Note to Ofwat’s Board – update on draft determinations for Northumbrian Water 1. Background On 15 May the Board reviewed the assessment of Northumbrian Water’s and Dŵr Cymru’s resubmitted business plans. Consistent with the approach taken with the enhanced companies, Board agreed to delegate authority to the Chief Executive and Chief Regulation Officer to determine the quantum of any outstanding interventions, and to confirm the draft determinations for both companies. It was also agreed that the draft determinations would be published early (around the end of May) as opposed to the original date of 25 June. In delegating authority the Board requested that that a summary of the draft determinations be circulated to Board members covering each company’s revenue requirements, ‘K’ factors and average bills over the period. It was also agreed that the delegated authority would remain in place apart from in the event that any Board member wished to discuss a particular issue, or that no new material issues arose. 2. Purpose The purpose of this note is to provide Board with the information it requested in relation to Northumbrian Water. The note for Dŵr Cymru will follow next week. We have also provided Board with an update on the outstanding issues and our financeability assessment. In light of the different timeframe associated with these determinations, we have adopted a template specific to these circumstances. We are not intending to replicate this template for the remaining draft determinations. The information in this note can be summarised as follows: • • • • revenue requirements; ‘K’ factors; average bills; and update on outstanding issues. 1 Note to Ofwat’s Board – update on draft determinations for Northumbrian Water We confirm that no new material issues have arisen since Board last met. We ask that the Board respond to the Board Secretary ([email protected]) at the earliest possible time, with the cut-off time for comments being 9 am Wednesday 28 May. 3. Northumbrian Water 3.1 Draft determination – financial model outputs In the table below we have set out the allowed revenues, k factors and average customer bills associated with our draft determination. Table 1 Draft determination Ks, allowed revenues and customers’ bills 2015-16 2016-17 2017-18 2018-19 2019-20 379.9 381.0 382.1 383.3 384.4 1,910.7 0.00% 0.30% 0.40% 0.11% 0.11% - Wholesale wastewater – allowed revenues (real) (£m) 274.9 275.9 276.8 277.8 278.7 1,384.1 Wholesale wastewater – K (%) 0.00% 0.35% 0.44% 0.15% 0.15% - Retail household allowed revenue (£m) 55 56 57 57 58 283 Retail non-household expected revenue (£m) 10 10 10 11 11 51 Average customer bill – water (£) 184 184 184 184 184 - Average customer bill – wastewater (£) 196 196 196 196 196 - Average customer bill – combined (£), 362 362 362 362 362 - Wholesale water – allowed revenues (real) (£m) Wholesale water – K (%) 2 Total Note to Ofwat’s Board – update on draft determinations for Northumbrian Water In the above table we have illustrated that bills will remain flat in real terms over 2015-20. However, because the combined bill in 2014-15 is £368 this draft determination will deliver a £6 reduction in bills by 2019-20. Accordingly, we do not expect this draft determination to give rise to any particular handling issues. It should be noted, that as with the enhanced draft determinations, the average customer bill illustrated above reflects a notional allocation (by Ofwat but based on the company’s split of household and non-household) of the overall revenue requirement across Northumbrian’s customer base. In practice companies will have some flexibility about how they recover the revenue requirement from different types of charges. We will shortly be publishing a consultation on the new charging rules. 3.2 Update on outstanding issues When we presented the recommendations to Board, there were outstanding issues in relation to: (i) outcomes; and (ii) legacy adjustments. Below we explain the decisions we have reached and provide an update on financeability. Outcomes We identified a number of issues with Northumbrian Water’s proposed performance commitments and the associated outcome delivery incentives. Below we set out the issues and the action we have taken. • Performance commitments – the company did not sufficiently justify why the level of some performance commitments should be reduced from what was originally proposed in the December plan. We have therefore set some performance commitments back at the level proposed by the company in December. • Transferred assets – the company did not sufficiently justify why it should differentiate between its own assets and those transferred in October 2011 (for sewer flooding). We have therefore set penalty only incentives for service relating to these assets. • Outcome delivery incentive (ODIs) – for a small number of ODIs the company has not justified the reward by reference to willingness to pay information. We have therefore removed the reward and expect the company to recalibrate the reward so that it is consistent with our methodology. • Deadbands – for some ODIs we have reduced (that is, tightened) the deadband to increase the strength of the incentive. 3 Note to Ofwat’s Board – update on draft determinations for Northumbrian Water The implication of these interventions is that it impacts the potential return on regulatory equity (RoRE) the company can earn (as opposed to the revenue requirement for the draft determination). In particular, the interventions we have made reduce the potential return that could be earned for service outperformance while increasing the potential penalties that would be paid in the event of poor performance. We expect that the company will address the issues on the reward side when it makes representations to our draft determination. Legacy We identified several issues with the proposed legacy adjustments submitted by Northumbrian Water. The key changes are as follows. • Wholesale water: reduced from £70.5 million to £57 million – this reflects: – RCM – the company provided insufficient evidence to justify a change in customer numbers in 2010; – OIA – the company did not demonstrate continued outperformance for a specific scheme; and – change protocol – we have concerns that the company will deliver its trunk mains discolouration project. • Wholesale wastewater: reduced from £26 million to £18 million – this reflects the following. – Change protocol – the company did not provide evidence that it delivered all its outputs from PR09. In addition we do not have confidence that the company will deliver its entire sewer flooding outputs given that it has to deliver 40% of the programme in the final year of the control period. We are also not accepting proposed logging up for AMP6 expenditure and instead this should be treated as ‘transitional expenditure’. – CIS – in light of the above changes we have increased the revenue penalty. The legacy adjustments submitted by Northumbrian Water would have increased the revenue requirement (that is, by approximately £96 million). In light of our interventions this impact is reduced to £75 million. 4 Note to Ofwat’s Board – update on draft determinations for Northumbrian Water Financeability Since the Board meeting Northumbrian Water has submitted revised financial ratios. The revisions, submitted on 22 May, were made to better reflect the approach we take to calculate financial ratios and in particular reflect changes to the treatment of tax. We are not proposing to reflect this new information in the draft determinations as it sets a bad precedent for the late submission of information for future draft determinations. We will instead consider this information as part of the company’s representation and in time for the final determination. It should be noted that we remain comfortable with our financeability assessment of Northumbrian Water. 4. Next steps We are seeking to publish the draft determinations at 7 am on 30 May. We ask that Board members respond to the Board Secretary at the earliest possible time, with the cut-off time for comments being 9 am Wednesday 28 May. 5
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