Water UK Asset Management Conference 2003

1. Water UK Asset Management Conference 2003 Capital Maintenance Expenditure During AMP4 - Balancing CAPEX and OPEX Frank Grimshaw Economic Regulation Manager Severn Trent Water

2. Asset Maintenance - Why It Is Key Value, Reliability Reliable Services Reasonable Prices Competitive return for level of risk Ofwat Investors Customers High standards, low risks Asset Stewardship to deliver Value Services Quality regulators Government Operators No Govt funding, no service problems, stable prices High value dependable services Careful Balance needed to Secure Continued Low Cost Dependable Services

3. The Need to Balance Capex and Opex • Ofwat, MD161 - “Each company needs to demonstrate how the flow of services to customers can be maintained at least cost in terms of both capital maintenance and operating expenditure” • UKWIR - Capital Maintenance Planning: A Common Framework “Since the Common Framework has as its basis the assessment of an economic level of capital maintenance, it is necessary to consider operational measures to address service deficiencies on a common basis alongside capital interventions”

4. Obligation to Maintain Assets • Licence Obligation - to maintain assets in a condition which enables it to carry out its obligations • Ofwat - “Companies are required to maintain their assets so that they can provide services to current and future customers” Obligation is to achieve required service levels - but opex must not be used to cover a capex shortfall if this is not economic in the long term

5. Where should opex-capex trade-offs be considered? • Unlikely to be economic for the worst condition assets, where probability of failure is high • May involve too much risk for assets with high consequence of failure Careful Balance needed to Secure Continued Low Cost Dependable Services

7. Example - Water Mains • Leakage and mains bursts increase with mains age • Maintain service at least cost: • balancing leakage detection and control and mains replacement • balancing mains replacement and operational interventions to achieve interruptions to supply targets

8. Natural Rate of Rise of Leakage increases with mains age

9. With other factors the same, Natural Rate of Rise of Leakage can be plotted against mains age

10. Leakage control costs increase with mains age

11. Minimising Costs • Analysis estimates appropriate average mains age, and associated mains replacement, to minimise total costs and achieve the leakage target. • Comparison of operating costs v mains replacement for interruptions to supply target • Mains replacement focused according to age, material and impact on leakage and interruptions to supply

12. Above-Ground Assets • Likelihood and consequence assessment at individual asset level based on: • asset design and past history of asset failure • availability of “back-up” processes • impact on service delivery • number of customers affected and duration of impact • likelihood of regulatory / legal sanction • Opex - capex trade-offs appropriate where risk is acceptable

13. Above-Ground Assets • Is the data available on opex changes with deteriorating assets? • Filling data gaps • cross-sectional analysis rather than time series • pooling data

14. Conclusions • Opex - capex trade-offs an important part of establishing the economic level of maintenance • But they don’t need considering in every case - only appropriate where level of risk is acceptable, and not for worst assets