Ofwat offers flexibility for PCDs where risk is hard to manage

Ofwat is consulting until 10 October on introducing a change control process for a subset of price control deliverables (PCDs).

PCDs set out the key outputs and outcomes that companies must deliver from AMP8’s bumper enhancement expenditure of £44bn.

Ofwat said where costs are greater than 0.5% of the wholesale water or wastewater totex, they would be considered material and new the change control process justified for a subset of PCDs where companies have less ability to manage delivery risk. Ofwat explained this relates only to scheme-specific PCDs (water resilience, resilience interconnectors, raw water deterioration and taste, odour and colour) or where the output is not specified enough to protect customers from changes in scope (i.e where the output tracked is a number of schemes or where it is split by complexity category such as the water supply PCD and WINEP investigations PCD). Firms will be able to submit change control requests in January of each year over the AMP.

Elsewhere in the consultation, Ofwat clarified elements of what it described as the PCD flexibility already built in to the final determinations. It said non-delivery PCD clawback would not be applied at the end of the 2025-30 period where a company has started work and has spent at least 70% of the allowed expenditure but the output is not completed; this would only be applied if the output is still incomplete by the end of the 2030-35 period. In contrast, the clawback would stand where outputs are not started or less than 70% of the cost allowance spent. In either case, late delivery penalties would be applied in the form of a time incentive PCD so that companies are no better off by delivering late.

Ofwat also increased flexibility associated with storm overflow and Industrial Emissions Directive PCDs specifically, the latter to support existing sludge treatment centres to be centralised at advanced anaerobic digestion hubs. 

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Explainer: Ofwat quantifies the benefits of delaying expenditure – by Verity Mitchell

Many companies fell behind in AMP7 on their agreed expenditure delivery schedules. Not only did this result in better cashflow metrics for the financially-stretched companies, but it was also hard to assess what was actual regulatory outperformance during the five-year period. Ofwat has recognised that delayed expenditure relative to final determinations can appear as outperformance, which then allows a company to retain a portion of the underspend. Overspend in the following price review period only partially offsets the benefits of delay.

With such a significant investment programme it will be a challenge to deliver all the outputs required. Ofwat has undertaken some financial modelling to work out how to make sure that customers won’t be overcharged for outputs that are not delivered on time in AMP8. The analysis indicates that the financing benefit grows with both the duration of the delay and the proportion of expenditure deferred. Ofwat wants to apply “a non-delivery PCD claw-back” for schemes that are not delivered. It needs to work out the mechanism though, to ensure that companies don’t benefit from late delivery but conversely are not out of pocket when schemes are almost completed.

It has worked out that, for the current five-year period, when around 70% of the allowed expenditure is delayed to year one of the next five-year period, the financing benefit from keeping the cash is relatively small and could be neutralised by a smaller “time incentive PCD penalty”. Where the company has spent more than 70% of the allowance by 2029, the company would be worse off from Ofwat applying a non-delivery PCD claw-back for the whole scheme. If the company spends less than 70% of the allowance though, the company would be better off as the financing benefit from delay would outweigh the non-delivery PCD claw-back.

Ofwat will therefore apply smaller time incentive PCDs to make sure that companies are not better off for being late. The 70% cut off ensures that companies do have the funding they need if they have almost completed a scheme.