Expert analysis of the UK water sector
July/August 2024
Issue 106
This website includes excerpts from the latest edition of THE WATER REPORT.
Full coverage is available only in the print and digital editions of the magazine. SUBSCRIBE HERE
PUBLISHED BY
KEW PLACE
What lies beneath?
The causes of concern below the surface of the PR24 Draft Determinations.
To the untrained eye, Ofwat’s PR24 Draft Determinations (DDs) may look reasonably pleasing for the water industry. Companies didn’t get everything they pitched for, but there is a record investment programme, uplifts to both base and enhancement spending, a higher rate of return than last time, “stretching but achievable” targets, and more protections against price effects.
However, that this is a sensible settlement as it stands is not a widely held view in the industry. Everyone is still working through the detail, but challenges seem widespread. Even the seemingly obvious fork between companies whose business plans passed muster and received rewards, and those whose plans didn’t, is less clear cut once you prod a bit deeper.
THE WATER REPORT provides a summary of what companies and those who advise them have told us are their key issues and concerns.
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The scale of the totex gap is enormous; in pound terms, the cut is the biggest in history. The gap will be even larger if contingent funding is not released.
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There is a distinct lack of customer presence in the Draft Determinations – little mention of customer research, engagement or the input of independent challenge groups.
Here are a few of its observations:
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Ultimately, investibility is difficult and an issue for every company under the DDs. Many say their plans are not investible as things stand.
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The scale of penalties - either in aggregate, or in some cases on single metrics – is daunting. Mapping the past five years of actual performance onto the new penalty regime would lead to massively increased penalties for some.
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Reams of documents – variously articulated as 3,000 pages, almost 100 documents and 200 spreadsheets – is arduous.
There is a distinct lack of customer presence in the Draft Determinations.”
The drafts: a door ajar
Enhancement allowances could be a happy hunting ground for firms seeking fixes ahead of Final Determination. PR24 lead, Chris Walters, looks over Ofwat’s draft decisions and more activist regulation.
He explains: “Quite a lot of flexibility is built into that, and it gives us the room to exercise discretion and make choices where we need to make choices to strike the balance that we need to strike…I never felt particularly hemmed in.”
The Draft Determinations (DDs) have not pleased everybody, or perhaps anybody would be a more accurate observation. Criticisms pull in different directions – not enough is being done/too much is being done; customers will overpay/investors will be put off. Walters sees this as a positive.
“It is very early days and we will need to reflect, but what we haven't heard …is any one particular group saying ‘this is fantastic; I love every single bit of it.’ Or any group saying, ‘this is terrible; I hate every single bit of it’. If we had that, I think I'd be nervous because that doesn't strike in the right kind of balance.”
Ofwat has an unenviable job by anyone’s standards in trying to balance competing pressures at PR24, under intense public and political scrutiny. Its first cut landed on 11 July. There are five months before final decisions are due.
Although he inherited the final methodology after joining Ofwat a little over a year ago, senior director for the price review Chris Walters insists that was “not a straitjacket”.
Hard truths
The water sector is facing an existential crisis, several generations in the making. PA says myths need debunking, and the Draft Determinations disappoint.
For the public to have access to a safe sustainable supply of water in the face of climate change and population growth, a raft of difficult decisions needs to be made which will have implications for society, the environment and our wallets.
Difficult trade-offs will need to be made by the new Government in the next few months as we head into the undiscovered territory that is AMP8 and beyond.
Ofwat’s PR24 draft determination didn’t go far enough and potentially kicks some of these difficult decisions further down the road.
Over the past few years two fundamental myths have emerged about the water
industry, which must be debunked for the debate to become focused on a pragmatic way forward.”
There’s a hole in my bucket
Living within PR24 Draft Determination allowances will require cost transformation in the water sector. Colm Gibson and Kenny McKay offer some advice.
Draft Determinations (DDs) are intentionally tough on companies. When company directors receive a DD, it is absolutely fine for them to spend ten minutes or so cursing, but after that, they need to turn their minds to implementing an optimal strategy, consisting of three workstreams.
The first workstream is to respond to the DD by using the appropriate due diligence processes. The second is to prepare to challenge Ofwat at the Competition and Markets Authority in the event that the first workstream fails to secure an appropriate Final Determination. The third workstream is to plan for how the company can deal with
a tough Final Determination. This article is focussed very much on this third workstream.
Partner and punish
The new Labour Government took its first steps to change the water sector after its election victory – but this was something of a game of two halves.
Hours after Ofwat issued its PR24 Draft Determinations on 11 July, new environment secretary and MP for Streatham and Croydon North, Steve Reed, and new water minister and MP for Hull West and Haltemprice, Emma Hardy, hosted a roundtable for water company chief executives to discuss four initial reforms and – encouragingly – to set out plans to work in partnership to attract investment, secure jobs and clean up waterways, according to a statement.
These measures were:
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telling Ofwat to ring-fence funding for infrastructure investment, and ensure unspent money is clawed back for customers – and “never allowed to be diverted for bonuses, dividends or salary increases”;
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an expectation that companies change their Articles of Association to make the interests of customers and the environment a primary objective;
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the creation of new customer panels, to give customers the power to hold executives and board members to account; and
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doubling compensation for customers when key standards are not met, and extending the circumstances when statutory compensation is due, including when boil water notices are issued.
Overcoming reservations
Thames and partners are showing the public their design vision for the South East Strategic Reservoir Option – and seeing sentiment shift.
It is almost two decades since Thames Water first proposed building a new reservoir near Abingdon in Oxfordshire. Now, reworked plans for a much needed super storage facility are gaining traction.
The needs case is accepted by all but a few staunch local opponents. London and the Thames Valley will need an extra 1bn litres of water every day by 2050 to support growth, build resilience to climate change and reduce abstractions, including from vulnerable chalk streams. A severe drought could cost the capital’s economy as much as £500m a day, risking lives and livelihoods.
Meanwhile, regional water resource planning has been beneficial in exhibiting the wider benefits of the scheme. The reservoir has
morphed into the South East Strategic Reservoir Option (SESRO), because it will also supply to Affinity Water and Southern Water. The reservoir would support 15m people with 270m litres of water a day.
And under the auspices of the Regulators’ Alliance for Progressing Infrastructure Development, SESRO has been making steady progress through pre-build regulatory hoops.
![SESRO [3].png](https://static.wixstatic.com/media/75eb38_d8ce2fd2593c473f885d4594ee8368a3~mv2.png/v1/crop/x_12,y_13,w_308,h_129/fill/w_431,h_181,al_c,lg_1,q_85,enc_auto/SESRO%20%5B3%5D.png)
will keep you on top of the threats and opportunities emerging from retail and upstream competition.
It's the eye on the competition
Ofwat adds fast cash to spice up interim supply
Ofwat bolsters retrospective cost recovery for interim suppliers with a mechanism to help recoup cash quickly.
Ofwat is to press on and introduce a cost recovery mechanism (CRM) that would allow business retailers who take on the customers of other retailers who exit the market abruptly to recover their efficiently incurred costs. But in addition, the regulator said another tool would be needed to enable such interim suppliers to recoup costs quickly.
As things stand, Ofwat has no legal means to direct retailers to take on customers in need of interim supply, and retailers have little
incentive to do so given the costs and risk involved. While affected customers would not suffer water service interruptions, they could be left suddenly without a retailer, bringing billing, customer service and settlement problems.
To make it more attractive for retailers to volunteer to step into the breach for customers, Ofwat will introduce an ex-post CRM, under which any interim retailer would be able to submit a retrospective claim for the efficient costs arising as a direct result of taking on that role.
Panel brings in new team to assure market performance
Strategic Panel chair, Trisha McAuley, explains why a new committee is being formed to drive future performance of the retail market.
After seven years monitoring and helping to drive the performance of wholesalers and retailers operating in the competitive water market, the Market Performance Committee (MPC) is handing over the reins to a new Performance Assurance Committee (PAC).
The MPC is a committee of the Panel, with the remit to monitor trading parties’ performance and ensure they are meeting their obligations under the Market Codes. It operates within the Market Performance Framework (MPF), which is being reformed to put customers’ needs
first. With such a radical overhaul of the MPF, the Panel felt it was appropriate to do the same for the MPC to ensure it can adapt and flex to meet the changing needs of the market.
Like its predecessor, the new Performance Assurance Committee (PAC) will carry the responsibility of determining how the new MPF and its intervention tools are applied. Subject to agreement, the PAC may also be able to adjust performance standards to help drive continual improvement.
With such a radical overhaul of the MPF, the Panel felt it was
appropriate to do the same for the MPC to ensure it can adapt and flex to meet the changing needs of the market.”
The time has come to fire up resilience
Waterscan’s annual conference inspired and armed industrial users to take action on water in the face of growing water scarcity and security risk.
Waterscan’s 2024 Water Matters conference in London in
June was framed around the central theme of building
business resilience in the face of growing water scarcity
and security risk.
The content on the day combined big picture motivation
(very big, planetary-level in fact) with business-relevant
practicals.
Associate director at consultancy Economic Insight, Ian
Thompson, explained that the forward direction of travel on
water prices was very clearly upwards. Water wholesalers have
pitched £100bn spending plans for 2025-30, up from £59bn
in 2020-25, on the back of historical underinvestment and new demands for higher environmental standards and greater resilience.
Waterscan’s Pendle agreed price rises were “inevitable” – potentially up 50-60% by 2030 once inflation is added in.
“There’s no stopping this,” he said, but he added that higher prices will bring increased focus on innovation, technology and water efficiency.
Strategic Panel chair, Trisha McAuley, argued that “what you get for your money” will become very important as prices rise; customers will want to know what they are paying for and what benefits this is providing. Water companies should communicate these messages clearly.
CONTENTS July/August 2024 full contents of the magazine
INTERVIEW & REPORT Ofwat’s Chris Walters on the Draft Determinations
REPORT Draft Determinations: Key points of contention
INDUSTRY COMMENT Outcome incentives
INDUSTRY COMMENT Severn Trent’s Regulatory Capital Vaue growth investor pitch
REPORT Thames Water latest
FEATURE Dividend intervention
INDUSTRY COMMENT Cutting your coat according to your cost allowances
INDUSTRY COMMENT Water’s existential crisis – and disappointing draft Determinations
REPORT Labour’s first water moves
NEWS REVIEW Wastewater enforcement
INDUSTRY COMMENT Pollution crisis
NEWS REVIEW EPA results
INDUSTRY COMMENT Manchester Canal case
INDUSTRY COMMENT Five-year priorities
FEATURE South East Strategic Reservoir Option consultation
NEWS Public Accounts Committee probes deeper into WICS
INDUSTRY COMMENT Skills shortages
NEWS REVIEW Water dips in UKCSI
will keep you on top of the threats and opportunities emerging from retail and upstream competition.
It's the eye on the competition.
REPORT Interim supply regime decision
NEWS REVIEW Path to a flourishing market
NEWS REVIEW Complaints 2023-24
INDUSTRY COMMENT Panel brings in new team to assure market performance
REPORT Affinity holds on to R-MeX lead
FEATURE Waterscan on water security
