External environment

Natural

Whether it's treating and delivering drinking water for our customers, or returning treated wastewater to rivers and the sea, the natural environment is fundamental to our business. We continue to invest to protect and, where appropriate, enhance the natural environment of the North West which, in turn, brings economic benefits such as underpinning the region's tourist industry.

We plan far into the future to ensure we are prepared for the changing natural environment, most notably the effects of climate change. With severe dry periods becoming increasingly common, we must ensure we continue to have resilient water resources and an infrastructure capable of moving water efficiently around the region. The potential effect of climate change on our future water resources is included in our 25-year Water Resource Management Plan.

We must tackle flooding incidents caused by the intensive bursts of rainfall which are becoming more frequent due to changing weather patterns. This was evident in December 2015, when Honister in Cumbria broke existing UK records for the most rainfall over a 24-hour period, with the consequential devastating flooding across the region. More details on the flooding incidents in December 2015 and how we responded are shown in the flooding and resilience business insight.

Additionally, we must ensure we are able to meet increased demand on our sewerage network as the regional population is expected to increase. A phased, long-term approach ensures that the necessary work can be delivered whilst not placing too much pressure on customer bills.

We have a responsibility to return water to the environment safely. Spills from our network can lead to pollution which can damage the natural environment and could lead to loss of reputation and financial penalties, depending on their severity. Our number of serious pollution incidents has decreased over recent years and it is an important area of focus within our 25-year Strategic Direction Statement. The Environment Agency assesses water companies' performance across a basket of measures including pollution and its overall assessment is included as one of our KPIs with all of the pollution sub-measures also reported within our Corporate Responsibility pages on our website.

We can make an important contribution to protecting and enhancing the natural environment by using fewer natural resources. We have been driving down our carbon footprint over the last decade (22 per cent fall in CO2 emissions since 2005/06) and have plans to reduce further going forward. Less than 10 per cent of our waste goes to landfill and our use of recycled products is increasing. We are increasing our renewable energy production with plans to almost double our renewable energy production from 2015 to 2020, the main contributor being solar opportunities. This will provide environmental benefits and add value to shareholders through energy cost savings.

Economic

Changes in the economy, such as inflation, interest rates or unemployment levels, can influence our ability to create value. Whilst outside of our direct control, we can mitigate some of the potential adverse impact associated with market movements, such as on inflation and interest rates, through our hedging strategies.

In recent years, unemployment in the North West has generally been higher than the national average. However, over the last year the North West unemployment rate has improved faster than the national average and is now broadly in line. A report from the Department for Communities and Local Government, published during 2015/16, reaffirmed that the North West continues to have more of the most deprived areas in England than any other region. Even as the North West economy recovers it is unlikely to have a significant impact on deprivation, which is the principal driver of our higher than average costs to serve our household customers. This is currently recognised by Ofwat through a special allowance for deprivation of £20 million per annum over the 2015–20 period.

Bad debts remain a risk to which we are exposed, particularly with the continuing tightening of real disposable incomes and the impact of recent welfare reforms likely to intensify. Whilst our debt management processes have been externally benchmarked as efficient and effective, we will continue to refine and enhance them whilst also helping customers back into making regular payment through use of manageable payment plans.

Interest rates have remained below the long-term trend and we have benefitted from this as we drew down or raised over £600 million of new debt in 2015/16. Comparatively low interest rates have also been beneficial to our future cost of debt as we continue with our interest rate hedging strategy.

Despite picking up recently to 1.6 per cent at March 2016, RPI inflation has been relatively low over the last couple of years, impacted by the falls in oil and commodity prices. The prices we charge our customers (and therefore revenues), as well as our asset base, are linked to RPI inflation, so lower RPI has meant slightly lower growth on these measures.

However, we also have a large quantity of index-linked debt which means our finance costs decrease as inflation falls, providing a partial economic offset to revenue (although this is not a perfect hedge as changes to revenue and index-linked finance costs are based on differing lagged measures of inflation). Our pension liabilities are also linked to inflation, which provides an additional economic offset against our asset base. Overall, we are currently more inflation-hedged than the other listed water and wastewater companies so we are better protected in a low inflation environment.

United Utilities' total forecast contribution to the regional economy over 2015–20 is estimated at £9 billion. Direct economic contributions from our activities include the purchase of goods and services and providing extensive employment. There is also an indirect economic contribution, for example when our suppliers, in turn, make purchases from their suppliers and when people whose jobs are supported by United Utilities spend their personal incomes.

Technological

Advances in technology can be used to help deliver improvements in the quality or cost of our service. Embracing innovation, using modern technology or techniques, is at the heart of how we do business. Our 'systems thinking' approach across the wholesale business is a key example of this.

We have also been utilising technology within our energy self-generation. For example, our Davyhulme sludge recycling centre employs a ground-breaking configuration of thermal hydrolysis to maximise energy generation from sludge and won an Annual Institute of Chemical Engineers award for innovation in 2013/14. During 2015/16, we built Europe's largest floating solar array system on our Godley reservoir, more details of which are shown within our business insight.

We also have to be mindful of our customers' ever increasing use of technology. We have recognised the increasing power of social media as communication channels for customers in doing business with us and we recently completed investment in a new digital external communications capability and a number of website improvements. This proved invaluable in handling the unprecedented increase in communication necessary with customers during the Lancashire water quality incident in summer 2015.

Technological advances give rise to greater risks as well as presenting opportunities. Cyber-crime has been on the increase in recent years and, as the holder of customer information, is a threat we take very seriously.

Business Insight

Systems thinking

Underpinning our improving operational performance is our drive toward 'systems thinking' based on four key themes:

  • improving the reliability of our assets with the object of reducing unplanned, and therefore costly, service interruptions;
  • improved use of data at local asset level and centrally for performance optimisation;
  • adopting a systems approach to our regional water system and wastewater drainage areas to optimise cost and service performance; and
  • resource allocation to production teams with full accountability for asset and system performance.

We are investing in this regulatory period in our new wholesale operating model and are progressing rolling out of this radically different capability. Our production line model is well established and last April we opened our new integrated control centre (ICC). This is increasingly becoming a central hub for planning and control of our operations and proved to be a tremendous asset during our handling of the major incidents we had to address last year.

Our new telemetry backbone has been successfully installed across our estate with only a small number of sites to complete. This provides the 'data highway' between our sites and the ICC, enabling enhanced monitoring and intervention.

We have full regional production planning up and running for both water production and sludge processing, supported by more enhanced decision-making systems capability at site level.

We are in the final stages of testing of our new maintenance system, providing more effective tasking of field engineering. We have also improved asset availability.

And, we are also using more sensors in our network and better analysing other data, such as weather forecasting, to help reduce costs and improve operational performance and, importantly, prevent issues before they impact the customer.

This is all supported by our digital strategy in which we have already seen our IT systems overhauled and for which data and its exploitation becomes central to our thinking.

Our 'systems thinking' approach is expected to deliver benefits of over £100 million across the 2015-20 regulatory period, which were already built into our business plan assumptions.

Political and regulatory

Over a long time frame the political and regulatory environment can change significantly. In the 27 years since the water industry was privatised by the UK Government, we have seen substantial tightening of laws and regulations. Whilst to some extent, changes to the regulatory environment are outside of our direct control, maintaining a good reputation is important to enable positive participation in regulatory discussions. By positively engaging and using our industry knowledge, we can help influence future policy with the aim of achieving the best outcome for our customers, shareholders and other stakeholders.

Economic regulation

The water industry currently operates within five-year planning cycles known as Asset Management Plan (AMP) periods. Prior to the start of each five-year period, companies submit their business plans which include their projected expenditure in order to enhance and maintain their assets. Following review of these plans, Ofwat sets the prices each company can charge their customers across the period. We have just finished the first year of the 2015–20 (AMP6) period.

Ofwat introduced a number of important changes for the 2015–20 price review, with the aim of evolving the sector in order to meet future challenges and placing greater focus on customers' needs.

Moving away from one single price control, there are now four separate price controls:

  • wholesale water, covering the physical supply of water;
  • wholesale wastewater, covering the removal and treatment of wastewater;
  • domestic retail, covering customer-facing activities (principally customer contact, billing, meter reading and cash collection) for household customers; and
  • business retail, covering customer-facing activities for business customers.

Ofwat (the Water Services Regulation Authority) is the economic regulator of the water and sewerage sectors in England and Wales, responsible for ensuring the companies provide customers with good-quality, efficient service at a fair price.

Separate retail price controls should provide retail businesses with greater incentives and focus on delivering more efficient service to business customers as competition expands, and also to household customers under a new industry average cost to serve approach.

The way companies' operating and capital costs are assessed has been modified to encourage companies to utilise the most efficient, sustainable solutions under a new 'totex' model. Where companies outperform their totex allowance, this gain would be shared between investors and customers, ensuring both receive the benefit.

There was also a move to a more outcomes-based approach, with greater emphasis being placed on customer engagement to agree the outcomes. Companies' performance will be measured through a range of outcome delivery incentives (ODIs) covering a wide range of measures assessing operational and environmental performance, with associated rewards or penalties.

Ofwat's SIM assessment is continuing, which will reward companies who perform well on customer service, or penalise companies who perform badly, relative to other water companies.

Each year all water companies are required to publish an annual performance report, the first of which is due in July 2016 and our report will be made available on our website at corporate.unitedutilities.com.

Changes in regulation opening up the competitive arena

Currently only very large business customers are allowed to choose their water supplier. Under this arrangement, the new water supplier would buy water directly from the regional water company and be allowed to use its network for this water supply. Although very few users have switched supplier in England, the 2014 Water Act aims to open up future retail competition to all business customers, including sewerage as well as water services from 2017. We are well positioned for this expansion of competition following our experiences in the Scottish market and our recently announced joint venture with Severn Trent, combining our business retail businesses (see Our performance 2015/16 for more details on this joint venture).

Following a request from government, Ofwat is currently assessing the potential costs and benefits of extending retail competition to household customers, with a paper scheduled to be published in the next few months. Ofwat expects to factor in the UK Government's conclusions and decisions in this area at its next price review in 2019.

The Water Act also paves the way for the future introduction of competition for certain parts of the wholesale, or upstream, business. Following this, Ofwat proposed, in its Water 2020 consultation document in December 2015, to open up competition in the areas of water resources and sludge treatment from 2020. We are fully engaged with regards to market reform, being always mindful of the potential impact on our customers and the value implications for our shareholders.

Environmental and quality regulation

The water and wastewater industry in the UK is subject to substantial domestic and European Union regulation, placing significant statutory obligations on water and wastewater companies with regard to, among other factors, the quality of drinking water supplied, wastewater treatment and the effects of their activities on the natural environment.

Defra is the UK Government department responsible for water policy and regulations in England and Wales; it also sets drinking water quality and environmental standards (many based on European law) which water companies must meet.

www.gov.uk/defra

The Environment Agency controls how much water can be drawn from the environment and the quality of water returned to rivers and the sea. The EA produces an assessment of water and wastewater companies' annual performance, and we include this as one of our KPIs.

www.gov.uk/government/organisations/environment-agency

The Drinking Water Inspectorate is responsible for ensuring compliance with the drinking water quality regulations.

www.dwi.gov.uk

Natural England is responsible for the protection of designated sites for nature conservation, for example Sites of Special Scientific Interest. Companies are required to manage these sites and to protect and enhance biodiversity.

www.naturalengland.org.uk

The Consumer Council for Water (CCW) represents customers' interests relating to price, service and value for money. It also investigates customer complaints. Customers who remain dissatisfied can refer their complaint to be adjudicated by an independent service, WATRS (see below). www.ccwater.org.uk
WATRS is an independent service designed to adjudicate disputes that have not been resolved through the water company's customer service teams or by referring the matter to the Consumer Council for Water. www.watrs.org

Social

We see some significant societal trends that we plan to address in our long-term strategy. We anticipate an increase in the North West population of around 600,000 by 2040 (more than the population of a large city such as Liverpool). We are planning to ensure our services and supporting infrastructure meet the needs of this growing population, which will include a higher proportion of older people. The North West remains the most socially and economically deprived region in England and so we can anticipate continued hardship for a number of communities and difficulties for some customers in paying their bills. We will remain committed to supporting these customers through a suite of payment assistance schemes and looking at new ways to help, like the introduction of our social tariff in 2015, supporting elderly customers. We are also adapting to the increasing use of social media from our stakeholders.

The communities in which we operate are of great importance to our business – it is where our customers and employees live and work. We continue to invest in our local communities both financially and through employee volunteering. We recognise the effect that our operations can have on the community and invest in programmes that support affected areas or help tackle current social issues.

Pictured: Outreach manager Carole Quinn (right) from United Utilities and Moira Osborne from Age UK Rochdale help to promote our new social tariff (entitled 'Help to Pay'). The scheme caps water bills for low income pensioners who may be struggling to pay their water bill and our partnership with Age UK Rochdale is helping to increase awareness of our social tariff directly to those customers who will benefit from this scheme.