WWU’s View on Operating Costs Workshop - Analysis and Assessment

1. GDPCR Costs WorkshopWWU’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’

4. Significant Features • 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

7. Opex BPQ Forecast

8. Forecast Assumptions and Process - Opex • 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)

9. Assessment • Different Drivers – Different Environment – for example • London – London Weighting, congestion, customer density (high) • WWU – geography, customer density (low), more assets all = higher costs

10. Network Features • 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.

11. Opex Cost Pressures • 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.

12. Assessment Assessment Starting point: - Needs to recognise cost reductions already made:- Net Change in Controllable Costs 2005/6 to 2007/8 NG DNs Scotia DNs 8 • We did not delay cutting costs • Amongst other things we: 6 Northern 4 2 0 £m Wales & West -2 -4 -6 -8 • Reorganised three head office locations into one • Came off NG contracts early • Brought Connections in-house • Renegotiated EPC rates • Pushed more work onto the Direct Labour force • Streamlined the organisational structure

13. 2006/07- Regression of Direct Opex vs Length

14. Indirect Opex – Main Points • 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.

15. LECG benchmarks used for WWU

16. Total Opex- Europe Economics Economics • 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.

17. 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

18. 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

19. Appendix 1 - Key Statistics • 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