GDPCR Costs Workshop WWU’s View on Operating Costs Bob Westlake 19 th April 2007.

GDPCR Costs Workshop

WWU’s View on Operating Costs

Bob Westlake

19th April 2007

2

Agenda

• Introduction to WWU

• Network Characteristics

• BPQ Forecasts

– Capex

– Repex

– Opex

• Main Assumptions

• Opex

– Assessment – Cost Pressures

– Factors

– Setting Allowances - Direct- Indirect

– Future Efficiencies

– Conclusions

3

Introduction to WWU

Wales & West Utilities (WWU)

• 1 of 8 RGN’s - 4 sold by National Grid Transco in 2005

• Turnover £240m, 2.4m connections, deploys c2200 people

This contrasts with; (approx numbers)

• Northern Gas Networks £275m

• Scotia Gas Networks £615m

• National Grid Gas £1.5bn

‘The gas distribution sector now has companies with very different scale and operating strategies’

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• Operating region is 27% of England and Wales, but with only15% of the population

• Difficult access given geography and road networks (e.g. drive fromnorth to south is over 9 hours).

• Length of LTS Network is 3.3 times national average per customer

• Distribution mains length per customer in Wales is 14% above national average

Significant Features

5

WWU October 2006, Net CAPEX Submission (2005/06 Prices)

Figures = Net Capex + Capitalised Overheads

08/09 09/10 10/11 11/12 12/13 Total

LTS and Storage 16.0 44.2 29.3 11.9 9.6 111

Connections 8.7 9.1 9.4 9.7 9.8 46.7

Mains Reinforcement 5.5 10.2 6 6.3 6.5 34.5

Governors 1.9 2 1.9 2 1.6 9.4

Other Operational 8.3 7.4 5.2 4.9 3.7 29.5

Non Operational 20.1 9.8 9.7 17.8 18.4 75.9

Total Net CAPEX 60.5 82.7 61.6 52.5 49.7 306.9

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08/09 09/10 10/11 11/12 12/13 Total

Mains 40.1 45.8 50.1 53.8 57.8 247.7

Services 27.2 28.2 29.3 30.4 31.5 146.7

LTS 1.6 12.6 8.4 7.7 6.2 36.4

Total Net CAPEX 68.9 86.7 87.8 91.9 95.5 430.8

WWU October 2006, Net REPEX Submission (2005/06 Prices)

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Opex BPQ Forecast

£million 05/06 prices 04/05 05/06 06/07 07/08 08/09 09/10 10/11 11/12 12/13

Direct cost 54.4 59.4 53.7 59.8 61.6 64.3 63.1 62.3 62.7

Indirect cost 20.7 23.2 25.9 24.2 24.5 24.9 25.3 25.7 25.9

Total Controllable 75.1 82.6 79.6 84.0 86.1 89.2 88.4 88.0 88.6

Shrinkage 6.9 11.6 11.3 11.3 11.3 11.3 11.3 11.3 11.3

Xoserve 0 2.8 3.5 3.2 3.1 3.1 3.1 3.1 3.1

Total 82.0 97.0 94.4 98.5 100.5 103.6 102.8 102.4 103.0

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• Direct labour wage costs to increase by RPI + 2.0%

• Material costs to increase by RPI + 2.5%

• Contract labour costs to increase by RPI + 4.5%

• Maintenance workload based on WWU policies and procedures

• Emergency & Repair forecast workload is based on our best

estimates taking into account historical information, average

system pressures and the mains and service replacement programme.

• No increase in Standards of Service

• GSMR requirements to remain constant (no enforcement of “12 hour”

rule)

Forecast Assumptions and Process - Opex

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Assessment

• Different Drivers – Different Environment – for example

• London – London Weighting, congestion, customer density (high)

• WWU – geography, customer density (low), more assets

all = higher costs

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• Greater length of pipe means:

• more inspection work• more emergency work • more repairs• more materials

• More work requires:

• more people

• more vehicles

• more travel time• more time for working

• more records

• This effect also puts a cap on the potential efficiencies that can be achieved.

Network Features

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• Environmental spend – clean up of contaminated sites – WWU statutory liability in excess of £25m.

• c. £6 m of costs already removed from WWU business in 06/07

• Landfill tax increases of £8 per tonne for next 4 years – will be £53 tonne in 10/11

• Traffic Management Act – potential costs of £5m per annum (not part of BPQ costs)

• Age profile of Industrial workforce requires investment in recruitment and training

• Skilled labour shortage – NTS pipeline projects and major construction schemes pushing up contract prices.

Opex Cost Pressures

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Assessment

• We did not delay cutting costs

• Amongst other things we:

Net Change in Controllable Costs 2005/6 to 2007/8

NG DNs Scotia DNs

Northern

Wales & West

-8

-6

-4

-2

0

2

4

6

8

£m

• Renegotiated EPC rates

• Pushed more work onto the Direct Labour force

• Streamlined the organisational structure

• Reorganised three head office locations into one

• Came off NG contracts early

• Brought Connections in-house

Starting point: - Needs to recognise cost reductions already made:-

Assessment

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2006/07- Regression of Direct Opex vs Length

Direct Opex (inc Shrinkage) V's Network Length

WWNE

WM

ScLo

NW

EE

SEy = 0.0018x + 11.565

R2 = 0.78

30

40

50

60

70

80

90

100

110

120

130

20000 25000 30000 35000 40000 45000 50000 55000

Total Length, km

Dir

ec

t O

pe

x 2

00

6/0

7,

£m

Y Total Direct 2006/07 £m Linear (Y Total Direct 2006/07 £m) Linear (Upper Quartile)

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• LECG cherry-picked a combination of external and internal benchmarks

throughout the report creating an artificially efficient GDN.

• It is too early to effectively benchmark GDN’s internally due to the short period

that the management teams have been in place.

• External benchmarks should be used for Indirect Opex Costs as they are

independent and represent best practice in private industry. WWU has

commissioned an independent study of appropriate external benchmarking.

• WWU has built the management and support functions from scratch with no

inherent inefficiency.

Indirect Opex – Main Points

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LECG benchmarks used for WWU

Support Services, £m BenchmarkLow

Savings, £m

High Savings,

£m

IS IS costs as a % of adjusted revenue 0.12 N/A

Finance & Audit F&A costs as a % of adjusted revenue 0.17 1.36

Regulation R costs as a % of total op costs 08/09-12/13 0.06 0.06

Insurance Insurance premium as a % of revenue 0.00 0.00

Property Management Total property costs per sq ft floor space 0.00 0.00

Corporate Centre & Comms

C&C costs as a % of total cont & non cont Opex 06/07 0.04 0.19

HR HR costs as a % of total adjusted revenue 06/07 0.00 0.28

Legal legal costs as a % of total adjusted revenue 06/07 0.00 0.00

Procurement & Logistics L&P costs as a % of total opex. 0.00 0.00

Total   0.39 1.89

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• WWU support the use of 2006/07 data, 2005/06 is not fully representative.

• Network length as a cost driver must be included.

• The NISEC02 data set for the TFP analysis is outdated and does not

reflect current UK productivity trends and has a 7 year credibility gap as it

ends in 1999.

• Too many assumptions made without supporting evidence – placing

considerable doubt on the output.

• Privatisation effect does not exist over 20 years on.

• Future savings not credible.

Total Opex- Europe

EconomicsEconomics

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Future Efficiencies

• Privatisation over 20 years ago - inconceivable there is still a

privatisation effect

• Why are utilities expected to out perform private industry?

• RPI captures efficiencies in the economy as a whole – therefore to

match economy efficiency need to match RPI

• To outperform RPI is to out perform private industries – no sound or

credible basis for this presumption

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Conclusions

• Direct opex is driven by geography, network characteristics, customer density and levels of performance, therefore network length must be taken into account

• Indirect opex is suitable for benchmarking, should be assessed externally against best practise

• Economies of scale are real and exist

• Top down regressions useful cross check

• Must use appropriate drivers and normalised 06/07 costs

• Future efficiencies should match RPI

• Can not expect utilities to constantly outperform general economy cost efficiencies in perpetu

• Future allowances must recognise legitimate cost pressures

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• 2,400kms of Local Transmission Pipelines

• 15 NTS Offtakes + 2 proposed as part of SW Reinforcement

• 316 LTS Pressure Reduction Stations and Above Ground Installations

• Holders – 15 HP vessels on 3 sites – 20 LP holders on 15 sites

• 3,478 District Governor Installations

• 95,000 Internal Public Reported Escapes per annum

• 24,500 External Public Reported Escapes per annum

• 19,200 Mains and Service Repairs per annum

Appendix 1 - Key Statistics