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Is the water sector under too much pressure from the regulator?

24 May 2018
The water industry is facing multiple complex pressures as it enters its next regulatory period – not least from the regulator. Jason Jones outlines the key issues  to be discussed at next month's ICE AMP7 workshop.
Is the water sector under too much pressure from the regulator?
Some of the complex pressures facing the water industry are apparent even to the general public.  Most recently, the severe winter weather caused by the ‘Beast from the East’ resulted in customer service disruption for some – in weather situations that were particularly difficult for more vulnerable water customers.  

Additionally, the ’Beast’ seemed to occur after periods of unseasonably warm weather.  The need to meet customer needs in such changeable weather is a pressure evident to both water sector professionals and  consumers alike.

Record breaking fines, financing debates and 25 year plans

There have also been record breaking fines imposed for pollution incidents – the most recent for £20.3m.  Water professionals have long expected that it was a question of ‘when, not if’ large increases in fines would occur.  Nonetheless, the fact that these are actually being imposed means that a potential pressure, with significant financial and investment implications, has now become very real.

Perhaps the most contentious issue in the public domain is that of some water companies’ financial issues, including financing models.  The size of dividends paid to shareholders, the size of executive pay, and the complex corporate structure of some organisations, have all been subject to political and media attention.

Ofwat has indicated it will take a tough stance on the cost of capital, a key enabler of financial returns to shareholders.  

Some companies have seen the establishment of non-trading subsidiary organisations in low tax domains as necessary to access low cost debt funding. Recent research by First Economics suggests that the additional efficiencies achieved by the privatised companies compared to those still publicly owned more than covers the dividends.  However, political and media interest in these issues continues and Ofwat has indicated that it will take a tough stance on the cost of capital.

At the same time government has proposed the introduction of 25 year plans for the environment.  The water sector already has 25 year strategies and water resource plans so although 25 year ‘environment plans’ are a welcome development these could have particularly marked effects on the way the water sector needs to perform and manage its assets in future.  

Regulatory context

Even without any new requirements from the regulator for improved performance, water engineers in the UK already face a demanding context.  However, the water industry is now approaching periodic regulatory changes – a new ‘asset management period’ (AMP) with an associated ‘price review’ (PR).  

This occurs every 5 years and sets out the regulator’s requirements for water company performance for that period.  There have been 6 asset management plan periods since privatisation in 1989, with AMP7 due to start in 2020.  

The price review in 2019 (PR19) is expected to include measures to increase competition between water companies, challenging targets for service provision, and also a squeeze on company profits.

Good past performance so less low hanging fruit?

The water sector has delivered significant customer service improvements since privatisation. Large capital and operational efficiencies have been achieved in every regulatory period. Leakages have been reduced by over 30%.  There has been a significant increase in environmental compliance, contributing to an over 50% increase in rivers meeting excellent water quality standards.  

During the first 20 years after privatisation the sector averaged efficiency gains of over 3 % per year, more than double that in comparable sectors of the economy during the same period.  Leading companies have been at the forefront of developing asset management approaches and procurement models such as alliancing that are seen as best practice and have been adopted across other infrastructure sectors.  

While this track-record is welcome it also indicates that many ‘low hanging fruit’ for improvements have already been taken.  Meeting Ofwat’s new tougher targets is going to be even more difficult than in previous AMP periods.

ICE workshop: water industry professionals to address issues

Can the industry achieve the step-change in performance and thinking required to meet the AMP7 challenges?

I believe it can but many companies will need to radically change the way they operate, especially introducing new contracting models to engage the supply chain and drive aligned collaboration and maximising the use of digital technologies and the introduction of innovative technical solutions to address areas such as dealing with drainage challenges caused by climate change and increased urbanisation.

To help water industry professionals meet these challenges ICE is hosting an industry wide seminar on 14 June 2018.

This workshop brings together key stakeholders from across the sector to understand how companies are tackling the challenges of meeting Ofwat’ s PR19 themes of great customer service, resilience, affordable bills and innovation while balancing the demands of customers and shareholders.