ANNUAL REPORT AND FINANCIAL STATEMENTS 2009

Revenue from regulated activities increased by six per cent to £1,500 million, principally as a result of an allowed price increase of 7.8 per cent (including inflation), partially offset by lower water demand. As expected and indicated previously, this level of growth is consistent with the position at the half year. The regulated price increase supports significant investment in UUW’s infrastructure which provides vital clean water and wastewater services to customers.

Operating profit for the year increased by 11 per cent on an underlying basis, primarily reflecting the allowed price increase and tight cost control, partly offset by higher depreciation and power costs. The higher depreciation charge reflects the high levels of capital spend, in line with the planned profile of the investment programme. In line with UUW’s policy, the business has entered into forward contracts for the bulk of its power requirements for 2009/10. This means that unit power costs in the forthcoming financial year are expected to be in the order of 10 per cent higher than in 2008/09. Bad debt expense is similar to the prior year, although this represents a marginally lower proportion of regulated revenue at 3.4 per cent compared with 3.6 per cent in 2007/08. However, cash collection continues to be challenging.

Capital investment in the year, including £118 million of infrastructure renewals expenditure, was £740 million. This high level of spend reflects the capital investment profile, as UUW completes the peak phase of its 2005-10 regulatory programme. After adjusting for the revised sewage sludge strategy, as agreed with Ofwat, cumulative capital expenditure on water and wastewater assets remains broadly in line with agreed regulatory assumptions. Overall, the business remains on course to meet its capital expenditure regulatory efficiency targets and deliver its outputs across the 2005-10 period.

Operational performance

Operational performance is a key area of focus and UUW is targeting an upper quartile position among UK water companies on key operational measures in the medium term. The regulated business continues to upgrade its infrastructure, replacing 227 kilometres of water mains during the year. UUW continues to supply a high quality of drinking water, with a mean zonal compliance water quality performance for the year of 99.92 per cent.

UUW is making good progress against its key performance indicators:

• Relative efficiency – UUW has closed the operational efficiency gap to the most efficient water companies over the last three years. This is reflected in Ofwat’s most recent (2007/08) assessment of United Utilities as band B for the water service and band C for the wastewater service and represents a one band improvement for both services over the three-year period.
• Security of water supply – UUW met its economic level of leakage rolling target for the third consecutive year in 2008/09, despite unfavourable winter weather conditions which made this target more challenging. This follows a period where the company had not met this target for five years. In addition, no water restrictions were required during the year.
• Pollution – the business has now met or outperformed its medium-term target of a 50 per cent reduction in major pollution incidents in each of the last three years. One water and 10 wastewater Category 1&2 incidents were recorded in 2008 compared with the base position of two water and 21 wastewater incidents in 2005. In addition, UUW has more than halved the number of failing wastewater treatment works from 18 works in 2007 to seven works in 2008, and performance so far this year has been encouraging.
• Sewer flooding – UUW continues to remove properties from the sewer flooding register. Ofwat has published a review of how registers of properties at risk of sewer flooding are compiled and reported in the water sector in England and Wales. UUW is currently in discussion with Ofwat regarding its methodology and processes in this area. This is expected to result in a restatement of the number of properties on UUW’s sewer flooding registers, with a resulting increase in these numbers in terms of both the start point in 2005/06 and the current position. However, it is envisaged that the restated numbers will still demonstrate progress over this period. UUW aims to build on the progress achieved over the last three years and will provide a further update when its sewer flooding registers have been reassessed. Following completion of this review, UUW expects to restate its historical overall performance assessment (OPA) scores for the three years 2004/05 through 2006/07 in relation to ‘flooding other causes’ and is in discussion with Ofwat regarding the extent of these restatements.
• Overall customer satisfaction – significant improvements have been delivered. Overall customer satisfaction, in response to enquiries, has improved from less than 50 per cent in 2005 to consistently over 70 per cent. These satisfaction levels are based upon a comprehensive independent survey conducted on behalf of UUW each month. Further progress has been achieved and customer satisfaction is now at its highest levels for many years, with a satisfaction rating of 76 per cent for 2008/09. The rating for the final month of the year was 80 per cent. The business remains focused on achieving further improvements.

Although UUW has delivered real progress, the business recognises that there is more to do. Sewer flooding incidents, influenced by adverse weather, together with environmental underperformance at Fleetwood wastewater treatment works are expected to continue to impact the 2008/09 OPA score. A funded capital investment programme has already been initiated at the Fleetwood works and an improvement in performance is expected in the medium-term.

Efficiency initiatives

UUW is broadly on track to meet its regulatory efficiency targets across the 2005-10 period, although the business is facing ongoing cost pressures in areas such as power and bad debts.

The company’s principal efficiency initiatives include an integrated performance management project, which increases remote operational site management and optimises chemical and power usage, and its asset improvement programme which is improving the efficiency of operational pumps. These schemes are key elements of United Utilities’ plan to mitigate its carbon emissions, alongside its combined heat and power assets which recycle energy generated from wastewater treatment processes. UUW has been awarded the Carbon Trust standard; and the business has developed the technology to convert biogas, a by-product of the sludge treatment process, into bio-methane for vehicle fuel and potentially to export into the natural gas distribution network.

Other key initiatives include supply chain management, which has been centralised and is delivering procurement economies, and a workforce management project. There is a strong drive to improve customer service and the business is focusing on reducing the number of customer queries, improving staff productivity and implementing improved cash collection procedures.

The workforce management system is a key initiative in increasing the efficiency of frontline staff, by using real time data across the workforce to enable more effective work scheduling. This project has been successfully implemented on time and below budget; early progress is encouraging. The system should provide the dual benefits of reducing the cost to serve and improving customer satisfaction. Cost savings of approximately £7 million per annum are expected by 2010.

2009 water price review

UUW submitted its draft water and wastewater business plan, covering the 2010-15 period, to Ofwat in August 2008 and submitted its final plan on 7 April 2009, entitled ‘Planning for the future’. These submissions form part of the 2009 water price review process and build on the company’s strategic direction statement published in December 2007. The business has worked hard to strike the right balance between improvements in the network and the impact on the bills paid by its customers. The final plan was welcomed by the Consumer Council for Water and supported by UUW’s independent engineering Reporter, Halcrow, which described the capital investment assessment as well considered, comprehensive and robust.

The total capital investment programme contained within the final plan, including infrastructure renewals expenditure, is approximately £3.7 billion (2007/08 prices), comprising £1.3 billion for the water service and £2.4 billion for the wastewater service. This compares with a programme of just over £3 billion in the 2005-10 period. Investment to meet regulatory quality standards, enhance the service to customers and maintain the supply/demand balance is forecast at around £1.8 billion. The remainder relates to essential maintenance of the water and wastewater infrastructure. Having raised over £1 billion of debt finance in the last year, the business would expect to borrow £1.6 billion across the five-year period 2010-15 to finance this plan.

The planned 2010-15 capital investment programme takes account of the geography and industrial legacy of the North West of England. It aims to maintain and improve current service standards and address new tighter quality standards as well as making provision for the challenge of climate change. The total proposed capital expenditure programme in the final plan is £3,704 million, compared with £4,035 million in the draft plan. The principal reductions are the deferral and removal of outputs (£433 million), the impact of recession on growth (£119 million) and greater future efficiency (£130 million), partly offset by the inclusion of further projects relating to sewer overflows/ unsatisfactory intermittent discharges (£351 million).

UUW expects to improve its efficiency further across the 2010-15 period. The business is aiming for a 1.5 per cent annual improvement in its underlying operating efficiency, although operating expenditure is likely to increase overall due to cost pressures in areas such as property rates and pensions. UUW is also targeting an average improvement in efficiency of between four per cent and eight per cent across the five-year period in respect of its capital investment programme.

UUW estimates that to finance this plan an average real, fully post-tax return of 4.85 per cent is required, which it believes would support an A3 credit rating. This compares with a cost of capital of 5.1 per cent assumed by Ofwat at the last price review in 2004, reflecting the reduction in the cost of debt finance available to the water sector during the early part of the 2005-10 period. However, this return represents an increase of approximately 0.2 per cent compared with the required return in the draft business plan, following UUW’s reassessment of its financing costs in light of recent financial market conditions. This reassessment is supported by NERA Economic Consulting’s (NERA) recently updated independent research (‘Cost of Capital for PR09 – A Final Report for Water UK’, January 2009) which has concluded that a higher cost of capital in the range of 4.6 per cent to 5.1 per cent (fully post-tax, real) would be appropriate for the UK water industry. NERA intends to reassess this cost of capital range later in the year.

United Utilities believes that Ofwat should ensure that water companies can at least maintain an A3 credit rating and should consider recent developments in the credit markets. The raising of debt finance is particularly important given the likely scale of investment that is still required in the water industry to replace and refurbish ageing infrastructure, make provision for climate change and deliver further statutory environmental obligations
and customer priorities. The board believes this to be an appropriate investment grade rating to allow UUW to raise finance to fund its substantial capital investment programmes, particularly in light of conditions in the debt markets over the last 12 months.

UUW believes that its services, which on average costs households around £1 per day for the supply of high quality drinking water and for environmentally responsible wastewater collection and treatment, represents excellent value for money. Within this plan, average household bills would increase by seven pence per day in real terms by 2015. This equates to an average real price increase of 1.8 per cent across UUW’s customer base during the 2010-15 period. The business believes this plan is consistent with its aim that bills, on average, should rise no faster than medium-term household income growth.

The next stage of the price review process is publication of the draft determination by Ofwat in July 2009, with the final determination due in November 2009.

Planning for the future

Business plan 2010-2015
UUW’s final business plan sets out how it intends to invest in and improve its service over the five years from 2010 to bring about even better drinking water quality and environmental performance, and what that means for customer bills.