WATER UK CITY CONFERENCE 21 JANUARY 2004 PHILIP FLETCHER

PR04 WHERE ARE WE? Methodology - March 2003 Companies’ draft business plans - August 2003 Ofwat’s overview of draft business plans Joint Customer Survey - December 2003 Public letter to Secretary of State - December 2003 Early Start indicators - December 2003

30% or more 20% - 29% 10% - 19% Less than 10% COMPANY PROPOSALS FOR % INCREASES IN WATER BILLS

50% or more 30% - 49% 20% - 29% Less than 20% WATER AND SEWERAGE COMPANY PROPOSALS FOR % INCREASES IN BILLS

BILL DRIVERS

CHANGES IN HOUSEHOLD BILLS PR04 COMPANY PROPOSALS

DRINKING WATER AND ENVIRONMENTAL QUALITY EA, EN + DWI advice to Secretary of State Company Preferred Strategy (CPS) + £36 (£6.9 bn) Using Ofwat reference assumptions Reference Plan A + £35 (£7.0 bn) Reference Plan B + £58 (£12.7 bn)

CAPEX TOTALS CPS£19.9 bn Reference Plan A£19.5 bn Reference Plan B£26.4 bn A constrained programme?£15.0 bn CPS elements: Quality£6.9bn Maintenance£9.0bn Security of supply£2.8bn Service improvements£1.2bn

OPERATING COSTS & TAX Operating costs: CPS forecasts increases in expenditure of 8% Pension costs account for about a third of this Other concerns include bad debt Inland Revenue changing the way it treats certain types of expenditure

FUTURE EFFICIENCY Scope for future efficiency is less than at previous reviews Companies’ estimates deliver a reduction of £10 (4% over 5 years) on the average bill We continue to refine our view on efficiency. Latest analysis suggests the efficiency savings will be less than the 3% pa assumed for draft business plans

ECONOMIES OF SCALE Perennial issue - Water Act completes new merger provisions Commissioned consultants to look at evidence for scale economies Technical report - not about Ofwat merger policy Any change would require new legislation

FINANCEABILITY A company’s cash flow, revenues and profits must allow it to raise finance on reasonable terms For some companies a significant element of price limits is to achieve their view of an acceptable financial profile Large capital programmes mean companies will not generate positive cash flows

COST OF CAPITAL WaSCs draft business plan estimates for WACC ranged from 5.2% to 5.8% All argued that the WACC used at PR99 was too low - too early to draw firm conclusions but no good case for setting below PR99 level To clarify - by this we mean 5.0%

NEXT STEPS Ofwat:company meetings to discuss draft plans Secretary of State principal guidance (roughly end January) Final business plans (7 April ’04 submission to Ofwat) Draft determinations (28 July ’04) (for consultation with WaterVoice and others) Final determinations (25 November ’04)

HANDLING UNCERTAINTY Future incentives Interim determinations of K Substantial effect Logging up/logging down

INTERIM DETERMINATIONS OF K (IDoKS) FOR applications this year - Anglian, Northumbrian, United Utilities and Bournemouth & West Hampshire Includes first two applications under the “substantial effect” clause (formerly the “shipwreck” clause)

WATER ACT 2003 (ROYAL ASSENT 20/11/03) Abstraction Constitutional change –WaterVoice –Water Services Regulation Authority (Ofwat2) –New duties Financial Penalties Competition

A SUSTAINABLE FUTURE? Continuing essential improvements to environment and drinking water. Infrastructure that continues to support high quality water and sewerage services. Stable companies which have the confidence of investors and the incentive to generate further efficiency. Customers who can see that increases in bills are justified by value.