Ofwat announced on Monday that Affinity Water was one of only two companies to prequalify for “enhanced” status at PR14. The regulator set the bar high and deemed only Affinity Water and South West Water to have delivered outstandingly against its tests for outcomes, costs and affordability, and to have demonstrated robust board assurance.
This is a huge achievement. The company now has until this Monday (17th) to announce how its business plan squares with the risk and reward package Ofwat put forward in January. Crucially, this will mean accepting the regulator’s prescribed weighted average cost of capital (Wacc) of 3.85 per cent; the number in Affinity Water’s December business plan was 4.3 per cent.
I interviewed chief executive Richard Bienfait before Monday’s announcement and asked if a 3.85 per cent cost of capital would be acceptable. Bienfait was understandably unwilling to be explicit at that stage, but hinted enhanced status would be an extremely valuable prize. “I can’t really answer that question,” he said. “But I will say we are ambitious to be enhanced.”
He also indicated the company wasn’t viewing its business plan as a closed book: “We’re reviewing our risk and reward and our Outcome Delivery Incentives (ODIs) as we speak,” he confirmed. Affinity Water’s ODIs as specified in December are heavily skewed to the downside. Of 13 measures to deliver four key customer outcomes, only two have positive financial reward possibilities: the standard Service Incentive Mechanism and a leakage measure (+1.06 per cent to -1.67 per cent), which Bienfait said reflects the strength of customer feeling on that issue (see below).
He also displayed confidence in Affinity Water’s credit rating in light of Ofwat’s tougher reward numbers – a pertinent issue for the company, given it is 80 per cent geared following a whole business securitisation last year. “We are looking at the numbers Ofwat has published; we know our own ratios; we have our own projections and we know our own rating and I don’t have concern for our rating,” he asserted.
So what are the stand-out features of Affinity Water’s outstanding business plan? Its board assurance statement is extensive, explicit and robust. Like many companies, its customer engagement programme has been deep and wide, reaching some 12,500 consumers. In particular it undertook repeated willingness-to-pay research where customers could express opinion on a range of price scenarios.
In the end, and despite achieving very high levels of acceptability (91 per cent) for a modest price rise, the company put forward a price cut of £5.70. This takes the average pre-inflation 2014/15 bill of £165.20 to £159.50 in 2019/20. Was the move to cut prices politically driven? Bienfait said: “We didn’t feel a single pressure there, but of course we felt pressure from all our stakeholders, including our customers… The good thing about what Ofwat has aimed to do this time around is to say ‘your business plan is a best and final’… We put ourselves in the shoes of having to look and scrutinise. We wanted to do the right thing and get the right balance. We think we got it right.”
Meanwhile, customers told Affinity Water that while they didn’t want the level of service they are receiving in the current period to fall in AMP6 (even if this meant cheaper bills), nor were they willing to pay more for service improvements. The company responded by proposing a higher level of investment in 2015-20 than in 2010-15, despite the bill cut.
Bridging the gap between lower bills and increased investment will be efficiency savings of £106 million – some 10 per cent of operating costs and base capital maintenance costs. Bienfait played his cards close to his chest on how these savings are going to be made, other than to cite thorough planning and to say that reducing error and serving customers well have significant positive effects on costs. However, he admitted the efficiency number poses a challenge: “We’ve had some quite heated discussions within the company as to ‘can we do this, can’t we do this’. It will take hard work and good planning. 2014/15 for me is about making sure we fulfil our AMP5 commitments, but also that we’re ready for AMP6.”
Another interesting element of the plan – and one that Ofwat singled out as innovative – is a vision to be “the leading community-focused water company”. What does this mean? There are eight water resource zones in Affinity Water’s patch. Bienfait explained each zone is regarded as a “community” and that going forward, the focus of much of its programme delivery and stakeholder engagement will be at community level – with local MPs, councillors, community interest groups, customers and so on.
This close attention to detail is a response to extremely pressing supply/demand and resource management challenges. All three of Affinity Water’s areas are classified as in “serious water stress” and yet face rising demand from population growth of 4 per cent to 3.72 million by 2020. This challenge is increased because, under the National Environment Programme, the company needs to reduce abstraction from particular sources susceptible to damage (typically chalk-based rivers that suffer harshly during dry periods).
It has consented to reduce daily abstraction over AMP6 (2015-20) by 42 megalitres, to be followed by a further 27Ml reduction in AMP7. Bienfait commented: “42Ml, compared to the 900Ml per day we put into supply – it’s a significant chunk, 4-5 per cent of the abstraction we use. So we will have demand rising and supply will be falling. Today we’re in balance, but in 2016/17 we’re not… well, that’s if we did nothing.”
Clearly the company is not planning to do nothing. As well as increasing supply – primarily through greater interconnection with neighbours such as Thames Water – much of the £505 million investment programme it has earmarked for AMP6 (up from £454 million this period) is concerned with managing demand. This includes plans to reduce leakage by 14 per cent (increased from an initial proposal of 10 per cent after fierce customer feedback), via renewing 82km of trunk and 482km of distribution mains. And introducing universal metering in four zones, involving the installation of 280,000 AMR units backed up by extensive consumer education and efficiency activity.
Those moved on to meters will be able to opt to remain on unmeasured charges for up to two years, to ease the transition. Bienfait also raised that from next month, some of those who struggle to pay their bill will be able to apply for a new social tariff, called “Li£t”. “It’s a ‘help-customers-pay’ tariff… a discounted tariff,” he explained. “We are directing to households with less than £15,800 income and who are on a form of Work and Pensions benefit. It is cross-subsidised – we had 80 per cent support from our customers for this. To begin with it’s going to be a 40p cross-subsidy, but over three years as we believe it will pick up, it will be £1.50 on a £160 bill.”
Also next month we will see how Affinity Water responds to Ofwat’s recently published principles on board governance – another pertinent issue for the company, given it is privately owned by institutional investors (see box). It is working on a governance code and has until the end of this month to present it.
The Affinity Water board’s assurance statement in its business plan offers a robust defence of its current governance (as well as its tax) arrangements: the company, it says, meets the requirements of the UK Corporate Governance Code except in that at least half the board excluding the chairman are not independent non-executives. But it argues no single group can dominate decision making and that its board “has the appropriate balance of skills, experience, independence and knowledge” to effectively discharge its obligations.
Bienfait was tight-lipped. He said Affinity Water is committed to high levels of transparency and good governance, so is supportive of Ofwat’s motives, but that: “It’s a pretty sensitive issue as to how companies will follow Ofwat’s principles and we will make our approach clear at the end of March.”
Finally, we turned to retail competition. Bienfait said Affinity Water is keen to participate in reforming the market and will work hard to be its customers’ choice of supplier. There are around 70,000 businesses in its areas, including 60,000 SMEs and 1,500 5Ml+users.
According to Bienfait, it is currently “preparing plans for getting ready”, although many of its existing practices in the business market effectively amount to a start. He gave the example of the company’s internal business market SIM, so “we can track our trend, and we can look to which customers we don’t give a great service to and which customers we are”. There are also new moves afoot, such as an intention to develop a business customer charter and new innovative tariffs.
The focus appears to be initially on retention, although Bienfait didn’t shut the door on acquisition. “We’ll be making sure we’re ready to perform within our area – and maybe outside our area,” he concluded.
Bienfait and Veolia/Affinity Water
Serving a population of 3.5 million in three geographically separated areas in southeast England, Affinity Water is the largest of the water-only companies. It was formed after Veolia sold its three separately managed water businesses to the current owners in June 2012; a month later, a programme to integrate the companies via common IT platforms and business systems began. The entity was rebranded as Affinity Water in October 2012 and is now viewed as a single comparator by Ofwat.
Richard Bienfait joined Veolia Water in 1997 as group financial controller. He was chief financial officer for the six years from 2004 and became managing director of the largest of Veolia’s regulated water businesses, Veolia Central, in 2010 as part of a new management team brought in to deliver a challenging PR09 settlement.
Affinity’s owners are: Infracapital Partners II (40 per cent); Morgan Stanley Infrastructure Partners (40 per cent); Beryl Datura Investment (10 per cent); and Veolia (10 per cent). Bienfait said the change in ownership has brought “fundamental change” in terms of the level of scrutiny the management team is under and the pressure to deliver. Far from only being in the investors’ interest, though, he said customers are benefiting too: “They take a very precise view of the business. They are very keen we provide great service to our customers. They know that if we don’t provide great service, that goes straight to the value of the business.”