We also expect population movement to areas where there are new housing developments. We must ensure the strategic infrastructure to supply new development is put in place and we continue to liaise with the various planning agencies to ensure we have latest information to assist our planning. In AMP5 we will: augment the strategic supply system to meet water needs from population growth and relocation. We have identified areas where there are likely to be housing and other developments and have modelled the effects of this on system capacity requirements. This takes into account predicted general increases in population in each area and also known growth points, eg. South East Northumberland, North Tyneside and Tees Valley. Network models have been used to identify an optimised range of schemes to ensure existing and future customers can continue to be provided with a reliable service and sufficient water pressure. We have reviewed requirements taking into account the predicted impact of the economic recession. Business plan Our plans 54

55 Our plans METERED CHARGING TRIALS, AUTOMATIC METER READING AND METER REPLACEMENT POLICY This section covers our plans for Essex & Suffolk and the North East. Automatic meter reading and metered charging trials Our aspiration is that our metered charges help customers to fully understand the value of water and encourage efficient water use. We propose to take a phased approach to our research regarding metered charging and tariff development. A requirement of most sophisticated tariffs is meters that can provide more information than those generally in use today. We have included in our final plan an allowance for pilot work in AMP5 to research the use of smart meters and automatic meter reading (AMR). As well as facilitating the use of sophisticated tariffs, smart meters can also give customers easy access to information about how much water they are using and help them manage their bills. A greater understanding of the capabilities of smart meters, how they can be read, and the water use behaviour patterns of consumers will allow us to explore the potential for innovative tariffs. In AMP5 we will: investigate the advantages of smart meters, AMR, and tariffs to encourage customers to save water use the results of the investigation to formulate future strategy Automatic meter reading in AMP5 As meter numbers increase we must ensure we continue to have the most effective and efficient way of reading meters. At the current time we have not been able to make an economic case for adopting AMR for external meters and we have excluded this from our final plan. We do, however, propose to fit AMR devices to new or replacement meters where these are inside customers properties. We often have difficulty obtaining access to read internal meters and AMR allows a reading to be taken from outside the property, avoiding repeat journeys and the need for estimated bills. Business plan Our plans 55

56 Our plans In AMP5 we will: provide an Automatic Meter Reading (AMR) device on each internal meter installed, whether it is a replacement meter, a meter installed on a new property or provided as part of the optant or selective metering programmes The information we obtain from the investigations described under Metered charging and tariff trials above, and advances in technology, may lead to more widespread AMR being an economic option in the future. Meter replacement policy Meters are mechanical devices and, as they age, they can become inaccurate. It is important that customers are charged on the basis of accurate readings. This ensures all customers are charged fairly and correctly. Recent work by WRc has shown that meters can become less accurate earlier in their lives than originally thought. As a consequence, we plan to replace meters at more regular intervals than we currently do, and generally before they become less accurate. In AMP5 we will: replace all meters that will be greater than 15 years old as at OUR PLANS: KEEPING THE WATER FLOWING MAIN THEMES Interruptions to supply Maintain the current level of unplanned interruptions to properties of over 6 hours Reduce planned interruptions by 12.5% Water pressure Introduce best practice recording of pressure Ensure no more than 274 properties experience low pressure Reducing interruptions to supply Unplanned interruptions Our current AMP4 target is that no more than 2,670 properties company-wide should be affected by unplanned interruptions of more than six hours duration, though the number of properties affected varies from year to year because of weather conditions. For example, underground pipes can fracture due to ground movement when there are sudden changes in temperature. Unplanned interruptions are mainly caused when a water main bursts. 56 Business plan Our plans

57 Our plans Although continuity of supply is of high importance to our customers, our CBA assessment, based on customer research, indicated that they are not willing to pay for improvements to the network to achieve an improvement to service. We will not, therefore, be making significant progress in AMP5 towards our 2020 SDS goal of halving unplanned interruptions to supply. Given that progress will not be made in AMP5, the SDS target for 2020 may not be achievable. However, we will continue to investigate more cost effective means of reducing interruptions. In AMP5 we will: continue to minimise interruptions of over 6 hours by efficient operational response reassess customers requirements before the 2014 review of price limits (PR14) Planned interruptions Planned interruptions are caused when the water needs to be turned off during work to improve the network, such as replacing old mains. We try to reduce the number of planned interruptions through careful planning and working, but the number of interruptions is also related to the amount of work being carried out to improve services for our customers. Company-wide properties affected by planned interruptions of more than six hours have averaged 33,000 per annum over recent years. While planned interruptions will always be necessary to undertake work on the water supply system, our aim is to minimise them and we will investigate innovative techniques that may reduce the number of properties affected. In AMP5 we aim to: reduce planned interruptions by 12.5% in AMP5 in line with our SDS goal to reduce them by 25% by 2020 Improving water pressure We aim to provide adequate pressure at the boundary of a customer s property. This should be more than enough to deliver acceptable flows to all parts of the house, provided the customer s supply pipe is in good condition. Whilst most properties receive pressure in excess of the required standard, there are a very small number that do not. Business plan Our plans 57

58 Our plans In the North East our AMP4 target for the number of properties at risk of low pressure is no more than 274 and we expect to meet this target. We are improving our systems to identify properties experiencing low pressure more proactively. This approach, already in use in Essex & Suffolk, uses extensive pressure monitoring and modelling techniques to allow identification of properties at risk where customers have not informed us about low pressure. This information will provide more accurate information and enable action to be taken to address the properties identified. In AMP5 we will: keep the number of properties at risk no more than 274 This is in fact an improvement to service for our customers as properties not previously known to have pressure problems will be identified and addressed without increased bills Improved information will stand us in good stead to continue to improve performance in AMP6 towards our 2020 SDS goal of no more than 100 properties at risk. OUR PLANS: DEALING WITH INCREASING FLOWS IN THE SEWERAGE SYSTEM MAIN THEMES Integrated drainage planning Flows into sewers from surface water (rainfall) are increasing in the North East Development creep is increasing the speed and volume of surface water run-off into sewers Our sewerage system was not designed for current storm intensities or run-off We are already working to understand changing storm patterns and their impact on the sewerage system Significant thought needs to be given to solutions - increasing sewer capacity is not always the right answer We propose to undertake a major study involving all agencies responsible for managing surface water delivering an integrated long term drainage plan by informing our future approach across the region Dealing with flooding from overloaded sewers The number of properties flooded in AMP4 far exceeds the assumption in the FD There is mounting evidence that the main cause is increased rainfall and development creep Despite doubling outputs and investment in AMP4 properties at risk of flooding exceed the target Our major programme to address sewer flooding in AMP5 has CCWater support Addressing growth from new development Thorough review of local plans undertaken Asset upsizing requirements identified in line with latest UKWIR methodology Plans take account of the economic recession Business plan Our plans 58

59 Our plans Integrated sewerage planning for the long term Background The sewerage system is the network of sewers and pumping stations that takes both sewage (such as waste water from baths, showers and toilets) and surface water (such as rainfall flowing from roofs, roads and patios) to the treatment works. When the sewerage system has to cope with more sewage and surface water than it is designed for, it overflows and can cause flooding. It is usually the excess surface water from rainfall that causes sewers to overflow. In recent years rainfall has caused significant flooding and there is mounting evidence that weather patterns are changing. In particular, we have experienced increasingly heavy storms in the North East in recent summers causing unprecedented levels of flooding. These storms are predicted to be more common in the future as a result of weather cycles and climate change. Increasing areas of hard surfaces, such as paving, add to the speed and volume of water running into drainage systems and make the situation worse. The term Development Creep is used to identify this type of demand growth coming from: house extensions and conservatories driveways, paved front gardens and patios widening of highways and removal of highway verges additional gullies in the existing road network reduced surface storage car park extensions for existing commercial and industrial developments Sewerage networks were not designed to accept the additional flows from development creep and it is believed that this is now playing an increasingly significant part in the increase to property flooding. The widespread paving of front gardens for car parking and construction of patios is believed to be of particular significance in run-off increase. The Royal Horticultural Society (RHS) and the Horticultural Trades Association (HTA) commissioned a survey in 2005 which showed that, in the North East, about 47% of front gardens have been paved over to provide parking spaces and almost 25% of front gardens are entirely paved over. Business plan Our plans 59

60 Our plans The average age of our sewerage system is around 65 years. Sewers were designed for rainfall characteristics of the past and the rate of run-off experienced at the time of construction. There have been major changes in both these factors in recent years and this has been the major cause of increased flooding from sewers. Some flooding comes from overloaded sewers but some is also caused by overflowing rivers and lack of capacity in the drainage systems maintained by local authorities and highways agencies. As identified in the Government s strategy Future Water and the Pitt review: Learning Lessons from the 2007 floods, it is important that the relevant organisations work together to find the best solutions to flooding in the future. We support a collaborative approach and will work with Local Authorities and other agencies in the development of Surface Water Drainage Plans (SWDP). Producing an integrated long term drainage plan We are already doing a great deal to understand the impact on the sewerage system of increased rainfall. We have a System Planning approach to identify and understand the issues across the whole region in eleven designated systems, based on river catchments. We have fitted nearly 500 remote real time monitors to combined sewer overflows to record the way in which the sewerage system is coping with flows and how those flows are changing over time. In AMP5 we propose to install an additional 1,045 real time monitors. Although weather forecasting is not our responsibility, we have worked with the Meteorological Office and the EA to provide a higher resolution rain radar station. This facility was built on our site at High Moorsley and commissioned in Autumn It will bring the North East up to the standards in place in the rest of the country, providing much better information about rainfall patterns and return periods. We are also sponsoring 85 weather stations at selected schools across the region to supplement the pattern of existing rain gauges maintained by the EA. This is called the GLOBE project. We are developing a software solution for the storage, management and assessment of rainfall storm data from the new radar station and the GLOBE network. This will deliver automatic calculations of storm return periods of rainfall events in the region. We will analyse this information together with that from the scientific community to predict the changing patterns of rainfall. The information from sewerage system monitoring and storm frequencies and intensities can then be brought together to inform planning and investment decision making. The solutions to be provided to resolve flooding need careful thought. It is not always practical or cost effective to build bigger sewers to take storm water. We need to find solutions by bringing together all the agencies concerned with drainage and flooding to work together, including local authorities, highways agencies, the EA and water companies. Business plan Our plans 60

61 Our plans In AMP5 we will: complete a major study by , to explore sustainable drainage options that take into account regional development and the impact of the changing climate This will initially be centred on Tyneside because it is the system with highest flooding risk and has a wide variety of catchment and sewer characteristics on which to test options. This research will be done in conjunction with relevant agencies and will build on a recent similar, but smaller, study in Hartlepool that was led by Northumbrian Water. It will contribute to the development of the wider SWDP. Our study will evaluate sustainable urban drainage techniques, the removal of highway drainage and other surface water from sewers, increases in sewer capacity and the possible separation of combined sewage and surface water sewers. In the study, we will investigate how the sewerage system will cope with future patterns of surface water flows and whether new sewers need to be designed to different standards. It will help us to identify the best range of solutions to minimise flooding from sewers in the future across all of our area. Dealing with flooding from overloaded sewers Background The integrated long term approach to drainage planning described above should allow more proactive action to be taken in AMP6 and beyond to control flooding from increasing rainfall. For AMP5 we propose to continue with an approach that: identifies and caters for growth from new development which is the subject of planning applications (but note water companies are not statutory consultees) deals with properties flooded from sewers in AMP4 but not addressed in AMP4, subject to a cost benefit test deals with the anticipated properties flooding in AMP5, subject to a cost benefit test Our approach, which is described in more detail below, relates to internal property flooding. Flooding in AMP4 The PR04 FD assumed 171 properties on the DG5 flooding register at the end of AMP3 would require resolution in AMP4. It also allowed for an estimated 215 newly emerging properties to be addressed over the five year period (43 per year), based on the historical average of the preceding six years of available data. Therefore, the total properties assumed to be addressed in AMP4, and for which an allowance was made in price limits, was 386. The total investment allowed was 45.7m. Business plan Our plans 61

62 Our plans The PR04 FD required the company to achieve a specific number of properties on the DG5 1 in 10 and 2 in 10 registers at the end of AMP4, irrespective of the number of newly emerging flooded properties. In our response to Ofwat regarding the PR04 Draft Determination (DD), NWL stated that this places an unacceptable risk on the company. This is because the number of properties flooding is weather dependent and there was no upper limit to the financial exposure. In actual fact, sewer flooding in AMP4 has been on an unprecedented scale to that recorded in AMP3 and previously. We believe it is outside the scope that either the company or Ofwat could have foreseen. Flooding of properties for the first time in the first three years of AMP4 was around seven times the historic level and that allowed for in the FD. Whilst a relatively small part of the increase was the result of our improved processes to identify properties at risk of flooding, the increase was predominantly caused by intense summer rainfall. This was exacerbated by faster run-off from the increasing area of impermeable surfaces caused by development creep. It was not the result of a sudden change in the capability of our sewerage system. AMP4 outputs and expenditure NWL responded promptly, stepping-up investment after the major increase in flooding in summer Our revised programme would have achieved the FD DG5 position in , provided the number of new properties flooding had returned to a 43 per annum average going forwards. However, the flooding in summer 2007 was again abnormally high and we had to reassess the programme with only two years left in AMP4 to design and deliver additional schemes. The revised programme being delivered in AMP4 reflects what is practical and achievable in terms of the time available and the availability of consultant and contractor resource. The level of flooding was again very high in 2008, again due to summer storms. Given that our accelerated sewer flooding programme was already delivering as many outputs as possible, this flooding adds to the shortfall against FD expectations. The total number of properties NWL plans to address in AMP4 is 755 compared to only 386 allowed for in the PR04 FD. Our investment in sewer flooding alleviation in AMP4 is projected at some 81m, almost 35m above that allowed for in PR04 price limits. FD and actual/forecast outputs are shown in the table below. Sewer flooding outputs (number of properties) - PR04 FD and actual/forecast AMP Total PR04 FD AMP4 actual/forecast Additional outputs delivered % additional outputs Business plan Our plans 62

63 Our plans Projected position at end of AMP4 It is necessary to forecast the flooding register position at the end of AMP4 to evaluate AMP4 performance and to plan investment for AMP5. We have taken the provisional DG5 1 in 10 and 2 in 10 register position for and adjusted this for projected newly flooded properties added in and the number of properties we plan to address in that year. The level of flooding in is unknown at this point in time but 140 properties have been assumed, in line with the forecast new annual additions in AMP5 (see Plans for AMP5 below). Removals from the register are consistent with the accelerated investment programme in place now. The projected DG5 figures are shown below. Projected DG5 1 in 10 and 2 in 10 register position at end of AMP Projected DG5 1 in 10 and 2 in 10 properties 387 PR04 FD DG5 1 in 10 and 2 in 10 properties 76 Our CBA indicates that, of the 387 properties projected to be on the 1 in 10 and 2 in 10 DG5 registers at the end of , 329 will be cost beneficial to address. The figures above do not include properties for which investigations are not complete. The investigations will confirm whether the properties should be included in hydraulic incapacity or other causes registers. The properties subject to investigations are included in the 1 in 20 register as required by Ofwat information requirements and as shown below. Projected DG5 1 in 20 register position at end of AMP Properties confirmed as 1 in 20 risk 128 Properties with investigation in progre ss 771 Projected to transfer to 1 in 10 or 2 in 10 registers 388 Of the 771 properties with ongoing investigations, we estimate 388 will transfer to either the 1 in 10 or 2 in 10 hydraulic incapacity registers and be considered for investment action. Of the 388 properties transferred, our CBA indicates that 330 will be cost beneficial to address. AMP4 regulatory treatment NWL accepted the PR04 FD package despite our continuing concern regarding the open-ended definition of the sewer flooding output. We believe there are sound reasons why Ofwat should not mechanistically apply its shortfalling processes to NWL s AMP4 sewer flooding performance in PR09. At the time of setting PR04 price limits, we do not believe either NWL or Ofwat could have anticipated that flooding might vary by the amount actually experienced and as described above. There is evidence that the increasing trend of flooding is mainly due to weather cycles and development creep. We have provided evidence to Ofwat in this regard. It is clear that the major change in the level of flooding between AMP3 and AMP4 is due to rainfall differences and development creep and not changes in asset capability. There are also a number of points to make regarding the magnitude of the difference between the predicted and actual positions and the nature of Ofwat s financial penalty regime. Business plan Our plans 63

64 Our plans 1. Uncontrollable risk The magnitude of flooding experienced in AMP4 is far in excess of previously recorded figures and could not have been foreseen. Such rapid changes are not the result of deterioration of assets but of changing weather patterns. Ofwat acknowledged our forecast number of newly emerging properties at PR04 as a reasonable central estimate. The company is potentially being penalised for not being able to forecast the weather accurately and should not be required to bear the consequences of risks that cannot be controlled. 2. Disproportionate financial penalties The additional flooding was beyond the company s control and yet the company responded by accelerating its programme as far as possible and investing much more than Ofwat allowed. This additional investment was supported by CCWater and was clearly in the interests of customers. Having responded in this way, it would be inequitable if Ofwat were to apply a punitive financial penalty by both failing to allow a return on the additional, worthwhile, investment and logging down for investment not allowed in price limits in the first place. 3. Asymmetric risk The financial downside risk NWL bears (which is determined by the number of properties that flood for the first time) has no upper limit whereas there is no upside gain (Ofwat say they will log down where it is necessary to address less properties than allowed in price limits). Ofwat s approach is asymmetric and, therefore, is not in line with good regulatory practice. 4. Poor incentives Ofwat s approach, if applied mechanistically, does not incentivise companies to remove additional properties in-period and is not in customers interests. The financial impact for additional investment without return and for falling short of the target (logging down) appears to be the same. Our view is that financial penalties should only be applied when a company has failed to deliver to reasonable expectations. We do not believe this is the case regarding our performance with respect to sewer flooding in AMP4. We acted promptly, and in the interests of customers, after flooding in both 2005 and 2007, and will invest almost double the amount allowed in price limits. Taking an approach that does not recognise the additional investment and, also, takes monies away that were not allowed in the FD in the first place would be disproportionate and unreasonable. Given the points above, we have identified a way ahead for PR09 which we believe shares the risk of these uncontrollable and unpredictable rainfall events fairly between the company and customers. The principles of this approach would also be valid for application in PR14 for AMP5. We propose that: a cap and collar approach to defining sewer flooding output requirements be adopted for AMP4 and 5, as described below. Business plan Our plans 64

65 Our plans Our proposal is that the company would bear the cost of addressing 50% more newly flooded properties than allowed for in the FD for AMP4. This means for AMP4 we would bear the cost of addressing 108 properties not allowed for in price limits. The cost of delivery of outputs over and above 323 properties (215 in the FD plus half of this number) would be logged up based on PR04 FD unit costs. There would be no shortfalling applied. The cap and collar approach is shown diagrammatically below. Sewer flooding: the cap and collar approach to dealing with uncertainty Advantages of the cap and collar approach It takes into account the fact that no one can possibly predict the location, severity, frequency and impact of heavy rainfall events up to seven years in advance It is symmetrical, representing good regulatory practice It retains an incentive (penalty) to ensure companies continue to invest in increasing the capacity of the sewerage system to meet growth in demand It provides an incentive to address as many properties in-period as possible if flooding is higher than predicted It limits the companies financial exposure from unpredictable weather related problems outside of its control It is proposed that this cap and collar approach should be applied symmetrically for AMP5, so that no action is taken by Ofwat (logging up or down) at PR14 for variations of up to plus or minus 50% of the number of newly flooded properties allowed in price limits. Plans for AMP5 Flooding from sewers is an unpleasant and unacceptable experience. We want to do as much as we can to address this problem in AMP5. Business plan Our plans 65

66 Our plans In AMP5 it is proposed to: address the backlog of properties at the end of AMP4 together with newly flooding properties in the first four years of AMP5 (all investment subject to a cost benefit test) Addressing the backlog of properties from AMP4 As described above, the backlog of properties at the end of AMP4 that are cost beneficial to address is projected to be: 329 on the 1 in 10 and 2 in 10 DG5 registers plus 330 properties awaiting investigation that are predicted to transfer onto the 1 in 10 and 2 in 10 DG5 registers and are projected to be cost beneficial This makes a total of 659 cost beneficial properties to address. The projected cost of addressing these backlog properties will be 72.1m. The approach we have taken is consistent with that used by Ofwat s in its draft baseline assessment but uses updated numbers. We agree with Ofwat that this investment should be classified as Enhanced Service Level investment. We assess that 116 backlog properties which are non-cost beneficial will require mitigation at a cost of 475k and investment of 180k will also be required to complete investigations outstanding at the end of Addressing new additions in AMP5 To determine investment requirements it is also necessary to predict the number of properties that will flood for the first time in AMP5 (additions). We have assumed an average of 140 properties per annum for this figure in our final plan. This is a change from our draft plan estimate of 198 additions per annum and is consistent with Ofwat s assessment for the draft baseline. Our CBA indicates that 119 of the 140 properties per annum will be cost beneficial to address. We have, therefore allowed investment in our plan to address 476 additions in the four years to at a cost of 52.03m. There will not be time to investigate, design and construct solutions in AMP5 for the properties that arise in the final year. We plan to mitigate non cost beneficial properties emerging during the AMP5 period and have included investment to deliver 105 outputs at a cost of 430k. In addition, investigations regarding properties predicted to experience flooding for the first time during are forecast to cost a total of 895k. Overall AMP5 programme AMP5 sewer flooding programme (properties addressed and costs in prices) Total Backlog (properties) Backlog ( m) Additions (properties) na Additions ( m) na Total (properties addressed) Total investment ( m) Mitigation ( m) Investigations ( m) Grand total investment ( m) Business plan Our plans

67 Our plans On the basis of this programme it is predicted there will be 340 properties on the DG5 1 in 10 and 2 in 10 registers at the end of AMP5. A total of 221 of these are estimated to be non cost beneficial to address and 119 would relate to cost beneficial additions in the final year to be addressed in AMP6. The actual number on these registers would depend on the number of additions in each of the last two years and the regulatory output should take account of this fact. Given the difficulty of predicting the future, we believe the overall programme shown above represents a reasonable view of the overall level of activity that might be required to achieve the stated AMP5 end DG5 position above. The evolution of the programme is shown below. Evolution of the sewer flooding programme Properties addressed (no.) Investment ( prices) m PR04 FD for AMP Actual/forecast AMP Proposed AMP5 draft plan Proposed AMP5 final plan The table above shows the extensive nature of the proposed sewer flooding programme in AMP5. We believe our proposed approach takes performance as far as is possible in AMP5 towards our SDS long term aspiration of zero properties flooded from sewers. At the end of AMP5, only those properties that have flooded in the final year will be on the DG5 register (because there has not been sufficient time to address these), plus properties from previous years that are non-cost beneficial to address. Cost benefit assessment and customer support Our assessment of the cost benefit of sewer flooding investment has been completed since submission of the draft plan. Our proposed programme is now based on extensive customer research to determine customer preferences and cost beneficial levels of investment for different locations, frequencies and severities of flooding. However, application of this information has not resulted in a significant difference to the overall level of investment in sewer flooding in AMP5. In our post draft plan validation research, 92% of respondents supported our proposals in terms of benefits and impact on bills. As the final plan does not differ significantly from the draft plan (with investment and overall outputs being circa 14% lower) we believe this demonstrates strong customer support. Planning to address growth We undertook a thorough review of local plans to determine the likely scale and location of development in the North East for our draft plan. This information was discussed with Local Planning Authorities to obtain an understanding of probability and timing of the development. We also established population growth by drainage area using data from a specialised consultant. This information has been reviewed in the light of the economic downturn resulting in a lower investment requirement than included in our draft plan. This work has identified that investment is required to address an increase in population and some relocation of population to Growth Points and other development areas. Business plan Our plans 67

68 Our plans In AMP5 we will: augment the sewerage system to meet the needs from population growth and relocation The information we amassed allowed an assessment to be made of which sewerage assets would require upsizing in AMP5. All of this work was undertaken in accordance with the UKWIR report Long Term/Least Cost Planning for Wastewater Supply-Demand. The result is that we have included in our plans for upsizing 14 named sewage treatment works (compared to 29 in the draft plan) and zero named sewage pumping stations (compared to three in the draft plan) and some network assets. It is essential that this work is undertaken as the development goes ahead to avoid the potential for failed discharge consents, spills and flooding from undersized assets. OUR PLANS: MAINTAINING THE SEWERAGE SYSTEM MAIN THEMES Better asset management planning demonstrates more sewer replacement is required We will increase hydraulic and condition monitoring We need to increase our sewer cleaning programme to manage flooding from blockages Sewerage system maintenance Since AMP4, we have introduced more robust asset management processes and methodologies. These, including the use of optimisation modelling (using the WILCO tool) have identified that sewer rehabilitation rates need to increase to manage structural condition. In AMP5 we will: We have also identified a new regime of sewerage system monitoring requirements (hydraulic and condition) which requires more investment than previously. This will ensure appropriate data is available to inform decision making as we prepare to meet the challenges of maintaining and augmenting the network in the face of increasing rainfall, whether this is from changing weather cycles or climate change. This monitoring is an integral part of our sewerage planning strategy. It will also help us to identify action that needs to be taken to reduce pollution incidents. make a significant increase in sewer rehabilitation to maintain structural serviceability continue to improve sewerage system monitoring Business plan Our plans 68

69 Our plans Managing sewer flooding from other causes Flooding from other causes can be caused by sewer collapses, blockages and failure of assets. The incidence of other causes flooding also increases greatly when there is heavy rainfall such as that experienced in 2005 and The main cause of other causes flooding from our sewerage system is sewer blockages. We are addressing this by undertaking cleaning in hotspot areas prioritised on customer contact information and predictive processes. We have identified that a slightly larger cleaning programme is required in AMP5 to ensure other causes flooding is managed effectively. This has been designed using our least cost modelling WILCO tool. The opex cost over and above base year costs is 0.6m per annum. In AMP5 we will: introduce a more proactive sewer cleaning programme OUR PLANS: IMPROVING THE WATER ENVIRONMENT MAIN THEMES Improving sewage treatment reliability Current compliance with discharge consents is already very high but our aim is to achieve as near to 100% compliance as possible by 2015 Preventing pollution incidents Major improvements made but more needed By 2015 we will reduce the more serious category one and two pollution incidents to near zero and minor category three pollution incidents to under 50 Stopping sewage litter Highest risk overflows already screened and further screening is not cost beneficial Reducing pollution incidents means less spills and less sewage litter We will continue our campaign for thoughtful disposal of sanitary products National Environment Programme Smaller programme in AMP5 than AMP4 Smaller programme than in other areas of the country Reflects major improvements already delivered in the North East Improving sewage treatment reliability The EA sets standards for effluent discharged into rivers, estuaries and the sea from water companies and industry. These discharge consent standards are set individually for each of our sewage treatment works taking into account what is required to protect water quality and ecology. Our levels of compliance with discharge consents are already high with over 98% of samples passing in Although perfect compliance cannot ever be guaranteed, we aim to improve the reliability of our treatment still further. Business plan Our plans 69

70 Our plans In line with our SDS goal, we aim to: achieve as near to 100% compliance with discharge consents as possible by 2015 We will achieve this improvement by monitoring performance carefully, identifying risks and taking appropriate action before failures occur. We will deliver a sustainable level of maintenance on sewage treatment assets to address asset reliability issues, safeguard environmental compliance and manage the risk of failures. Our planning is in line with the common framework and builds on the robust action plan, methodologies and processes that were put in place to manage sewage treatment works serviceability in AMP4. We have identified that a significant increase in sewage treatment works capital maintenance is required. The main reason is the asset replacement required at our coastal and estuarial works. In AMP2 and AMP3 there was major investment to provide higher levels of treatment at six locations. These discharges typically had only preliminary treatment facilities and this was increased to advanced treatment including primary, secondary and UV disinfection stages. Three of the works are extremely large and deal with flows from the major North East urban areas: Tyneside, Wearside and Teesside. The short to medium life assets at these works are now due for replacement for the first time, hence an uplift from historical levels of capital maintenance is required. Trade effluent discharged into our sewers can also cause problems for our treatment works. We will continue to set appropriate consents for businesses to discharge into our sewers to ensure that compliance of our works is not compromised. We will work with traders to assess and manage the risks to ensure that our works remain compliant. In line with our SDS goal we will: Preventing pollution incidents Pollution incidents happen when a sewer, pumping station or treatment works discharges effluent into a watercourse that affects water quality or damages wildlife. We have been working hard to reduce pollution incidents from our sewerage system and have made significant improvements. reduce the more serious category one and two pollution incidents from an average of around 10 to near zero, and minor category three pollution incidents from around 135 to under 50, by 2015 Our plans to continue to implement more real time monitoring on the sewerage system will assist us to meet these objectives. Business plan Our plans 70

71 Our plans Stopping sewage litter Combined sewer overflows are designed to overflow when there is heavy rainfall. When a sewer overflows, unsightly sewage litter, such as sanitary products, may be found in rivers and streams. Currently one third of overflows, those most at risk of polluting, are screened to prevent this nuisance. Although stopping sewage litter is important to our customers, our strategic CBA indicated that further installation of screens was not cost beneficial. In AMP5 we will therefore aim to: reduce sewage litter by reducing spills from the sewerage system (see preventing pollution incidents above) and continuing to encourage appropriate disposal of sanitary products rather than flushing these away National Environment Programme sewage treatment discharges The draft NEP was produced following a long period of close liaison between the EA and NWL. We believe the resulting programme contained well justified schemes and sensible investigations. This was further reviewed for the final NEP and requirements reduced further. The proposals for AMP5 continues the trend of reducing environmental quality programmes in successive price review periods (the value of the AMP5 programme is 73% lower than AMP4). We understand that the programme in the North East is lower than in other areas and this reflects high levels of investment in the past that has already achieved excellent river and bathing water quality in the region. In AMP5 we propose to: undertake the NEP programme as specified by the EA The main aspects of the programme are as follows: bathing water schemes at Newbiggin North, Spittal (Berwick) and Blyth bathing water investigations at Tynemouth (Cullercoats), Saltburn and Seaham two Water Framework Directive schemes at Hustledown and Sedgeletch nine flow compliance schemes investigations into treatment for chemicals at six works one Fisheries Directive investigation on the River Don The bathing water quality enhancement aspect of the NEP is cost beneficial according to our strategic CBA. Also, in our post draft plan validation research, 92% of respondents supported the draft NEP programme to improve bathing waters, which has been included unchanged in the final plan. 71 Business plan Our plans

72 Our plans The EA are currently assessing the benefits of our two WFD schemes. The results are not yet available but we expect these schemes to be cost beneficial based on the predicted high levels of improvement to river water quality. We have not undertaken a CBA for flow compliance schemes as the EA intend to apply revised discharge consents to prevent river water deterioration, with which we must comply. In our post draft plan research, 90% of respondents supported the draft NEP river quality programme which has since reduced in size for the final plan. Our overall view is that our relatively small final NEP programme is well justified and has the support of our customers. First time sewerage schemes In consultation with Local Authorities we have identified two first time sewerage schemes (under Section 101A) for AMP5. OUR PLANS: ENCOURAGING BIODIVERSITY AND ACCESS MAIN THEMES Encouraging biodiversity Protecting wildlife is an integral part of our operations We will continue to encourage biodiversity on all of our sites Working in partnership, our initiative Branch Out will help build habitat resilience and adaptation to climate change bringing benefits to water, wildlife and communities Access to conservation sites We are committed to enabling access to countryside and wildlife in line with our duties Investment is needed to ensure we comply with: - the Wildlife and Countryside Act 1981 as amended by the Countryside and Rights of Way (CROW) Act 2000 and the Natural Environmental and Rural Communities (NERC) Act the Water Industry Act 1991, C3, 4 & 5 and subsequent codes of practice - health and safety legislation Encouraging biodiversity Biodiversity is about protecting wildlife and is an integral part of our operations. Our SDS aspiration is to increase biodiversity on our land holdings and to encourage others to follow our lead. In AMP5 we will work with partners such as NE, the RSPB, Wildlife Trusts and the EA to ensure our actions to encourage biodiversity fulfil our legal obligations, are aligned with their aims and are consistent with good practice. Our actions to encourage biodiversity will apply not only to those sites with environmental designations, such as Sites of Special Scientific Interest (SSSI), but also our other sites. We are promoting a new initiative called Branch Out. Branch Out involves working in partnership to reconnect habitats for the benefit of water quality, people and wildlife. This initiative will encompass a number of landscape scale projects that will help build resilience and adapt to climate change, whilst also bringing benefits to water, wildlife and communities. The company already has a strong partnership approach to the delivery of biodiversity and catchment related projects. Branch Out projects will also be delivered via partnership working, both building on existing partnerships and developing new ones. Our contribution to these projects may take the form of staff time to help develop the projects, Just an Hour events and / or money to help fund the projects. Initial projects will include working with the Wildlife Trusts on their Living Landscapes projects, and the RSPB. Business plan Our plans 72

73 Our plans Branch Out initiatives for AMP5 Catchment management projects We described earlier in Our plans under Providing safe and clean drinking water quality our proposals with respect to catchment management, which contribute towards Branch Out objectives. Improving the quality of water bodies for drinking water supply purposes also has a benefit for wildlife. These projects are as follows: Catchment Liaison Officer ( 40k opex per annum) Peatscapes ( 35k opex per annum) Living landscape and partnership projects ( 100k opex per annum company wide) For example, Peatscapes has a significant benefit to wildlife, as well as improving abstracted water quality. During AMP4 we have worked successfully in the North Pennines Area of Outstanding Natural Beauty (AONB) in partnership with the EA, NE and the Peatscapes project to improve the management of the peat landscape, including blocking off drainage channels in the peat. This has many benefits, which we are evaluating through a programme of hydrological and ecological monitoring. Water colour in the river Tees is currently deteriorating and is expensive to remove in water treatment. Blocking up the drainage ditches improves the hydrological storage capacity of the peat which creates wetter moorland and naturally regulates the flow of water from the peat moorland into the river. This helps hold colour and sediment in the peat, improving the colour of the river and making it less expensive to treat at our Broken Scar water treatment works. Moorland drainage ditch Wetter moorland improves the habitat for a variety of wildlife, reduces soil erosion, provides drinking areas for birds and livestock during the summer and helps the peat absorb carbon thus helping to combat climate change. The reduced run-off also helps to reduce the risk of flooding in lower-lying populated areas. We propose to continue with our contribution to the Peatscapes project, to help control colour in our catchments in the North Pennines and to continue our hydrological and ecological monitoring of AMP4 peatland restoration sites. Living landscapes projects Since we have worked with the Wildlife Trusts and supported some of their Living Landscapes projects. These projects focus on the restoration of riparian habitat and have the potential to benefit biodiversity, water quality, flood risk management and public access. Our support allows the Wildlife Trusts to drawdown additional grant funding, to enable these landscape scale projects to be delivered. We propose to continue with our contribution to the Living Landscapes and other similar projects, to benefit biodiversity and help control risks to the water environment, from which we abstract. 73 Business plan Our plans

74 Our plans In AMP5 we propose to: introduce catchment management initiatives under water quality and WFD drivers that will also encourage biodiversity continue with our contribution to the Peatscapes project and our monitoring of AMP4 peatland restoration sites continue with our contribution to the Living Landscapes and other similar partnership projects that meet our Branch Out criteria Our Branch Out proposals have the support of Natural England and the EA. Public access to conservation sites Water undertakers are required to manage their land to protect SSSIs, encourage biodiversity and enable access by the public. These duties are governed by legislation such as: the Wildlife and Countryside Act 1981 (WCA) (as amended by the Countryside and Rights of Way (CROW) Act 2000 and the Natural Environmental and Rural Communities (NERC) Act 2006 the Water Industry Act 1991, C3, 4 & 5 and subsequent codes of practice. We want to encourage the public to visit our sites by providing carefully planned and safe facilities at appropriate locations. Our proposals for AMP5 will allow NWL to: comply with its duties under the legislation described above Our investment plans, which have been included under the CROW Act driver, are necessary for the company to comply with its duties. The work includes improvement work on a number of sites visited by the public to ensure facilities: meet Health & Safety requirements where appropriate, meet requirements for disabled access fulfil visitor expectations We manage investment levels by focussing our efforts on facilities for access at our larger sites such as Kielder Reservoir where there is significant visitor interest. We also make as much use as possible of matched funding and this has been allowed in our investment proposals. Business plan Our plans 74

75 Our plans OUR PLANS: SUSTAINABLE OPERATION AND RESILIENCE MAIN THEMES We will develop and implement a carbon reduction plan across all aspects of our operations, including improving energy efficiency 20% of our energy will be produced from self-generated renewable resources by 2015 Our aspiration is to achieve a 50% reduction in operational carbon from 2007/8 levels by 2020 We will comply with the requirements of the Carbon Reduction Commitment Our plans to maintain water supplies take climate change into account We have reviewed the risk of our assets flooding and identified a small requirement for protection measures We plan to update our assessment of the overall resilience of our operations to ensure investment proposed in the future is well founded. Introduction We will seek to manage our operations in ways that conserve and enhance the environment, and we will factor sustainability into our planning and actions in all areas. Treating and distributing water inevitably uses resources such as chemicals and power. We will continue to identify ways to reduce our consumption of natural resources. We will minimise waste and recycle or reuse materials wherever we can. Our approach to sustainability extends to our suppliers where our procurement processes take sustainability indicators into account. Our customers expect service to be maintained in all but the most exceptional circumstances. This requires us to have assets that are properly maintained and resilient to a range of potential circumstances. We aim to maintain essential services, safeguard public health and protect the environment even when the unexpected happens. We will continue to review risks to ensure we have resilient assets and arrangements to cope with unexpected circumstances. This includes risks associated with changing weather patterns, climate change and flood risk. Reducing our carbon emissions The use of most forms of energy (such as electricity generated from non-renewable sources) creates carbon emissions to the atmosphere, which are a major cause of climate change. While energy is essential to provide both drinking water and wastewater services we are committed to reducing the energy we use and our carbon emissions. In AMP5 we will: develop and implement a carbon reduction plan seeking to reduce our carbon emissions as much as possible across all of our operations Where we have to use energy we aim to procure as much as possible from renewable sources, which do not add to carbon in the environment. We will look for ways to reduce energy consumption in all areas. We will adopt suitable low carbon technologies as these become available and will increase our use of renewable energy. 75 Business plan Our plans

76 Our plans By 2015: 20% of our energy will be produced from self-generated renewable resources We aspire to achieve a 50% reduction in operational carbon from levels by There are two key projects in AMP5 that will move us towards these targets. Projects to increase self generated renewable energy 1. Work management This involves the introduction of satellite and communications technology to link office based staff with field workers to plan work more effectively. As well as providing a more responsive service to customers, the scheme is expected to reduce our mileage per job by around 30%. 2. Sludge treatment This takes advantage of an advanced sludge digestion process, capturing the energy generated to help power the treatment plant. We are introducing this technology at Bran Sands Regional Sludge Treatment Centre in AMP4 and will install similar facilities at our major Howdon site in AMP5. The investment at Bran Sands and Howdon will generate a significant reduction in our carbon emissions. Meeting our target for renewable energy, and the opex efficiency target for the sewerage service, is dependent on Howdon advanced sludge digestion investment being recognised in PR09 price limits. Increasing self-generated renewable energy is one strand of our approach to achieve a 50% reduction to operational carbon. Other strands include reducing the use of energy and using cleaner energy from the national grid. It should be noted that the Carbon Reduction Commitment (CRC) is to be introduced by Government in The requirements have not yet been published and, therefore, the impact on the water industry is not yet known. The water industry is a large user of energy and the cost of meeting the CRC is unavoidable and may be significant. We have not included any cost increase in our final plan associated with the CRC. Future proofing our operations It is clear that changing weather patterns and climate change will have a significant impact on our operations and we need to act to deal with the consequences. Climate change will make rainfall more variable with more frequent storms, as well as more prolonged dry periods. Impact on water resources In the North East we have impounding reservoirs to capture the rain when it falls and store it for future use. This means that we have sufficient supplies for the longer term, even taking the impacts of climate change into account. Business plan Our plans 76

77 Our plans Dealing with potential flooding of critical assets More intense storms and sea level rises mean that some of our assets may be subject to the risk of flooding in the future. We have undertaken an extensive risk assessment for fluvial (river) flooding and sea level rises across all of our areas. A consultant, Royal Haskoning, was commissioned to undertake a coastal and estuarial study and we have also carried out an extensive fluvial flooding assessment using the EA's 1 in 100 and 1 in 1,000 year flood maps. Risks to all assets, water and sewerage, were assessed. In AMP5 we will: take action where necessary to protect our assets from flooding We have considered the information we have gathered in more detail since submission of our draft plan and concluded the risks are even smaller than we originally thought, in the medium term. Only one small scheme is required in the North East to address the identified risks. Sewerage service For sewerage assets at the draft stage we found 18 sewage works to be potentially at risk of fluvial flooding along with a number of pumping stations. Our review for the final plan has shown that none of these is a significant risk and we have removed the associated investment from our plan. We will continue with our ongoing programme of relocating or raising critical assets away from flooding risk as part of our routine refurbishment programme. Business plan Our plans 77

78 Our plans Control of surface water flooding We described the pressures on sewers and drainage systems from changing rainfall patterns, and how we are dealing with this challenge, in the section entitled Dealing with increasing flows in the sewerage system. Improving water supply resilience Drinking water supply facilities are potentially at risk from a number of external factors. External risks, which can change over time, can include electrical supply failure, fire or flooding and could result in one of our treatment works or pumping stations being out of action for a number of days or weeks. While it is important that risks are evaluated and appropriate management action taken, we think that a measured approach is required, avoiding a knee-jerk reaction to recent flooding events, making only those investments that represent value for money. We have included in other areas of our plan, measures to ensure security of supply is maintained as population increases and relocates to particular areas. A secondary impact of this work will be to improve resilience and system flexibility. However, our plan does not include any measures specifically to improve resilience other than the flooding protection measures outlined above. In AMP5 we will: refresh our assessment of risks to system resilience in the light of changing circumstances This study will enable a properly considered view to be taken of risks and potential management actions before factoring these into our longer term plans. This will include particular consideration of potential supply interruptions to populations of over 25,000. We have learned from recent events that it is possible to manage extended supply interruptions to populations up to this level. But for larger events the logistics of providing an alternative temporary supply can be extremely difficult. Where risks are found to be high we will investigate what can be done that is both practical and affordable to reduce the risk. However, it is not possible to eliminate every risk and, even with the best planning, it is not always feasible to guarantee uninterrupted mains water supplies in extreme circumstances. In this event, we have extensive emergency planning procedures which we update and test regularly. Business plan Our plans 78

79 Costs of achieving our plans COSTS OF ACHIEVING OUR PLANS In this section we set out the costs of achieving our plans, including costs outside our control. The scope for future efficiency, operating costs, capital investment, taxation and dealing with uncertainty and change are all covered. Note that operative costs and capital expenditure in this section reflect company-wide requirements (North East plus Essex & Suffolk) except where shown otherwise. MAIN THEMES Scope for future efficiency We have set challenging annual opex efficiencies for AMP5 of 1% for the water and 2% for the sewerage service Costs of operating the business (opex) Energy prices have been extremely volatile in recent years Opex for and will exceed the PR04 assumptions due to energy price increases and deflation in Efficiency assumptions take into account increases in input prices not captured in RPI We have identified a number of areas where increases in opex are required, the most significant being energy costs and pensions We have included pension costs on the basis of cash contributions rather than accounting charge (as agreed with Ofwat) and have included partial deficit recovery from 2012 Capital investment (capex) and capital charges Our capex unit costs are generally below industry average We have robust capital estimating processes Total AMP5 capex to deliver our plans is 1.27 billion, net of contributions compared with 1.06 billion in the AMP4 FD Increases in capital maintenance and growth areas are partly offset by reductions in other areas We have completed our asset revaluation and this results in an increase to Current Cost Depreciation relative to our draft plan Costs excluded The costs of the transfer of private sewers to company ownership and the implementation of changes to the competition regime have not been included Tax We have reflected our latest understanding of HMRC rules. This results in an increase in taxation relative to our draft plan Dealing with changes in AMP4 and AMP5 There are a number of items to log up and to log down at the end of AMP4 We have set out a number of proposed Notified Items including Traffic Management Act and transfer of private drains and sewers Business plan Costs of achieving our plans 79

80 Costs of achieving our plans SCOPE FOR FUTURE EFFICIENCY We will continue to seek more efficient ways of working and of optimising our operations and investment activities. We will encourage innovation and make appropriate use of new technology. This will help offset the increases in bills from other factors including those resulting from government policy such as increased business rates, changes to taxation and new requirements such as the Traffic Management Act. Opex frontier shift The scope for the most efficient water company to make greater efficiency savings than the economy in general is called the frontier shift. A report commissioned from First Economics by Water UK has concluded that a frontier shift at, or slightly above, RPI is supported by a number of different pieces of evidence. Reckon, in their recent report to Ofwat on the scope for efficiency in AMP5, also conclude a rate of growth of zero percent per year relative to RPI is appropriate for the period for the water industry. Overall Reckon does not believe that the large cost reductions made in the 1990 s from privatisation and the development of incentive based regulation will be repeated again. The First Economics and Reckon findings are also consistent with recent decisions by Ofgem, the CAA and Competition Commission. As for the draft plan, we have assumed a zero opex frontier shift. This means the company in must match the efficiency gains made by the economy as a whole, as reflected in the Retail Prices Index (RPI). Opex catch-up efficiency We recognise that there is scope for the company to become more efficient relative to other water companies. A comprehensive review of the potential for future opex efficiency has been undertaken with the involvement of all departments of the company. This has helped us to identify the scope for future efficiency. As for the draft plan, we have incorporated an efficiency saving of 1% each year for the water service and 2% each year for the sewerage service. We have included the same percentages for base and enhancement opex. The principle that they are the same is supported by the Reckon report referred to above. These targets represent efficiency savings of 8.8m by the last year of AMP5 for water and 9.3m for sewerage. These are challenging targets. Specific delivery mechanisms have not yet been identified for all of the savings. It should be noted that our sewerage service efficiency target assumes the Howdon sludge digestion spend to save scheme will be allowed for in price limits. Capex frontier shift The report from First Economics referred to above concluded that water industry capex unit costs will increase faster than RPI. The report indicated that it would not be unreasonable for companies to factor increases in unit costs of 1% to 2% above inflation into their business plans. Business plan Costs of achieving our plans 80

81 Costs of achieving our plans As for the draft plan, we have assumed a zero capex frontier shift. This means the company in must match the efficiency gains made by the economy as a whole. Capex catch-up efficiency Information from the first PR09 Cost Base submission, suggests that our unit costs are less than the industry average (median) for the majority of asset areas. The methodology for Ofwat s Capital Incentive Scheme (CIS) suggests that a reduction to capex for efficiency savings in these circumstances is not appropriate. In the final plan, therefore, we have included generally below median unit costs and assumed efficiency gains match the economy as a whole. Capex estimation Wherever possible, our capex estimates are based on the actual costs of doing similar work in the recent past. These costs are derived from the same source as our cost base information to be used by Ofwat to assess comparative efficiency. There is, therefore, consistency between cost base estimates and those for the AMP5 capital programme. In a number of cases we have been able to enhance the quality of our estimates since our draft plan was produced by progressing the optioneering and feasibility process for schemes to an advanced and detailed level. An example of this is the major Howdon sludge digestion scheme. OPERATING COSTS AMP4 position Total operating costs have fluctuated significantly from year to year in AMP4 almost entirely because of changes in energy prices. Water companies must use energy (power) to pump and treat both water and sewage. They are, therefore, relatively high users compared to many other industries. Despite recent falls, energy prices remain above the levels assumed when Ofwat set prices in This will cause our total opex to significantly exceed the PR04 FD opex in year and This masks the fact that in the first four years of this AMP period, we have broadly matched Ofwat s assumptions regarding opex efficiency in all areas except energy. In we are forecasting that RPI will be negative, heavily influenced by reducing domestic mortgage interest payments, whereas most of our input costs will still increase. This will cause our costs to exceed the FD opex by a further significant amount over and above the amount related to energy prices. The timing of companies energy purchases will determine when different companies will be affected by the impact of the market price increases and this could materially distort both base year opex and comparative efficiency assessments. The effects of this on the comparative efficiency assessment could be material considering energy forms a significant part of water companies opex costs and prices can fluctuate by over 50% from one year to the next. We believe Ofwat should consider how these timing effects can be eliminated from its efficiency assessment. Business plan Costs of achieving our plans 81

82 Costs of achieving our plans We will not qualify for an opex incentive allowance at PR09 due to the impact of energy price rises not allowed for in the PR04 FD. AMP5 base opex A number of increases to base opex in AMP5 have been identified, which will not be reflected in RPI. The table below summarises the increases. Increases to base opex ( m, price base) Energy Pensions Business rates EA abstraction charges Water efficiency Customer debt Other changes Total water Total sewerage Total Brief details of each item are provided below. Energy This is the most significant area of increasing costs since the base year. Energy price changes are outside companies control and are material to price setting, exceeding the impact of opex efficiency savings. In our energy costs (electricity and gas) were 24.7m but these have increased significantly in to 38.2m. In our draft plan we anticipated further price increases in However, market prices have since fallen and we now expect that will be the peak year for our energy costs. In order to manage our exposure to energy price volatility, we have adopted a flexible procurement strategy under which we purchase our future energy requirements in a series of tranches, up to two years in advance. To date we have purchased 33% of our requirements for We have, therefore, based our projected cost on a weighted average of the power purchased to date and the current market price for the outstanding volume. This has given a cost of 34.1m for (07-08 prices), an increase of 9.4m on the base but a reduction of 4.1m on the peak year. It is important that this reduction from is taken into account in the comparative efficiency assessments which are applied in price setting. Pensions At PR04 we received additional funding for our defined benefit pension scheme which recognised an increase in the future service cost in anticipation of the actuarial valuation as at 31 December Business plan Costs of achieving our plans 82

83 Costs of achieving our plans There have been a number of changes with an impact on pension costs over the past five years both in general, including changes in accounting standards, changes in mortality assumptions and the impact of the recent economic downturn, and specific changes that we have made to our scheme to ensure that it remains sustainable and affordable. The impact of these changes is summarised below. The triennial valuation of the scheme as at 31 December 2004 resulted in increased contribution rates above the level funded at PR04. In place of monthly contributions, the company agreed to make equivalent capital injections to the scheme to cover the five year period January 2006 to December Pension costs were funded at PR04 under accounting standard SSAP24, which effectively reflected the contributions made to schemes. The revised accounting standard FRS17, implemented in the financial year , required pensions to be accounted on a different basis meaning that the full cost is not reflected in operating costs. To mitigate against increasing costs, we reviewed the scheme and, after consultation with employees and trade unions, made changes by amending benefits and increasing employee contributions for existing members and closing the defined benefit scheme to new entrants from 31 December A triennial valuation of the scheme at 31 December 2007 took account of the changes made to the scheme. This resulted in reduced contribution rates compared with the 2004 valuation. This demonstrated that the changes made to the scheme to mitigate against future risks had more than offset the impact of revised mortality assumptions and changes in market conditions to that date. At the December 2007 valuation the scheme was in surplus (106% funded). However, the recent economic downturn has had a significant impact on the value of pension scheme investments and, at December 2008, the scheme had moved from a surplus to a deficit (75% funded), according to the Trustee s interim funding update. Throughout this period we have endeavoured to keep Ofwat fully informed of the changes that we have made to our scheme and the issues arising over the period. Our letters of 12 July 2006 and 25 July 2008 to Keith Mason at Ofwat deal with the above points in more detail. More recently our letters of 18 December 2008 and 11 March 2009 (also to Keith) deal with future deficit recovery. In light of the issues highlighted above, the changes made to the scheme and our discussions with Ofwat, we have included adjustments to pension costs within our plan reflecting the impact of the FRS17 accounting standard and contributions for deficit recovery. We were pleased to receive clarification in letter PR09/24 that, notwithstanding the FRS17 accounting change, Ofwat will base its allowance for future pensions on its assessment of required cash contributions, which is consistent with the treatment at previous reviews. Accordingly, we have included a 4.5m adjustment to reflect the difference between the accounting charge within base operating costs and the cash contributions required to fund the scheme, based on the contribution rates from the December 2007 valuation. This is effective from January 2011 as we have paid advance contributions to the scheme up until this date. It is also consistent with the uplift in funding allowed by Ofwat at PR Business plan Costs of achieving our plans

84 Costs of achieving our plans The recent economic downturn has had a significant impact on the financial markets and consequently on the value of pension scheme investments. This has resulted in our pension scheme moving from a surplus at December 2007 to a deficit at December However, we continue to take a long term view of the scheme and believe it would be inappropriate to instigate a formal valuation and consequential review of contribution rates so soon after markets have fallen so sharply. The next triennial valuation of the scheme will be as at 31 December 2010 and is likely to require contribution rates to increase with effect from January 2012 to deal with deficit recovery. A formal valuation now would require the Trustee to put in place a deficit recovery plan, with deficit payments starting immediately. Analysis carried out by the scheme actuary as part of the routine reporting to the Trustee, and reported to the Trustee Board in March, confirms a deficit funding requirement of 16m per annum based on a recovery period of 13 years, ie. remaining average working life. Whilst this is the basis used as the recovery period in the past, the Trustee could consider a longer period, perhaps up to 20 years, having regard to the strength of the employer covenant and the ability to pay deficit contributions. A recovery period of greater than 10 years will trigger greater scrutiny from the Pensions Regulator. If we anticipate a recovery in the markets, and with the expectation that a longer recovery period would be acceptable to the Trustee Board when considering the 2010 valuation, we have included an increase in the employer contribution of 6.0m per annum with effect from January Our recent correspondence with Ofwat confirms this approach. In addition to the above, the Pensions Act 2008 introduced measures that will come into effect from 2012 aimed at encouraging greater private pension saving. These measures will place a duty on employers to automatically enrol all eligible workers in a good quality workplace scheme and provide a minimum contribution. This will result in employees not currently in a pension scheme enrolling into the company s defined contribution scheme thus increasing pensions costs by 0.4m per annum from Business rates All commercial property rates are revalued every five years and the next revaluation is due to take effect on 1 April At the time of producing the draft plan, we had not received details from the Valuation Office Agency (VOA) and so included no changes to rates liability post March We subsequently received a draft assessment for our water cumulo rates from the VOA which increased the rateable value of our water assets by 87%, a potential cost increase of over 15m. In addition, for our individually rated properties, principally sewage treatment works, early indications based on construction cost indices are that assessments could rise by 25% to 30%, at a potential cost of over 2m. We believed that the draft cumulo valuation was fundamentally flawed and challenged robustly the draft assessment directly with the VOA, as well as lobbying through Water UK. In March 2009 we were informed verbally by the VOA that the final valuation would be reduced, though it would still represent an increase of 30%. For the purposes of our final plan we have applied the reduced cumulo valuation, although at the time of finalising the plan we had not received confirmation of this value in writing. We have also assumed that other works will increase by 25%, the rate poundage will reduce and transitional relief arrangements will apply. This limits the cost increase to 2.3m per annum. As discussed at our pre-final business plan meeting with Ofwat on 14 January 2009, we expect the actual outcome of the valuation to be used in the price determination. 84 Business plan Costs of achieving our plans

85 Costs of achieving our plans Abstraction charges The Environment Agency issued an indicative five year forecast of abstraction licence charge increases to the industry in November This showed 0% increases in the Northumbrian region for the period to and 10% increases in the Anglian and Thames regions in which our Essex and Suffolk operations are based. We have assumed that the same increases will apply in and have included the net impact in our final plan. Customer debt We believe that the new Tribunals, Courts and Enforcement Act will cause the company to incur additional costs. The Act was introduced in July 2007 and will be enacted through Statutory Instruments starting in It introduces a number of mechanisms which will cause delays in being able to pursue customer debt. We have included a central estimate of 2.2m for the effects of the Act in our final plan. Water efficiency Water undertakers have a long-standing statutory duty to promote water efficiency. Historically this statutory duty has been adopted very differently by companies, mainly dependent on their supply demand balance and the water stressed nature of their operating area. For example, we have been much more proactive on water efficiency in our Essex and Suffolk area, which is water stressed, than in our Northumbrian region, which has the benefit of plentiful water resources. Ofwat has recently introduced new targets for water efficiency. We have, therefore, included in our final plan the cost of the increased activity which will be required to achieve the water efficiency targets. Sewer flooding prevention We have identified that a more proactive approach is required to clean sewers and remove the cause of blockages which can cause flooding. We have included in our plan provision for a step change in the level of sewer cleaning (see Our plans: maintaining the sewerage system ). National insurance The government Pre-Budget Statement in November 2008 announced that from April 2011 employer s national insurance contributions would rise by 0.5%. We have included this increased cost in our final plan. Impact of deflation on manpower costs We have forecast that RPI will be negative in , based on projections received from a number of financial institutions. This is principally driven by reducing domestic mortgage interest payments which clearly have no impact on our price base. Ofwat s price setting approach assumes that all costs will reduce in line with the negative RPI. However, employment legislation prevents companies from unilaterally reducing employee pay making it impossible to match Ofwat s assumption in this respect. We have, therefore, increased manpower costs by RPI but applied a floor of 0% to reflect employment legislation. This is a material issue as manpower costs form a significant part of our price base. Business plan Costs of achieving our plans 85

86 Costs of achieving our plans Traffic Management Act The Traffic Management Act was enacted with an aim of reducing congestion and disruption on the road network. The Act provides local authorities with the power to implement permit schemes under which utility companies and others will require a permit to undertake certain activities in the highway. We have included a central estimate of permit costs in our final plan. Discharge consent charges The Environment Agency has implemented changes to the charging regime for discharge consents. We expect the unified charging scheme to increase our discharge consent costs by 20% from April 2010 whilst the introduction of operator self-monitoring is expected to reduce consent charges by around 11%. We have, therefore, included the net impact of these changes in our final plan. New opex in AMP5 There are also a number of new opex cost changes arising from quality and service enhancement projects, increases in the customer base, reductions in demand and maintenance requirements. The table below summarises these increases. New opex ( m, 2007/08 price base) Water Abberton scheme Additional meters Property/network increase Demand Reductions Service enhancement Sewerage Additional meters Property/network increase Demand Reductions Environmental quality Total water Total sewerage Total Brief details of each item are provided below. Abberton scheme This major resource scheme will be completed in 2013 and will start incurring additional opex at that point (see also Our plans: Meeting future water needs). Additional meters (water and sewerage) Our metering policies are progressively resulting in significantly increased numbers of meters to read. 86 Business plan Costs of achieving our plans

87 Costs of achieving our plans Property/network increases Increases in property numbers in AMP5 will result in increased costs of supplying water (eg. operating a larger network, more pumping stations, increased customer billing and contact). Service enhancement (water) This cost relates to the enhanced service project to address taste and odour complaints (see also Our plans: Providing safe and clean drinking water ). Environmental quality programme The NEP programme (see also Our plans: Improving the water environment) requires improvements to be made to sewage treatment works which will result in increased opex (eg. the addition of new treatment processes). Catchment management initiatives This cost relates to a number of initiatives with the overall objective of protecting drinking water sources. The initiatives will also help achieve good ecological status and encourage biodiversity (see also Our plans: Providing safe and clean drinking water and Our plans: Encouraging biodiversity and access ). Demand reductions We have forecast reductions in demand in AMP5 for both the water and sewerage services, mainly due to the economic recession. This includes reductions in non- household demand and impacts of the recession on house building. We also have advance warning of the termination of one of our special agreements at Bran Sands due to the closure of an industrial customer in June We have included the reduction in variable costs attributable to reduced service provision in our final plan. CAPITAL INVESTMENT Costs of maintaining service capital maintenance Investing appropriate levels of capital maintenance is integral to meeting the objectives we have identified, including safeguarding compliance with drinking water and environmental quality standards and maintaining stable serviceability. We have used robust asset management processes to identify the optimum mix of activities required to meet the objectives. We are confident that our proposals represent the minimum level of investment required in AMP5. The following table shows the levels of capital maintenance required for infrastructure and non-infrastructure assets for the water and sewerage services. Figures for AMP4 FD, AMP4 forecast and AMP5 (draft and final plans) are provided for comparison. Business plan Costs of achieving our plans 87

88 Costs of achieving our plans Capital maintenance investment AMP4 and AMP5 Essex & Suffolk and North East ( m, price base, net of contributions) AMP4 FD AMP4 Forecast AMP5 Draft plan AMP5 Final plan Water infrastructure Water non-infrastructure Sewerage infrastructure Sewerage non-infrastructure Total water Total sewerage Further information on our plans and the differences between AMP4 and AMP5 investment levels can be found in the Our plans section. We describe below the main changes between draft and final plan investment levels. Water infrastructure maintenance Whilst there have been some changes in individual areas (eg. inclusion of the impact of the Traffic Management Act and review of data in asset models), there is no overall difference in investment between draft and final plans in this area. Water non-infrastructure maintenance In this area, investment has reduced by 5% between draft and final plans. The main reasons are as follows: we have reviewed asset deterioration models using latest data cost estimates have been finalised for water resource schemes we have undertaken more work on optioneering of schemes we have removed AMR devices on external meters as this is not economic we have transferred investment to meet our obligations under the CROW Act to the Quality enhancement investment area Sewerage infrastructure maintenance There is a 12% reduction in investment between draft and final plans in this area. This is mainly the result of transferring sewer flooding investment to service enhancement and supply/demand investment categories and re-running our WILCO models with latest data. These reductions have been partially offset by an increase in the cost of re-sewering of the network at Kilton Beck, near Skinningrove. Sewerage non-infrastructure maintenance In this area, investment has reduced by 4% between draft and final plans. The reasons are as follows: we have reviewed asset deterioration models using latest data the cost estimate for Howdon advanced digestion scheme has been revised we have undertaken more work on optioneering of schemes Business plan Costs of achieving our plans 88

89 Costs of achieving our plans Costs of customer financed improvements to service We have included a number of customer financed improvements to service in our final plan. For Essex & Suffolk we propose to improve the taste and odour of drinking water and undertake work to protect assets from flooding. The North East will also benefit from improvements in these areas together with reductions to flooding from sewers and complaints about odour from sewage treatment works. Details are as follows. Enhanced service level investment ( m, price base) Capex Draft plan Capex Final plan Water service: Essex & Suffolk Water service: North East Sewerage service: North East We have transferred investment on removing the backlog of sewer flooding and on addressing odour from sewage treatment works from infrastructure maintenance and supply/demand into the enhanced service category in line with Ofwat s view, accounting for most of the increase in sewerage service investment. We have also continued to develop our investment requirements to protect our assets from flooding resulting in a reduction in this area. Further details of the proposed schemes can be found under Our plans. Costs of quality enhancements We have identified a programme of quality enhancements for both the water and sewerage services. They are in line with final assessment letters of support received from the DWI and the draft NEP provided by the EA. Details are as follows. Quality investment ( m, price base) Capex Draft plan Capex Final plan Water service: Essex & Suffolk Water service: North East Sewerage service: North East The Quality investment programme for both the water and sewerage services is significantly lower in AMP5 than AMP4. Water service investment has increased between draft and final plans due to the following: revised solution to meet the new standard for lead in drinking water in line with DWI requirements (Essex & Suffolk and North East) increase in the cost to deliver the statutory drinking water acceptability programme (discoloured water alleviation) due to better information regarding the required solution (North East only) transfer of investment from water infrastructure maintenance regarding our duties under legislation such as the Countryside and Rights of Way (CROW) Act Business plan Costs of achieving our plans 89

90 Costs of achieving our plans Sewerage service quality enhancement investment has decreased between draft and final plans due to schemes removed from the NEP programme. Further details of the Quality programmes can be found in the Our Plans section of this document. Costs of meeting water and sewerage new development and growth The table below shows the costs of new development and schemes to enable growth to be managed (supply/demand investment). Supply/demand investment AMP4 and AMP5 ( m, price base, net of contributions) AMP4 FD AMP5 Draft plan AMP5 Final plan Water service: Essex & Suffolk Water service: North East Sewerage service: North East The main reason for the increase in water growth investment in Essex & Suffolk between AMP4 and AMP5 relates to the Abberton water resource scheme and leakage control related mains renewal, both required to manage the supply/demand balance in Essex. Changes in water service investment since the draft plan include: our decision not to introduce selective metering on change of occupier in Suffolk in AMP5 (as this is not economic) our decision not to fit AMR devices to external meters as this uneconomic a review of investment requirements in the light of better information (eg. Abberton) and the economic downturn The main driver of the change in sewerage supply/demand investment between AMP4 and AMP5 is the larger programme to address properties flooded from sewers, more of which is now allocated to supply/demand. Sewerage service investment has also decreased since the draft plan due to a review of investment requirements in the light of the economic downturn. Overall investment programme summary The table below shows the overall investment summary for AMP5 compared to that for AMP4 (FD and forecast). The total of 1.27 billion for AMP5 compares to 1.06 billion included in the PR04 FD. Whilst the Quality enhancement programme has reduced in size relative to AMP4, this has been offset by increases in capital maintenance and in supply/demand investment. Business plan Costs of achieving our plans 90

91 Costs of achieving our plans Overall we believe it is a well founded programme which will maintain services for customers, provide some important improvements to drinking water and environmental quality, address flooding from sewers and ensure we can meet future demand for water and wastewater services. Capital investment in AMP5 ( m, price base, net of contributions) AMP4 FD AMP5 Final plan Water service Capital maintenance Levels of service enhancement Quality enhancement Supply/demand Total Water service Sewerage service Capital maintenance Levels of service enhancement Quality enhancement Supply/demand Total Sewerage service Grand total Capital charges Infrastructure renewals charge The infrastructure renewals charge (IRC) determines how much infrastructure capital maintenance investment will be directly paid for each year through customers bills. Actual and forecast infrastructure renewals expenditure (IRE) is averaged out over a 15 year period (5 years into the past and 10 years into the future) to determine the IRC for each year. This has the effect of smoothing out the impact on bills of lumpy investment or step changes in investment. The table below shows the IRE and IRC assumed in the PR04 FD and actual/forecast. IRE and IRC (water and sewerage services) AMP4 and AMP5 ( m, price base) AMP4 AMP IRE PR04 FD IRE Actual/forecast IRC PR04 FD IRC Actual/forecast Business plan Costs of achieving our plans 91

92 Costs of achieving our plans Current cost depreciation For above ground assets (eg. treatment works and pumping stations), current cost depreciation (CCD) is the means by which this investment is reflected in price limits. Customers effectively pay for capital expenditure over the lifetime of the assets it finances. To determine CCD, it is necessary to understand the value of the assets (the Modern Equivalent Asset Value or MEAV) and the asset lives. Since the draft plan we have completed a full revaluation of our assets and this has resulted in increased CCD. The CCD we have used for our final plan is 139m ( 129m) in , rising to 147m ( 143m) in (in prices and draft plan numbers shown in brackets). This is a lower bound estimate based on our revalution in order to avoid customers paying more than is absolutely necessary in the next five years. Changes in taxation Several important changes to the UK capital allowances regime, as well as a reduction in the rate of corporation tax, have been introduced by the last two Finance Acts. The changes take effect from 1 April 2008 and calculations of the company's tax liabilities for PR09 in the final plan, therefore, reflect the following changes: Corporation tax rate reduced from 30% to 28% Plant and Machinery Allowances reduced from 25% to 20% per annum Long Life Asset Allowances (LLAAs) increased from 6% to 10% per annum Industrial Buildings Allowances (IBAs) gradually phased out between 1 April 2008 and 31 March 2011 As far as the water industry is concerned the phasing out of IBAs is the most significant of the changes, given the historical levels of such expenditure. For the draft plan we made an assumption that HRMC would reach an agreement with the water industry to reduce the impact of removing IBAs by allowing LLAAs to be claimed in place of IBAs. HMRC has since confirmed that this will not be allowed. We have, therefore, reflected the full cost of losing IBAs in our final plan on the basis that: there will be no tax deductions after March 2011 for the unrelieved element of historical expenditure allocated to IBA capital expenditure will continue to be allocated under the principles of the industry/hmrc agreement such that there will be no relief for IBA items after March DEALING WITH RISKS AND UNCERTAINTIES In general, companies should include their best central estimate of future costs in the business plan. However, in some cases there is considerable uncertainty as to whether, and to what extent, costs will be incurred. It is, therefore, important to have a mechanism for dealing with significant changes as and when they arise. In these circumstances, Notified Items give advance notice that certain areas will qualify either for logging up/down or an interim determination of K, provided triviality and materiality tests are met. They protect customers and reduce business risk. 92 Business plan Costs of achieving our plans

93 Costs of achieving our plans Notified items (relating to the North East) Adoption of private drains and sewers Since production of our draft plan, Ministers have signalled that water companies will assume ownership of certain private drains and sewers in We do not support this proposal and it will result in a significant price increase for all customers (up to 4% on the sewerage bill). The extent and form of the transfer is currently unclear and Ofwat has indicated that companies should not include any costs incurred as a consequence of the transfer in final plans. Given that the transfer of drains and sewers will result in significant operating cost and investment requirements, it is important that Ofwat provides a clear commitment in the PR09 FD that appropriate costs in AMP5 will be reflected in an interim determination and/or for logging up. This should include an indication of the process and criteria that will be used to assess and confirm expenditure as properly incurred. Traffic Management Act The Traffic Management Act (TMA) came into force in This allows Local Authorities (LA s) to require payment for permitting companies to work in the highway, from April At the time of producing our draft plan, many LA s had not yet started to implement the TMA and so we excluded the costs. However, LA s are starting to implement the Act now. We have included an estimate in our final plan for costs of permits using the information available at this time but, given the uncertainty, we believe a symmetrical Notified Item is required to deal with significant variations from the estimated cost. Customer debt We believe that the Notified Item should be retained for customer debt relating to the continued inability to disconnect and extended to cover the impact of the new Tribunals, Courts and Enforcement Act. Levels of debt generally (not just relating to water bills) are rising in the economic recession and customers who have not had difficulty paying bills in the past are being affected for the first time. Customers prioritise which bills to pay and place water bills lower in priority to those where services can be withdrawn. Debt is expected to continue to rise as a direct result of the loss of power to disconnect. Business plan Costs of achieving our plans 93

94 Costs of achieving our plans Whilst the timing and impact of the introduction of the Tribunals, Courts and Enforcement Act is unclear at this stage it will clearly impact upon the Industry during the next five years. There are three areas where we expect to see changes in the way that we have to deal with customers with water and sewerage debt. Three impacts of the new Tribunals, Courts and Enforcement Act 1. An increase in value of debt necessary before we can apply for a Charging Order 2. Introduction of the Debt Relief Order protecting the debtor from further enforcement activity from creditors (including the company) for a period of one year 3. Administration Order to be available in the future without the need for a County Court Judgment These measures will undoubtedly lead to a longer debt recovery process with a resultant increase in costs. Whilst we have included a central estimate for the increased costs in our final plan, we believe any significant variations should be dealt with through the customer debt Notified Item. Tax changes We believe that Ofwat should retain the Notified Item for the taxation implications from any changes in accounting for IRE following the possible introduction of International Financial Reporting Standards (or the convergence of UK Generally Accepted Accounting Practice with IFRS). We also believe a Notified Item should be included to provide for the impact of a radical overhaul of the corporation tax system that may arise if there were to be a change of Government at the next general election. In particular, it is known that considerable thought has been given to the possible replacement of capital allowances with a depreciation-based system of tax relief. Although such a change would affect all businesses in the UK the water industry could be especially disadvantaged. Costs of competition We have not included any specific cost or revenue changes in our final plan relating to competition. This is because the detailed requirements have yet to be determined and are subject to the ongoing review and consultation process. We believe a Notified Item is required to cover the additional costs associated with competition. Business plan Costs of achieving our plans 94

95 Costs of achieving our plans Energy price forecasts Energy costs form a significant proportion of our operating costs (17% in ) and are, therefore, an important factor in assessing prices for Energy prices have been extremely volatile in recent years and are very difficult to predict. Since we produced the draft plan, energy prices have dropped significantly but remain well above the assumption made at the last periodic review for We have reviewed our assessment of energy costs for the final plan, taking into account latest information. Energy price changes are beyond companies control and it is, therefore, important that a realistic provision for energy costs is made when Ofwat sets prices. Given the significant uncertainty about energy prices and the potential financial implications, we remain open to consideration of potential in-period adjustment mechanisms. Such a Notified Item would allow material differences between assumed and actual energy prices (up or down) to be reflected in an interim price review, reducing the financial risk on companies and also ensuring customers do not pay too much. DEALING WITH CHANGES AMP4: logging up, logging down and shortfalling The outputs expected of the company in AMP4 were set out in the PR04 FD. However, there are many reasons why things can change in any five year period and as we reach the end of AMP4, it is necessary to take account of these changes. If changes have been required by new or changed obligations on the company and this has resulted in an increase in capital investment, then this investment is remunerated at the next price review ( logged up ). On the other hand if obligations change resulting in a decrease in investment, the reduction is adjusted for at the next price review ( logged down ). We summarise significant logging up and logging down items overleaf. Business plan Costs of achieving our plans 95

96 Costs of achieving our plans Logging up and logging down items Logging down Abberton pipelines: partly postponed to AMP5 in line with evolving programme (see also Abberton utility diversions under logging up ) Section 19 distribution Undertaking: reduction in the scope of the work Acceptability of drinking water programme (discoloured water): rephasing of part of project into AMP5 and reduction in scope Sludge ship: no longer required because of revised sludge strategy (see also revised sludge strategy under logging up ) Hustledown Freshwater Fisheries Directive quality scheme: AMP4 scheme no longer required Intermittent discharges confirmed by EA as not required Aklam Road environmental improvement scheme: postponed to AMP5 because of complex nature of problem and solution development Logging up Abberton utility diversions: brought forward to AMP4 (Abberton pipeline logging down offsets this see above) Greater number of properties removed from the DG5 sewer flooding register in accordance with our proposed cap and collar approach Revised sludge strategy including Bran Sands sludge digestion (sludge ship logging down offsets this see above) Commercial contracts at Bran Sands (balancing income included in final plan) Optional and selective meters: greater numbers Properties connected: greater numbers (new development capex) Langford nitrates scheme: correction of mistake Business plan Costs of achieving our plans 96

97 Financing our plans FINANCING OUR PLANS MAIN THEMES Our view remains, as for our draft plan, that a real cost of capital of 4.7% (post tax) is appropriate This generates financial ratios that, as a package, are at the limit of what would be acceptable to sustain a solid investment grade rating We have not included a financeability uplift We have assumed deflation of -1.5% in We have assumed inflation of 2.2% in and 2.5% in the following four years We have assumed that Ofwat uses a notional gearing level for PR09 of 60% from April 2010, which will be very close to our actual gearing We have modelled dividends paid by Northumbrian Water Limited (the regulated company) in line with the cost of equity in the cost of capital calculation. This mirrors Ofwat s approach at PR04 We have assumed that 23% of debt in April 2010 is index linked (reflecting NWL s current position) Introduction In the section on Key challenges we described why it is important for all stakeholders that water companies have a stable financial position and are able to finance their functions. To obtain finance for the high levels of investment required to maintain and improve services, the company must remain attractive to financial institutions willing to lend to the sector. Investors require a fair return on their investment in line with the associated risks and need to have confidence that the company will meet its repayment obligations. We have developed our financing plan to meet these requirements. In this section we set out how we will finance our plans. We describe our view of the weighted average cost of capital (WACC) and our financing and dividend policies. Determining the Weighted Average Cost of Capital (WACC) Key issue for customer bills When an investor buys shares in a company (an equity investment) or lends money to a company (a debt investment), this is done to earn a fair return, just as an individual expects interest when placing money in a savings account. The WACC for a company is the average of its cost of debt and cost of equity capital, weighted according to its balance of debt and equity. If the WACC is too low, it will not be sufficient to allow the company to service existing debt and raise money at reasonable rates to finance future investment programmes. If it is too high, customers will pay more than is necessary. The WACC is material to prices as financing costs account for around 35% of water company bills. It is, therefore, important to use an appropriate value for the WACC when setting prices. Business plan Financing our plans 97

98 Financing our plans We believe the WACC should be determined by reviewing a range of evidence, with the primary source being a CAPM analysis. CAPM is the Capital Asset Pricing Model, an established method used to assess the cost of capital. The credit crunch and the deteriorating economic outlook have generated volatile and uncertain conditions in financial markets and have increased the costs of borrowing money. It is, therefore, particularly difficult to assess a reliable forward estimate for the WACC with any degree of confidence at this time. Components of WACC Our view of the value of the components that make up the WACC is provided in the table below. We show for comparison the assumptions made by Ofwat in the PR04 Final Determination and the values identified by NERA in its report for Water UK in January Value of CAPM components NWL FBP and Ofwat PR04 CAPM component Ofwat PR04 FD (%) NERA 2009 (%) NWL final plan 2009 (%) Risk Free Rate Debt Premium 1.50 Real Cost of Debt (pre tax) Equity Risk Premium 4.85 Cost of Equity (post tax) Gearing Post tax WACC Mixed (Vanilla) WACC It should be noted there is a potential range for each of these components and, therefore, some judgement has to be made. In determining our view of the components, we have sought to identify a balanced position that takes into account the benefits of the low-cost index linked funding available three years ago but also of the pressure on the capital markets from recent events. This results in a WACC that is almost 10% lower than that assumed for PR04. We have taken some account of the NERA report (Cost of Capital for PR09: January 2009) for Water UK, the water industry association, in our analysis of the WACC. NERA s proposed range for the WACC increased between draft and final plans, taking into account latest market evidence. Despite the deterioration in economic conditions and tightening of financial markets that has taken place we have not changed our cost of capital from that proposed in our draft plan. This is because we have placed greater weight on longer term trends. Business plan Financing our plans 98

99 Financing our plans There is a risk that market conditions do not improve or may even deteriorate further. In this case we would look to the safeguards inherent in the regulatory framework, including interim determinations, the substantial effect clause and the regulator s duty to ensure that companies can finance their functions to provide appropriate remedies as the circumstances dictate. The cost of capital used in our final plan, at 4.7%, is within the range of 4.6% - 5.1% proposed by NERA. We have taken account of the extensive analysis by NERA of the risk free rate and associated cost of debt and have assumed a cost of equity in the middle of the range quoted by the NERA report. Whilst we do not intend to repeat the full NERA analysis here, we make the following observations on the findings of the report. Key points from the NERA report We agree with NERA that UK government index linked gilts do not provide an accurate measure of the real risk free rate for the cost of capital due to distortions in the financial markets. We support the use of swap rates as a more robust basis for estimating the risk free rate. We agree with NERA s use of a composite of time series data and current rates to calculate the cost of debt. We believe this provides a realistic view of the debt funding mix that companies face and aligns with Ofwat s own PR09 approach of considering a range of data on the cost of debt over the interest rate cycle. We agree that use of the Dividend Growth Model (DGM) is a useful cross check for estimating the cost of equity. It supports a cost of equity towards the upper end of the CAPM range indicated by NERA, hence our assumption of 7.75%. We have assumed gearing of 60% for the generic CAPM calculation. This happens to be close to our own level of gearing but is also consistent with Ofwat s PR09 Methodology and Approach stating that a conservative approach will be taken and that market developments lead us to expect that there will be very few companies materially below our gearing assumption. Cost of debt In our modelling, we have considered separately the cost of existing debt from the cost of new debt. Our existing debt (at March 2009) has a weighted average cost of around 5.8% in nominal terms. Our view of future debt costs of 7.4% nominal reflects a combination of new bonds and EIB debt. This increase is directly attributable to the impact of the credit crunch and subsequent recession that has ended the benign debt market for an indefinite period. The weighted average of these rates, given the NWL financing mix of 80% historical debt, 20% new debt is around 6.2% nominal which translates to the 3.7% real cost of debt used in our modelling. This 3.7% cost of debt is slightly below the NERA range for two reasons: 1. NERA assume a higher proportion of debt from new rather than historical sources (30% rather than NWL s 20%). 2. We have reflected the fact that we are currently pre-financed to late 2011, by which time we anticipate debt markets may be more favourable. 99 Business plan Financing our plans

100 Financing our plans In our financial projections we have calculated interest payable as the sum of our forecast actual interest costs for all debt existing at 31 March 2009, and the cost of new debt described above. In our view, unlike PR04, Ofwat will have to take separate views on the costs of existing and future debt and model accordingly. Using the current blended cost of debt for future financing costs would underestimate the cost of new debt. We have assumed 23% of our debt in April 2010 is index linked. This is based on our current (JR08) level of index linked debt. We do not anticipate raising further index linked debt (ILD) in the foreseeable future. Current market conditions mean the cheaper (monoline insured) ILD products of three years ago are no longer available and, in general, ILD is only available at rates that are not attractive by comparison with conventional debt. We do not foresee the market for lower cost ILD re-opening for the period covered by this plan. The WACC in context Whilst we provide details of each component of the WACC to support our assessment, it is important to recognise that the resulting overall figure must be sufficient to generate a sustainable financial position. Adjusting the value of individual components of the WACC without checking the overall position could result in a WACC that is unsustainable. Our view, based on current information, is that a real post tax WACC of 4.70% will produce sustainable financing ratios. The WACC we have identified relates to the plan and assumptions we have set out in this document. If any assumptions Ofwat make are different, and this changes the risk profile, then an appropriate adjustment to the WACC will be required. For example, if the company faces higher financial risks investors will require a higher return on investment to reflect those risks. Financing our operations The company finances its operations through a mixture of retained profits and borrowings. The continued high level of investment means that cash outflows exceed annual revenues and, therefore, income from bills alone is insufficient to finance the business. In our modelling we have assumed that external financing requirements for the period of the plan are met by issuing further debt. The cost of debt remains lower than the cost of equity and we assume that sufficient debt finance will be available at reasonable rates to meet our financing requirements. Continued reliance on debt financing will, therefore, minimise the impact of financing costs on customers bills. It is our intention to maintain, in broad terms, our existing financing strategy. This entails raising medium to long term debt that provides a balance sheet match with long term assets and fixing a major proportion of interest rates. Northumbrian Water Group has a policy to keep a minimum of 60% of its borrowings at fixed rates of interest. Index linked borrowings are treated as variable rate debt. We have assumed that all debt is issued on a conventional basis with an appropriate mix of fixed and variable rate debt. We will continue to seek a spread of maturities such that re-financing requirements in any five year period are not excessive. Business plan Financing our plans 100

101 Financing our plans We do not envisage major changes on the proportion of borrowings coming from corporate bonds, EIB and other sources over the period. NWL s policy is to ensure that debt in the regulated business does not exceed 65% of the RCV. Currently, gearing in the regulated business is around 58%. Gearing of 60% has been assumed in the final plan. Regulatory gearing remains broadly stable over the period to It should be noted that if Ofwat assumes a higher level of gearing than this, then a tax dis-benefit may arise if tax on interest costs is only allowed at that higher level. Financeability and credit ratings In our view, the cost of capital should be set such that financeability uplifts are unnecessary. A real cost of capital of 4.7% generates financial indicators that, taken as a package, are at the limit of what would be acceptable to retain a solid investment grade rating. We have not included a financeability uplift in our plan. Should financeability uplifts be required then Ofwat needs to be explicit about the regulatory treatment. Financeability uplifts were included at PR04 and, despite the more recent turbulence in the financial markets, companies have in the main not seen financial ratios under stress. The regulatory treatment of the PR04 financeability uplifts at PR09 needs to be clarified. NWL abated K in the final three years of AMP4 (2% in total) to reflect the fact that it's financeability uplift was not required. The key credit rating agencies are Moody s, Standard & Poor s (S&P) and Fitch. All three have published ratings for NWL. Moody s and S&P rate corporate bonds for the appointed business. For the ILD issuance, a joint rating by Moody s and S&P has been required by monoline insurers. It should be noted that each of the main rating agencies adopts a slightly different view regarding the key financial ratios and, as a result, specific ratios may be considered problematic by one agency but not others. Investors will necessarily default to the lowest rating with any higher rating being ignored. If financeability uplifts are required (which is likely if a lower WACC is assumed), we believe that each of the options proposed by Ofwat has downsides as follows. A more flexible approach to financial ratios Measures of cash interest cover, including the Post Maintenance Interest Cash Ratio (PMICR), appear to be of primary importance for credit rating agencies. For these key ratios Ofwat cannot take a more flexible approach since the credit ratings agencies do not have the same flexibility of interpretation. Index linked debt (ILD) Whilst this debt has, at first sight, improved financial ratios such as cash interest cover, there are some important provisos. First, S&P include the indexation part of the interest charge when calculating cash interest cover. This removes the improvement in ratios initially gained through ILD. For NWL, this reduces cash interest cover by as much as 0.5x. We are glad to see that Ofwat have introduced this ratio into the Reservoir model (Cash Interest Cover (profit and loss interest)). 101 Business plan Financing our plans

102 Financing our plans Second, the market for new issuance is much reduced. We believe Ofwat should not assume any new debt can be issued as ILD, although average industry levels of ILD might be considered for the opening notional balance sheet. Finally, when considering the proportion of ILD to use in the cost of capital calculation Ofwat should not include swap based ILD since the cost of this debt is in line with that of conventional debt. It may be appropriate to include swap based ILD when considering the requirement for financeability uplifts but the proviso relating to S&P s treatment of ILD applies here. Equity Investment Investor surveys indicate that there is a negative perception of rights issues. We believe Ofwat should only assume a rights issue in exceptional circumstances, such as where a company has adopted an imprudent level of gearing or has an exceptionally large capital programme. Where new equity is assumed the full costs of issuance should be allowed. Conclusions on financeability The difficulties in generating a net present value (NPV) neutral financeability adjustment described above inform our view that the WACC should be set at a level that avoids the need for a financeability uplift. Dividend policy It should be noted that discussion on dividends in this plan refer solely to the dividend paid by the regulated business of Northumbrian Water Limited to its parent company. The external dividend paid by Northumbrian Water Group to shareholders is a matter for the NWG Board. This is not subject to regulatory oversight and is outside the scope of this plan. We have assumed the regulated business adopts a dividend policy in line with Ofwat s PR04 approach. This entails a total shareholder return reflecting the assumed cost of equity. We have, therefore, assumed a dividend yield based on the cost of equity less 2%, with 2% real growth each year. This approach requires a re-basing of the dividend at March 2010, to take account of the equity (RCV less Debt) in the regulated business at that point. This re-basing results in a small reduction in the regulatory dividend modelled. This approach is consistent with our current dividend policy and that applied by Ofwat at PR04. Any reduction from this policy could have serious consequences for future equity participation. Overview of our financing proposals Our financing strategy, based on raising medium to long term debt, will minimise the impact of financing costs on customers bills. Despite the further deterioration in economic conditions and tightening of financial markets that has taken place we have not changed our cost of capital from that proposed in our draft plan. It is significantly lower than that assumed by Ofwat at PR Business plan Financing our plans

103 Financing our plans We have assumed a dividend paid by the regulated business consistent with the cost of equity implied in this cost of capital. This plan generates financial ratios which are at the limit of those consistent with retaining a solid investment grade credit rating. We have not assumed a financeability uplift. Business plan Financing our plans 103

104 The outcome for customers THE OUTCOME FOR CUSTOMERS We have set out in this document our plans for and beyond and the costs of delivering these. In this section we summarise what this means for our customers in terms of the benefits they will receive and the bills they will pay. MAIN THEMES Delivering benefits for customers Extensive customer research has driven the objectives in this plan Our plans are consistent with the longer term goals and objectives in our SDS The main benefits our customers will receive are: - further reductions in discoloured water complaints - reductions in properties flooded by sewers - concerns about the taste & odour of drinking water addressed - improved river and bathing water quality - improved customer service - current high levels of performance safeguarded in all other areas Main changes since our draft plan Significant increases in costs outside our control such as rates, abstraction charges, customer debt (Tribunals, Courts and Enforcement Act) and the Traffic Management Act are only partially offset by a reduction in energy costs Tax increases as a result of abolition of Industrial Building Allowances The economic recession has resulted in a pensions deficit that requires increased contributions Reduced demand resulting the economic recession results in increased prices (the company s costs have to be recovered from lower volumes) We have completed our asset revaluation resulting in an increase in depreciation There is a small decrease in capital investment Prices and bills The overall average annual increase in prices, excluding inflation, required by our plan is 3.4% comprising 4.3% for the water service and 2.1% for the sewerage service We have phased the unsmoothed K profile to spread the large first year increase over three years whilst maintaining a stable financial position Because investment and costs (per property served) in Essex & Suffolk are higher than in the North East, it is proposed to apply water price limits differentially This results in average annual price increases, excluding inflation, for the water service of 3.7% for the North East and 4.9% for Essex & Suffolk The overall average annual price increase in the North East for water and sewerage services, excluding inflation, is 2.8% We will maintain the current discount to the standard household tariff for large users Tariffs for industrial non-potable water users on Teesside will rise in line with inflation Overall outcome Significant benefits will be delivered in line with customers views Changes outside of our control have led to prices higher than those in our draft plan and more than we would have liked However, bills in the North East will remain amongst the lowest in England and Wales We believe our plan represents excellent value for money Business plan The outcome for customers 104

105 The outcome for customers Delivering benefits for customers Levels of customer service and customer satisfaction are already very high. Drinking water quality and environmental performance are also very good. Our plans, which take into account the results of extensive customer research, build on this position. We summarise the benefits to customers of our plans in the tables below. Further details can be found in the section entitled Our plans. Key benefits for customers in Customer satisfaction Further improvements to satisfaction with service and value for money Less reason to complain about service (getting more things right, first time) More convenient ways to pay bills including on line payment facilities Water Quality New standard for lead in drinking water met Fewer discoloured water incidents in the North East Greater satisfaction with the taste and odour of drinking water Meeting future water needs Water supplies secured in the North East Reductions in leakage in the North East to achieve the revised economic level of leakage Additional demand on the water system met (from population growth and relocation) Keeping the water flowing Reductions in the number of planned interruptions (eg. to undertake work on the water system) Maintain the current very low levels of properties at risk of low water pressure Dealing with increasing flows in the sewerage system Major programme to address flooding from sewers, where cost beneficial Development of sewerage planning to identify actions to cope with increasing rainfall Additional demand on the sewerage system met (from population growth and relocation) Improving the water environment Further improvements to river & bathing water quality Further significant reduction in pollution incidents by 2015 Reduced sewage litter by reducing system spills and customer campaigns Encouraging biodiversity and catchment management Biodiversity (wildlife) continued to be encouraged on all our sites Development of our partnership initiative Branch Out to help build habitat resilience Improved liaison with farmers and land managers to protect abstracted water quality Continuation of our involvement with the Peatscapes project to reduce colour in the River Tees Sustainable operation and resilience Delivering the benefits of our plan whilst reducing carbon emissions to protect the environment Assets protected from flooding risk from changing rainfall patterns 105 Business plan The outcome for customers

106 The outcome for customers Overall price limits Ofwat sets price limits (K factors) for the water and sewerage services combined. There is a price limit for each year, from to It also provides indicative price limits separately for the water and sewerage services. The price limit denotes the percentage increase or decrease to prices above or below inflation. However, the actual change in individual s bills will vary somewhat depending on factors such as the need to ensure average measured and unmeasured bills are in proportion and the characteristics of customers properties and water use. We can provide all of the benefits in our plan for the following overall price increases: Price limits (%) 2010/ / / / /15 Average Water* Sewerage Overall price limit * The water service price limits cover both the North East and Essex & Suffolk The price limits shown above are phased. Without any phasing (or smoothing) there would have been a total K of +11% in , which we believe customers would have found unacceptable. Smoothing K has two impacts. First it results in customers paying higher bills at the end of the period. Second it can result in unacceptable financial ratios in the early part of the period. It is, therefore, necessary to find a smoothing option that provides an acceptable balance between reducing K in the early years and providing acceptable financial ratios. We considered a wide range of smoothing options. The one we propose is to spread the first year K over three years while ensuring that the overall net present value (NPV) of cash flows for the five years is the same as the unsmoothed version. It was not possible to smooth bills over the full five years without creating unacceptable financial ratios. Smoothing bills over five years would also have resulted in customers paying significantly higher bills at the end of the period. Application of price limits Indicative price limits for the water service determine the average percentage increase to bills allowed across the North East and Essex & Suffolk. When setting tariffs, it is necessary to consider whether there are reasons for price limits to be applied differentially in the two areas to reflect any significant variations in costs. This is to ensure customers bills in each area continue to reflect the cost of the services they receive over the longer term. For example, it would not be fair to expect someone in the North East to pay for improvements to service benefiting people in Essex & Suffolk. Business plan The outcome for customers 106

107 The outcome for customers Our analysis shows that there is significantly more water investment (per property served) in Essex & Suffolk than in the North East. This is because action is required to address a current deficit in water resources in Essex and to ensure sufficient water is available to supply customers as population grows in the region, for example in the Thames Gateway. Such large investment is not required for any reason in the North East. The EA has also signalled, following submission of our draft plan, that increases in abstraction charges in AMP5 will be considerably greater in Essex & Suffolk than the North East. We are, therefore, proposing to apply the indicative water price limit in a way that reflects differences in investment and costs between the North East and Essex & Suffolk. This results in the following price increases by area. Indicative water price limits have been included for reference purposes. Average price increases for the water service by area, not including inflation (%) 2010/ / / / /15 Average Water price limit Price limit applied to the North East Price limit applied to Essex & Suffolk The annual average water service price limit of 4.3% has been split differentially, resulting in an annual average for the North East and Essex & Suffolk of 3.7% and 4.9% respectively. Sewerage service price limits apply to the North East only and so the issue of differential application does not arise. Prices for the North East consist, therefore, of the water service increase in the table above and the indicative price limit for the sewerage service. This is as follows. Average price increases in the North East for water and sewerage services not including inflation (%) 2010/ / / / /15 Average Water Sewerage Total Business plan The outcome for customers 107

108 The outcome for customers Customers bills and tariffs Customers bills We have described above the price increases required to deliver our plan. The tables below show the resulting changes to bills. It should be noted that the percentage changes to average bills between and do not equate exactly to the price increases described above. This is due to the effects of changes in the customer base, including customers moving between unmeasured and measured tariffs. Average household water bills ( in prices) Average household water bill (North East) Average household sewerage bill (North East) Average total household bill (North East) The bills shown in are lower than they could have been because the company decided not to use all of the allowed price increases in , and This demonstrates our commitment to increase bills only where necessary. It also makes the increase from to appear larger than it would have been had customers not received the benefit of lower bills in the current period. By households will pay on average 41p per day for water services and 48p per day for sewerage services in the North East in 2007/08 prices. We believe this represents excellent value for money considering the benefits customers will receive, as described elsewhere in this document and summarised above. Large user and industrial water tariffs We will maintain the current discounts to the standard volumetric household tariff for our larger water customers. There is no evidence to point to the need for a variation in the discount going forwards. Based on the costs of operating and maintaining the discrete industrial, non potable water system on Teesside our analysis indicates that charges should rise by inflation only. Business plan The outcome for customers 108

109 The outcome for customers Drivers of changes in bills from to Bills in to will be higher than those in The main drivers of the change in bills are shown in the tables below (numbers may not add exactly due to rounding). Main drivers of changes in bills: water service North East ( in prices) Average forecast actual household bill in End of AMP4 reconciliation (changes in costs and revenues) 2.80 Impact of reduced return on capital (3.42) Scope for reduction through efficiency improvements (2.46) Asset maintenance to maintain service Drinking water quality improvements Customer financed service enhancements Maintaining security of water supplies 2.44 Changes to operating costs outside company s control 3.19 Changes in taxation 2.73 Average household bill in Notes 1. Includes a major programme to make further reductions to discoloured water, adding 0.90 to the average household bill. 2. This relates to a scheme to improve the taste & odour of drinking water. Business plan The outcome for customers 109

110 The outcome for customers Main drivers of changes in bills: sewerage service North East ( in prices) Average household bill in End of AMP4 reconciliation (changes in costs and revenues) 3.52 Impact of reduced return on capital (2.74) Scope for reduction through efficiency improvements (4.72) Asset maintenance to maintain service 2.08 Environmental quality improvements 0.85 Customer financed service enhancements Maintaining the supply/demand balance Changes to operating costs outside company s control 3.79 Changes in taxation 1.32 Average household bill in Notes 1. This relates to addressing the backlog of properties on the sewer flooding registers at end of AMP4 (adding 1.12 to the average household bill) and a small programme to address odour from sewage treatment works (adding 0.06 to the average household bill). Drivers of changes in bills from draft to final plans Customers bills will be higher in AMP5 than we indicated in our draft plan. There are a number of reasons for this, many of them outside of our control. The average household bill for water and sewerage services in the North East for in our final plan is 322, 9.8% higher than in our draft plan. Business plan The outcome for customers 110

111 The outcome for customers The table below accounts for the main changes in average total K. Drivers of changes in total average K from draft to final plan (%) Average total K at draft plan stage 1.3 Government and other externally driven changes Tax increases (including removal of Industrial Building Allowances) 0.6 Abstraction charges and increased water efficiency costs 0.2 Rates revaluation 0.1 Traffic Management Act and Tribunals, Courts and Enforcement Act 0.1 Changes as a result of the Economic recession Reduced demand (fixed costs spread over lower volumes) 1.0 Pensions deficit resulting from falling stock market prices 0.2 Lower inflation (0.3) Other changes Revaluation of assets completed - higher Current Cost Depreciation 0.4 Lower capex programme (some as a result of the recession) (0.1) Energy price reductions (but still an increase on PR04 assumptions (0.3) Net changes to other operating costs 0.2 Average total K in final plan 3.4 Conclusion the overall outcome for customers We have produced an integrated, well founded plan which has been endorsed by our Board of Directors. It takes a significant step towards the goals and aspirations set out in our SDS. We have placed our customers at the heart of the process and believe that our plan delivers the benefits they want. Customer research undertaken post draft plan shows a high level of support for our proposals. The foundation of our plan is maintaining compliance with drinking water and environmental standards, maintaining high levels of customer service and ensuring our customers have sufficient water we will not compromise on these objectives. In addition to this we will deliver a relatively small programme of quality improvements and a small number of carefully justified service enhancements, including further significant work to address flooding from sewers. Since we submitted our draft plan, a number of factors outside our control have pushed bills upwards. These include increases in taxation and rates and the impacts of the economic recession. In assessing the costs arising from these changes, we have taken a balanced view, incorporating in our plan central estimates of the costs we will incur. We believe we have taken a balanced view of risk throughout our plan, ensuring bills are no higher than they need to be. As well as always including central estimates, there are a number of assumptions we have made with significant downside risk. These include our assumption about the impact of the economic recession on revenue, where reductions in industrial demand could easily be much greater than we have forecast and our prediction that the cost of debt will reduce from current values. Despite the increases, our bills in the North East will remain amongst the lowest in England and Wales. We believe our plan represents excellent value for money and will allow the company to continue to deliver top class services in the North East. Business plan The outcome for customers 111

112 Annex A ENDORSEMENT BY THE NWL BOARD AND BOARD STATEMENT ON THE ROLE AND INVOLVEMENT OF THE BOARD IN THE BUSINESS PLAN PROCESS Business plan Annex A 112

113 Annex A FINAL BUSINESS PLAN PART A COMPANY STRATEGY ENDORSEMENT BY THE NWL BOARD The Board considers that the long term strategy underpinning the Final Business Plan is consistent with our Strategic Direction Statements which were also approved by the Board. The Board was engaged in developing the strategy for the Final Business Plan and has received regular updates as the plan has been produced. Our strategy has been developed taking into account the extensive customer research conducted by the company and the views of other stakeholders. The input of the quadripartite review group consisting of Environment Agency (EA), Drinking Water Inspectorate (DWI), the Consumer Council for Water (CCWater) and Northumbrian Water has been particularly helpful. The Board believes the strategy represents excellent value for money for our customers and provides a robust forward plan. The key assumptions and policies which are material to the plan have been discussed and agreed by the Board. The company s processes for completion of the Final Business Plan are described in the Board Statement following this endorsement. The processes include a quality plan and quality assurance processes similar to those applied to the Annual Return. The Board considers that these represent sufficient processes and internal systems of control to fully meet its obligation for the provision of business plan information to Ofwat. A full description of the role and involvement of the Board in the business planning process is also included in the Board Statement. So far as each current director is aware, there is no material information relevant to the Final Business Plan of which the company's auditor or reporter is unaware. Each director considers he or she has taken all the steps they could reasonably have been expected to have taken as a director in order to make himself or herself aware of any relevant information and to establish that the company's auditor and reporter are aware of that information. Each Board member has reviewed Part A of the Final Business Plan in its entirety and the final version takes into account the comments received. The Board gave John Cuthbert (Managing Director) and Alastair Balls (Independent Non-Executive Director) authority to sign the final version of the Draft Business Plan on its behalf. Business plan Annex A 113

114 Annex A BOARD STATEMENT STATEMENT ON THE ROLE AND INVOLVEMENT OF THE BOARD IN THE BUSINESS PLAN PROCESS The Board has been actively engaged in the development of company strategy for the Business Plan. PR09 has been a standing item on the agenda at each Board meeting of Northumbrian Water Limited (NWL) throughout 2007, 2008 and Strategic Direction Statement The Board established our approach to customer consultation and took the decision to put customers at the heart of our SDS and Business Plan. We started our PR09 project by considering what our customers want. This meant reviewing existing customer research and complaints data before embarking on a comprehensive customer consultation exercise involving some 1,700 customers in our northern and southern areas. The Board received updates on the key findings of the customer research and this helped it to identify the key themes for the SDS. The Board was involved throughout the process of developing our SDS which we called Looking to the Future. This included endorsing the decision to produce separate documents for the North East and for Essex & Suffolk and agreeing the appropriate messages for each version. The Board agreed the outline and themes for inclusion in the SDS. It then reviewed an initial draft and provided guidance on content and presentation before providing detailed comments on later drafts and approving the final version of the document. The Board has participated in a series of stakeholder events organised to discuss and receive feedback on our SDS, including lunches and dinners hosted by the Chairman at locations throughout our northern and southern operating areas. We also organised a well attended event at the House of Commons for the MP s whose constituencies we supply. We have received overwhelming endorsement for our SDS from a wide range of stakeholders in the North East and Essex & Suffolk. Developing the Business Plan The Board has overseen the development of the draft and final business plans as the initial step towards the long term vision outlined in the SDS. It has considered how best to reconcile challenging aspirations with the need to ensure that bills remain affordable and finances stable. The periodic review and company business plan formed the main item of the annual NWL Board Strategy Days in January 2008 and February As company plans have developed, the Board has received updates at successive Board meetings during 2007, 2008 and 2009 on key components including capital investment, operating costs and financing assumptions. This has allowed the Board to provide comment and input ideas. Important decisions have been endorsed by the Board as development of the plan progressed. The Board had a major input to the development of Part A of the final business plan. A draft, was circulated to the Board for comment in March 2009 and was discussed by the Board at the March Board meeting. The Board s comments were incorporated in the document. Business plan Annex A 114

115 Annex A Internal processes for completion of the business plan and quality assurance procedures An overview of the project structure together with the business processes and quality assurance procedures established for PR09 is provided below. This framework was endorsed by the Board at the outset of the project. We have produced a PR09 Quality Plan which is a formal document setting out how the PR09 submissions must be developed and approved. Included in the document are details of the organisation and responsibilities, protocols for decision-making and authorisation, Quality Assurance (QA) requirements and key principles to be applied by all concerned (eg. use of central forecasts and affording the Reporter and Financial Auditor access to all relevant information). The PR09 Quality Plan was judged to be fit for purpose by our Reporter. The Periodic Review Steering Group (PRSG) heads the organisational structure for delivering the PR09 submissions. Its membership includes the four Executive Directors of the Board and the Technical Director who is the management team member directly responsible for asset planning and capital investment. The PRSG ensures that the strategy adopted has Board endorsement and is applied throughout the PR09 project structure. It also oversees the application of the Quality Plan. Under the PRSG is a series of project groups dealing with specific topics (eg. Asset Planning, Opex and Income & Supply/Demand). It is their responsibility to ensure appropriate action is being taken by designated managers, in accordance with PRSG direction, to produce the necessary information to an appropriate programme. The chairmen of these groups meet as the Project Management Group to ensure a coordinated approach is adopted and interactions are identified and managed. Comprehensive processes for QA and sign-off are in place and operating. In particular, all data and narrative to be included in the business plan must be reviewed and signed off by the provider, a nominated reviewer and a Director. As can be seen from the above, the Executive Directors of the business through their role on PRSG have played a hands-on role in establishing the planning processes and in overseeing the QA procedures. Updates on progress have been provided at each Board meeting. In addition, the Board asked an independent non-executive director (NED), Alastair Balls, to review the processes and QA procedures used in developing the business plan and to report back to the Board on his findings. The processes and procedures used for the business plan are similar to those in the June Return, where Mr Balls performs a similar role. The company Reporter, Roger Sawdon, provided an update on his audit work for the business plan to NWL s Operations and Regulation and Scientific Services Directors and Mr Balls (the NED nominated by the Board) on 24 March The process described above and, in particular, the input from the Reporter and the feedback from an independent NED, enabled the Board to be satisfied that the processes and systems of internal controls are operating as expected. 115 Business plan Annex A

116 Annex A A robust plan In developing the business plan, the company has endeavoured to ensure that all the material issues that it might reasonably be expected to consider have been taken into account. Our approach to projections in the business plan has been to take a reasoned and considered view of central estimates based on the best and most complete information available at the time. We have set out material assumptions and judgements. It is important to recognise that the one certainty about all forecasts, whether produced by companies or by regulators, is that they will be proved wrong the only question is by how much. Hence, the critical point is not how accurate these projections will be, since this cannot be known in advance, but whether they are soundly based and constitute a robust and fit for purpose plan. The Board has set the strategy for the plan, reviewed the internal processes for producing the plan, and challenged the key assumptions. The Board is satisfied that this business plan represents a robust basis for business and regulatory planning. Board Approval Part A of the final business plan and the strategy it described received final approval by the Board at the March 2009 Board meeting. The Board authorised the Executive Committee of the Board to approve Parts B and C on the basis that these more detailed documents must be consistent with the strategy approved by the Board and with Part A. Business plan Annex A 116

117 Annex B ANNEX B GLOSSARY OF TERMS Business plan Annex B 117

118 Annex B GLOSSARY OF TERMS Abstraction Taking water (in our case for water supply) from the natural environment AMP Asset Management Plan Setting out work needed on the asset base to meet stated objectives AMR Automatic Meter Reading Using electronic devices to read meters remotely Catchment Management Managing pollution in the catchment, rather than by removing it with treatment CBA Cost Benefit Analysis A technique used to help inform investment decisions where costs are compared with benefits CC Competition Commission AONB Area of Outstanding Natural Beauty A precious landscape whose distinctive character and natural beauty are so outstanding that it is in the nation s interest to safeguard them. Aspiration Our long term objective. The timescale for achieving our aspirations will vary. Some, such as customers having no cause for complaint, may never be entirely achieved but represent aspirations we will constantly work towards Asset Base The physical infrastructure used to supply water and deal with wastewater (including treatment works, pipes, sewers and pumping stations) Biodiversity Diversity of animal and plant species BWD Bathing Water Directive European legislation establishing water quality standards for bathing waters CAA Civil Aviation Authority Capex Capital investment expenditure Capital Maintenance Planned work carried out by water companies to replace and repair water and sewerage assets to provide continuing services to customers. CAPM Capital Asset Pricing Model An economic model for valuing returns by relating risk and expected return. Based on the ideal that investors demand additional expected return (called the risk premium) if asked to accept additional risk Catchment River basin providing water for drinking water supply 118 CCD Current Cost Depreciation The accounting charge in the current cost accounts to account for depreciation of assets CCWater Consumer Council for Water Water customers representatives CMPCF Capital Maintenance Planning Common Framework A framework agreed by regulators and water companies to guide capital maintenance planning Compliance Meeting the requirements of drinking water or environmental standards Cost of Capital The minimum return that providers of capital require for them to invest in or lend to a business, given its risks Cost of Debt The minimum return that lenders require for them to lend to a business, given its risks Cost of Equity The minimum return that providers of capital require for them to invest in a business, given its risks CP communication pipe the water pipe between the water main and the customer s boundary CRC Carbon Reduction Commitment A mechanism used by government to incentivise carbon reduction Credit Rating Assessment of a company s financial standing. Investment grade credit rating means a sound financial position CROW Countryside Rights of way Act 2000 Business plan Annex B

119 Annex B DBP Draft Business Plan Document produced by water companies describing the company s plans for future services & the impact on prices of implementing the strategy DD Draft Determination Following the review of the Final Business Plan submission, Ofwat publishes a Draft Determination of K for each water company. The Draft Determinations are issued for consultation. DEFRA Department of Environment, Food and Rural Affairs Depreciation A measure of conception, use or wearing out of an asset over a period of its useful economic life that is reflected in the company s financial accounts DG A key level of service monitored by the Director General of water services DGM Dividend Growth Model A financial model used to provide an estimate of equity returns by reference to the expected growth in dividends Discharge Consent Permit to discharge to a watercourse (eg from a sewage treatment works) granted by the EA which specifies the volume and content allowed Discoloured Water Drinking water which has an unacceptable appearance caused by sediment in the main (eg brown colour). Whilst unpleasant, it is not harmful to health Drainage Catchment Area of land draining to a particular sewage treatment works Drinking Water Inspectorate (DWI) - Regulates drinking water compliance EA Environment Agency Regulates discharges to the environment and water abstraction ELL Economic Level of Leakage - The point at which further leakage control activity would cost more than alternative means to bridge the gap between supply and demand ESW Essex & Suffolk Water EWT Essex Wildlife Trust. FBP Final Business Plan Document produced by water companies used by Ofwat to determine draft price limits FD Final Determination The Final Determination of price limits made by Ofwat following consideration of representations made on the Draft Determination FMEA Failure Modes & Effects Analysis A method of determining asset maintenance needs Frontier Shift The scope for the most efficient water company to become more efficient than the economy in general GAC Granulated Activated Carbon Gearing Amount of debt compared to asset value or shareholder equity HMRC Her Majesty s Revenue & Customs Hosepipe Ban Ban on use of hosepipe or similar water using device during drought HTA Horticultural Trades Association IBA Industrial Buildings Allowance A form of tax relief for capital investment ICA Instrumentation Control & Automation equipment ICF Infrastructure Condition Factor Measures background leakage from very small leaks which cannot be located & repaired individually IDOK Interim determination of K (the company s price limits) Condition B of the company s operating licence allows Ofwat to make adjustments to the price limit in any year for certain relevant changes of circumstance or in response of a notified item, provided that these are material. IFRS International Finance Reporting Standards Business plan Annex B 119

120 Annex B Impounding Reservoir A reservoir used to collect and store rainwater or river water IRC Infrastructure Renewals Charge Determines how much capital maintenance investment will be directly paid for each year through customer bills IRE Infrastructure Renewals Expenditure Expenditure to maintain infrastructure assets is averaged out over a 15 year period (5 years past & 10 years future) to determine IRC for each year K Factor The annual regulatory price limit applicable above or below the annual change in RPI Levels of Service Specific measures of services to customers LLAA Long Life Asset Allowance A form of tax relief for capital investment Logging-up A mechanism by which a company can seek to have the reasonable continuing net additional costs of meeting changes in obligations, standards or demands not previously recognised in price limits, reflected in the periodic review of prices LPA Local Planning Authority M&G Management & General Investment category covering support assets MEAV Modern Equivalent Asset Value The cost of replacing the asset base NE Natural England a regulator concerned with protection of wildlife NEP National Environment Programme The programme that water companies must carry out to improve the environment NERC National Environment & Rural Communities Act 2006 NI Notified Item Any item notified by Ofwat as not having been allowed for (either in full or not at all) in the most recent final determination and eligible for consideration for an interim determination of price limits or logging up should the event not allowed for actually occur (subject to a triviality threshold NRR Natural Rate of Rise Measures the rising magnitude of leakage from mains bursts NPV Net Present Value the current value of a future stream of cash flows sometimes used to compare options. NWL Northumbrian Water Limited OFGEM Office of Gas & Electricity Markets OPA Overall Performance Assessment A score given to all companies with regard to performance in a number of compliance and service areas Opex Operating expenditure comprises for example power, payroll costs, chemicals and consumables PMG Project Management Group An NWL group involved in managing the production of the business plan PMICR Post Maintenance Interest Cash Ratio A financial term used by credit rating agencies PR09 Periodic Review of price Limits to be completed in 2009 PRSG Periodic Review Steering Group An NWL group overseeing the development of the business plan Programme of Measure s Actions required to meet the requirements of the Water Framework Directive in a river basin area QA Quality Assurance Business plan Annex B 120

121 Annex B Quality Enhancements A generic term for work programmes implemented by the water companies to improve the quality of drinking water or the environment, such as treating wastewater discharges to a higher standard. These enhancements are required to fulfil new legislation or national initiatives approved by Ministers RCC Relevant Change in Circumstances variations in circumstances, as laid down in Condition B of the licence in respect of which Ofwat may make adjustments to price limits subject to materiality. Key variations include changes in legal obligations placed on companies. RCV Regulatory Capital Value the capital base used in setting price limits. The value of the appointed business which earns a return on investment. Renewable Energ y Energy generated from natural sources such as sunlight, wind etc., which are renewable (naturally replenished) Reservoir Ofwat Financial Model used for the preparation of the PR09 Business Plan RHS Royal Horticultural Society RPI Retail Prices Index a measure of inflation RSPB Royal Society for Protection of Birds SDS Strategic Direction Statement setting out water companies goals and aspirations for the longer term SELL Sustainable Economic level of Leakage - The point at which further leakage control activity would cost more than alternative means to bridge the gap between supply and demand taking into account social and environmental costs Service Reservoir Enclosed reservoir used to store treated drinking water Sewage wastewater from toilets etc Sewage Litter Unsightly litter from sewer overflows such as sanitary products Sewerage System The network of sewers which conveys rainwater Sludge Digestion A form of treatment involving biological digestion of sewage sludge. This generates methane which can be used to generate heat and power SUDS Sustainable Urban Drainage Systems The practice of controlling surface water run-off as close to its origin as possible before it is discharged to a water course or sewer Surface Water Run-off from hard areas such as pavements and patios, mostly rain Sustainable Development Achieving economic and social goals in ways that can be supported for the long term by conserving resources, protecting the environment, and ensuring human health and welfare SWDP Surface Water Drainage Plans Tariff Basket The basket of charges for household and nonhousehold (using less than 5 Ml/d) customers to which the annual regulatory price limits apply comprising: charges for unmeasured water supply, measured water supply, unmeasured sewerage services, measured sewerage services and charges for trade effluent TMA Traffic Management Act a Act formulated to ease traffic congestion WACC Weighted Average Cost of Capital For a company, the average of its cost of debt and cost of equity capital, weighted according to the balance of debt and equity which finances the company s assets. Wastewater Sewage and surface water WCA Wildlife & Countryside Act 1981 WFD Water Framework Directive European legislation establishing required status of surface and ground water and requiring plans to achieve this status Business plan Annex B 121

122 Annex B WRMP Water Resources Management Plan Water company statutory plan setting out a 25 year strategy for managing water resources WSP Water Safety Plan Risk based approach to managing water quality from source to tap WI Water Industry Wilco An optimisation tool which identifies a programme of activities that provide the best benefit (attainment of service objectives) per pound spent UKWIR UK Water Industry Research Limited Business plan Annex B 122

123 Annex C ANNEX C TABLES AND TABLE COMMENTARIES Business plan Annex C 123

124 Annex C CONTENTS TABLES: One page summary for the North East operating area Table A1 (North East) Price limits, bills, water sales and the supply/demand balance Table A2 (North East) Water service Current performance and planned outputs Table A3 (North East) Sewerage service Current performance and planned outputs Table A4 (North East) Water service Key activity projections Table A5 (North East) Sewerage service Key activity projections Table A6 (Company-wide) Efficiency improvements Table A7 (North East) Water service Expenditure projections Table A8 (North East) Sewerage service Expenditure projections Table A9 (Company-wide) Financial projections Table A10 (Company-wide) Summary of justification of company investment proposals COMMENTS ON THE TABLES COST-BENEFIT CHARTS AND COMMENTARIES: 1. Taste and odour of drinking water North East (proposed service enhancement) 2. Discoloured water and compliance with standards for iron and manganese North East (proposed drinking water quality enhancement) 3. Sewage odour abatement schemes (proposed service enhancement) 4. Bathing waters improvements (NEP environmental quality enhancement) 5. River water quality improvements (NEP environmental quality enhancement) 6. Proposals to maintain and improve river water quality Business plan Annex C 124

125 Annex C ONE PAGE SUMMARY FOR THE NORTH EAST OPERATING AREA Business plan Annex C 125

126 Annex C Business plan Annex C