The Water Report: Initial* summary of key points from yesterday’s PR24 Draft Determinations

*this will be developed for Monday’s The Week In Water

1) Expenditure

• Draft determinations (DDs) allow £88bn, a 50% increase on PR19, but a 16% (£16bn) cut on company business plan (BP) proposals of £104bn. This is a bigger cut than imposed at PR19 (11%). Ofwat said it had cut expenditure it considered inefficient, not properly justified, not required, previously funded (10-20% of the enhancement cost challenge – e.g. for storm overflows previously funded to meet existing permit levels), or covered in base allowances (20-30% of the enhancement cost challenge).   

• Base allowances up 13% on PR19 to £56.4bn, driven by: higher costs including for energy; allowances for increased rates of mains replacement; and accommodating population growth, including by increasing capacity at sewage works. 

• Enhancement allowances tripled from £11bn at PR19 to £35bn, which Ofwat described as a “step change increase”. 90% of this is statutory (£26bn for Water Industry National Environment Programme (WINEP) / Water Resource Management Plans (WRMPs), £4bn for other legal requirements). 

• £29bn of totex to be spent on WINEP/environmental improvements.

• Investment funding to be ring-fenced, with a claw back mechanism so any unspent money is returned to customers. 

Key items of expenditure include:

• £10bn on storm overflows – an average 16 spills per year is targeted by 2029-30

• £6bn on nutrient reduction

• £4bn on increasing supplies, including 9 reservoirs, 7 transfer schemes, 12 water recycling plants, to deliver 425m extra litres per day by 2030. £1bn of this is to support RAPID programme schemes.

• £2bn on drinking water quality improvements, including addressing PFAS and replacing lead pipes

• £1.5bn for 10m smart meters

• £0.5bn leakage enhancement allowances

• £225m on other demand reduction activities

• £297m to increase mains replacement rates.

Other points of interest

• 18 major projects (each worth £200m+) to be delivered outside of price controls, via Direct Procurement for Customers Specified Infrastructure Projects Regulations.

• £2.2bn on NBS, including £1.6bn to reduce storm spills through SUDS and wetlands, and £250m on nutrient removal. Ofwat said its framework was sufficiently flexible and supportive for firms to have put forward NBS. £255m to fund ‘Advanced WINEP’ (innovative approaches) for Anglian Water’s Partnership Centre of Excellence to encourage nature-first solutions, and UU to deliver 58,000m3 equivalent storage via rain gardens, permeable paving and other natural means. 

• Net zero – £317m of net zero challenge funding for Anglian, HD, Severn Trent and UU for 14 schemes seeking innovation in wastewater treatment process emissions  and one nature-based NZ catchment strategy. £60m in base allowances for low carbon technologies. 

• Mains replacement – New expectation that all companies will replace at least 0.3% of water mains  a year through base allowances (Ofwat said the rate has fallen to 0.1% a year, lower than the level implicit in PR19 base allowances). Through combined base and enhancement allowances, 8000km of mains (2.2% of total) to be replaced by 2030, at an average rate of 0.46% a year. 

• Competitive funds – £400m Innovation Fund; £100m Water Efficiency Fund. 

2) Bills and affordability 

• The DD put bill rises at £19/yr on average – £94 over the period (before inflation). This is a third less than BP proposals (an average rise of £144 over five years), and £44/yr on average less for customers to pay than under the BPs. 

• The rise is driven by increased investment, higher financing and operating costs, and more spend on asset health measures, notably mains replacement. 

• The cut to BPs is driven by Ofwat reducing planned expenditure and pegging returns to a lower level than some companies based their plans on. 

• Affordability support will double to over £500m over five years. 8% of customers up from 4% will  be on social tariffs, an increase of 1.4m customers. Significant shareholder contributions proposed by companies including UU, Welsh and Wessex.

• Three companies currently trialling innovative tariffs to support affordability and water efficiency; all indicated they will do so in AMP8.
  

Source: Ofwat

3) Common Performance Commitments

• 24 CPCs, with Outcome Delivery Incentives (ODIs) attached. Eight of these are new environmental PCs. 

• The table shows the 18 CPCs with absolute targets, together with the business customer experience in Wales PC which also has an absolute target. 

• Full compliance is expected for three CPCs: Compliance Risk Index, serious pollutions (zero) and discharge permit compliance.

• In addition, there are three experience PCs which do not have absolute targets. C-MeX (for household customers), where incentives have been increased and firms will be benchmarked against companies elsewhere in the economy. BR-MeX for business customers and retailers, and D-MeX for developers.

Source: Ofwat

4) Deliverability

In addition to existing reporting requirements and £1bn of AMP8 scheme acceleration to AMP7, at PR24 new general measures to support deliverability include: 

• Board assurance on deliverability was a key part of business plan quality assessment

• 18 large schemes to be delivered outside of price controls via SIPR/DPC

• Incentives included for on-time delivery

• PCDs introduced to hold companies to account on delivery and return money to customers if outcomes are not delivered in full. 

• All companies will be required to provide independent third party assurance for the delivery of enhancement schemes.

• A Delayed Delivery Cashflow Mechanism will also be introduced for all companies, so Ofwat can claw back and return to customers money for enhancement investments where these are delayed so bills reflect actual delivery profiles.

For Thames and Southern, Ofwat introduced a Delivery Mechanism, under which some expenditure will only be accessible once firms prove they can deliver the schemes it will fund. This means customers will not fund spending until Ofwat is clear on the timing and profile of elements of the companies’ plans. If triggered, this would increase average 2030 Southern bills by an additional £16, and Thames bills by £5. In addition for firms subject to the Delivery Mechanism, Delivery Action Plans will track delivery capacity for enhancement programmes, and Delivery Plans will set out completion milestones for enhancement schemes over the five years. 

5) Risk and return, and financeability

• BPs indicate £7bn of new equity needed by 2030.

• DD set allowed rate of return at 3.72%, reflecting a cost of equity of 4.8% and debt at 2.84% and underpinned by a gearing ratio of 55%.

• Portsmouth and South Staffs secure cost of debt adjustments as small companies. 

• 1.2% retail margin.

• Ofwat has asked four companies (Thames, Southern, Wessex and South East) to provide additional board assurance and to prepare Financial Resilience Plans  (and where relevant, evidence of investor support), to demonstrate financial resilience in the context of the DDs. It has asked a further six firms to provide updated board assurance statements in response to the DDs. 

6) Turnaround Oversight Regime

Special provisions will give Ofwat closer regulatory oversight while struggling companies deliver a turnaround. Company arrangements will be bespoke but the package includes:

• Enhanced monitoring – for example, a company could be required to create a transformation plan with root cause analysis of the underlying issues and how improvements will be achieved, giving Ofwat enhanced visibility which could be supplemented by deep dives or strategic reviews. 

• Independent monitoring – Ofwat could appoint an Independent Monitor with full access to company information to monitor and report on the company’s progress.

• Additional customer protections – such as a gearing cap defined in the licence, an RCV adjustment in circumstances where dividend distributions are made above a defined gearing level, and mechanisms to ensure expenditure is targeted at areas that will benefit customers. 

• Initially the TOR has been applied to Thames (see below) but could be applied to other companies. 

7) Uncertainty mechanisms

• Energy price changes to be provided for under the true up for base expenditure. Materials, plant and equipment costs added to enhancement true up.

• Cost sharing rate reduced to 40% of over/under spending on enhancement expenditure to insulate companies more from overspend, and provide customers with a greater share of the benefit of underspend. Cost sharing rate reduced to 25% for uncomplicated schemes of £100m+ and strategic resource schemes – to reflect the higher uncertainty. In all, £2bn of expenditure to be subject to enhanced cost sharing rates. 

• For 21 complex or novel schemes of £100m+, expenditure will be gated; PR24 allowances only provide for development funding and companies will recover additional spend at PR29. Construction funding for strategic resource options to be contingent on schemes proceeding. In all £3.1bn will be contingent.

8) Business plan grading

• Plans were assessed on quality first (against 26 expectations across six areas), then ambition (against affordability, and stretch and efficiency), and a complex array of rewards/penalties applied depending on how companies performed and how much Ofwat had to intervene to reach the DD position. These incentives relate to a financial adjustment to RCV, and cost sharing rates on base expenditure.

• 13 companies (all but Thames, Southern and Wessex) passed the quality test – three post Ofwat’s intervention, making them ineligible for any reward (Welsh, South Staffs, South East; Welsh and South Staffs secured a 0bp adjustment and a 50:50 sharing rate, but South East’s plan was deemed to also lack ambition, resulting in a -15bp penalty and a 55:45 cost sharing rate).  

• Of the remaining 10, Severn Trent and SWW were deemed sector leading on ambition, including on base expenditure as well as on a number of PCs. Their rewards of a 30bp adjustment and 50:50 cost sharing rates (and which include protection from any reductions in the allowed return and base expenditure allowances between now and FD) will be contingent on delivery. 

• The remaining eight of the ten (Anglian, Hafren, Northumbrian, UU, Yorkshire, Affinity, Portsmouth and SES) eligible for rewards on quality were deemed ‘standard’ on ambition. They received a 5bp reward and a 50:50 cost sharing rate.  

• Southern, Thames and Wessex did not meet Ofwat’s minimum quality expectations, despite intervention. They each received a -30bp penalty and a 60:40 cost sharing rate. Thames, Wessex and South East did not show sufficient ambition either, in Ofwat’s view. Each had specific reasons, though Ofwat identified “a common feature across each is that the companies have not yet committed to delivering or financing a plan that we consider is consistent with their legal obligations”. For lagging financial and operational performers Thames and Southern, Ofwat is requiring both financial resilience and delivery plans, among other things. The situation is different for Wessex, which is a high performing company on many metrics and not a concern under Ofwat’s Financial Resilience Monitoring assessment. Ofwat said Wessex did not meet minimum quality expectations in six areas that had a material impact on its ability to conduct the price review. Among other things, these relate to compliance with statutory requirements of the WINEP, and Wessex basing its plan on a 4.45% return and questioning financeability under Ofwat’s PR24 early view on return and notional capital structure. Ofwat encouraged these companies to work on “resolutions” and said their categorisation could be changed and they could escape the associated penalties at the FD stage, should they meet its requirements. 

9) Thames Water

• Due to the nature and extent of financial and operational issues at Thames, Ofwat put the company into the new Turnaround Oversight Regime. Thames must provide a Financial Resilience Plan, Delivery Action Plan and re-evaluate its turnaround plan. Ofwat is considering appointing an Independent Monitor with full access to company information to scrutinise and report on progress. 

• To get out of TOR, Thames would need to provide evidence of sustained improvident in operational performance, delivery capability and medium term financial resilience. Ofwat mooted on the latter: "That could mean introducing a limit on the amount of debt the company can take on, a separation of the business into two or more water companies, or looking to a public listing to secure additional equity.” 

• There was little forbearance from Ofwat for Thames given its situation. Its BP totex was cut by £5bn to £16.9bn, 20% of which will be conditional (£3.3bn). Bills rises were held to £99, compared to the BP £191, taking the average bill to £535 by 2030, not £627. Outcome expectations are stretching, including a 64% cut in storm spills and a 19% cut in leakage, and Thames is subject to the normal ODI penalty regime. 

10) Dates

• Ofwat’s Your Water Your Say sessions, for customers and stakeholders to comment on its DDs – 23 and 24 July. 

• Consultation closes – 28 August. 

• FD planned for 19 December, but Ofwat is consulting on a licence change that would provide for a January FD as a backstop.