Welcome to bioresources form of control workshop (These slides were - PowerPoint PPT Presentation

Welcome to bioresources form of control workshop (These slides were used to promote discussion and do not represent confirmed policy or company positions) 17 January 2017 Trust in water 1

Agenda Agenda Item Time 1 Introductions 10:30 to 10.40 Bioresources RCV allocation – progress and next steps 2 10:40 to 12:00 Iain McGuffog, David Young, Reckon 3 Coffee break 12:00 to 12:10 Bioresources form of control: Volume measure 4 12:10 to 13:10 Alison Fergusson, Khaled Diaw 5 Lunch 13:10 to 13:50 Bioresources form of control: discussion points 6 13:50 to 15:00 Facilitated by Khaled Diaw, Thames Water and Welsh Water. Trust in water 2

Update on RCV allocation for bioresources Iain McGuffog 17 February 2017 Trust in water 3

Today Introduction Presentation from Reckon Discussion groups on some of the key questions for our consultation Trust in water 4

Why In May we set out the four main reasons for considering a focused allocation of the RCV to be beneficial: Ensuring a level playing field for sludge transport, treatment, Ensuring a level playing field for recycling and disposal so that wider markets and protecting the third-party service providers interests of wastewater have clarity and confidence that customers where WaSCs are they are participating in markets involved. on equal terms with incumbent companies. Avoiding over-recovery of gains Maintaining consistency from legacy asset between charges and cost sales/purchases by incumbent recovery. companies. Trust in water 5

Background At the working group on October 20 we discussed: • some of the different valuation approaches (roll forward of PR09, company valuing assets or processes, standard cost exercise) • the trade offs between precision and simplicity, in terms of cost accuracy and consistency between companies • some of the key valuation challenges, such as what assets/processes are valued and costing topics such as land Today: • Update on RCV allocation • Presentation from Reckon on their work • Early discussion on key topics for our consultation on the bioresources valuation guidance Trust in water 6

Change in context for valuation • The PR09 MEAV valuation focused on the context – role in building blocks of price setting with an overall comparison of non-infrastructure depreciation and maintenance expenditure • Much has changed since then – the context for this valuation is different • PR14 approach to RCV run off • Bioresources trading and markets Trust in water 7

Information Notice 17/01 (bioresources) • We propose to collect information from companies on the valuation of their sludge transport, treatment and disposal assets and how this relates to its economic value in advance of the submission of PR19 business plans • Use upstream services definition in RAG 4.06 • Valuation for 31 March 2020 When What Early March Consultation on guidance 2017 Early April 2017 Consultation closes on draft guidance Late April 2017 Ofwat publishes decision on guidance By 29 Companies to submit bioresource asset valuation and RCV allocation September 2017 plus assurance information to Ofwat January 2018 Ofwat provides feedback to companies on their asset valuation and proposed RCV allocation to inform their PR19 business plans December 2019 Ofwat decision on RCV allocations as part of PR19 final determinations Trust in water 8

Bioresources RCV allocation Presentation to Ofwat Form of control workshop , 17 January 2017 Nicholas Francis – Partner, Reckon LLP

Background to the RCV allocation Allocation of wastewater RCV between sludge and network plus Part of package of initiatives to help unlock potential for markets to play greater role in activities relating to sludge treatment and disposal Separate price control for sludge (hence RCV allocation) • Average revenue control for PR19 • No RCV guarantee on post-2020 investment • Measure to increase extent of market information available • Ofwat decided to make sludge RCV allocation on focused basis Means that sludge RCV not driven by value of historical RCV and not • distorted by any privatisation discount

Objectives for the focused allocation Ofwat wants to ensure that sludge RCV reflects the economic value of sludge assets and that sludge charges reflect capital costs Several benefits envisaged Ensure that competition in wider waste markets not distorted by • unduly low pricing by water companies who can provide services using assets financed through the RCV Send the right price signals to service providers who may be able to • participate in markets for provision of sludge services to a wastewater company Protect against the risk of unfairly transferring value from customers • to investors

Reckon/Jacobs project for Ofwat Ofwat commissioned consultancy support in late November 2016 Project team led by Reckon , supported by Jacobs • Mix of regulatory economics, accounting and engineering expertise • Main elements Conceptual work – what should asset valuation represent? • Review of high-level approaches • Work through practical questions for valuation methodology • Contribute to guidance for consultation • Final report - end January 2017

Economic value concept Economic value of a set of assets depends on the value that can be generated by using (or selling) those assets For sludge assets, several sources of revenue Treatment and disposal of wastewater sludge ( price controlled ) • Energy generation (market prices) • Sale of sludge by-products / biosolids (market prices) • Circularity arising from price controls for sludge PR19 / beyond Make assumption about regulated prices to resolve circularity • Prices under hypothetical assumption of effective competition from new • market entrants (using newly built assets)

Calculation of economic value

What we envisage • Clear methodology for calculation of economic value – Builds on net MEAV concept from PR09 / RAG 1.05 – Tailored to purposes and risks for sludge asset valuation • Valuation led by companies, subject to Ofwat review • Common industry-wide template – Exposes key calculation steps – Enables more like-for-like comparisons between companies Rules/guidance on a series of practical questions and issues •

Practical issues we’re working through Costing new-build assets Site configuration • Adjustments for remaining Processes to be costed • economic life of actual asset Choice of technology/process • Purpose of adjustment • Treatment of non-appointed assets • Potential approaches • Assumed level of capacity • Level of granularity • Land values • Asset age vs condition • Link to company/reg. accounts • Adjusting for differences between actual and hypothetical assets Other issues Adjustments for revenues • Timing of valuation / updates • Adjustments for O&M costs • Shared services / M&G • Treatment of energy generation • Tankers and transportation • Time horizon for adjustments • Liquor treatment • Discount rate • Grants and contributions •

Discussion groups on approach Peter Jordan Trust in water 17

Guidance Objective is to get a consistent approach to bioresource valuation Emphasising company ownership of proposed valuation and RCV allocation – other options would have less flexibility Enables Ofwat risk based review and proportionate intervention – customer protection and enabling efficient trading Introduction – why allocate Approach – set out the principle of economic value Process – consult on our view on the key assumptions and set out the practical process steps that we expect, e.g. Step 1 Step 2 Step 3 Step 4 Step 5 Define the Establish Reflect the Consider Propose Modern the current cross and Equivalent economic assets checks explain value approach Information and assurance – tables and information with governance expectations Trust in water 18

Illustration – current MEAV v economic value Trust in water 19

Summary of approach – reflected in tables and information Processes you Arrive at a net Cost of hypothetical Adjust hypothetical would build as if you economic value of new asset: new assets to reflect were a hypothetical the current assets = differences in new entrant to focused valuation of Gross valuation economic value of provide same RCV at 31 March Book life actual assets regulated service 2020 Cross check against: Economic value: Modern equivalent Company led PR09 valuation roll assets for: Discounted costing using a forward? consistent difference of cost Same service at site and income approach to other Cost and condition Location companies of current assets? Time period over which current Backwards look – assets deliver value historic expenditure / statutory accounts Valuation includes: Forward looking concept: Consistency If valuing current Land between charges assets as at 31 On costs Consistent with and cost recovery March 2017, roll Infrastructure sludge strategy (e.g forward to 31 Non site costs such approved plans, Sufficient revenue March 2020 with as vehicles recent build implied for expenditure net of Common costs e.g. choices) maintaining actual depreciation IT, offices assets M&G Trust in water 20