Ofwat water resources working group 29 September 2016 Trust in - - PowerPoint PPT Presentation

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Ofwat water resources working group 29 September 2016

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Agenda

No Item Time (minutes) Lead 1 Welcome and introductions 10.00 (10m) Colin Green Peter Hetherington 2 Cost assessment for water resources: introduction and discussion 10.10 (60m) David Young 3 Break 11.10 (5m) All 4 Access pricing for bilateral markets in England – sub group update and discussion 11.15 (60m) Mat Stalker 5 Project updates:

• Licencing (verbal update)
• Market information platform
• Capacity discussions

12.15 (15m) Peter Hetherington Ian Pemberton Ian Pemberton 6 Lunch 12.30 (30m) All 7 Targeted incentives: The abstraction incentive mechanism 13.00 (60m) Jon Ashley Mike Pocock Ilias Karapanos 8 Targeted incentives: Water trading incentives 14.00 (60m) Peter Hetherington Daniel Davies Phillip Dixon 9 Regulatory accounts consultation: water resources boundary 15.00 (30m) Peter Hetherington Simon Harrow 10 Actions and agenda for next meeting 15.30 (15m) Colin Green

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Project management

We have set up a Water 2020 working groups website where all papers, plus minutes of the meetings are available for download: http://www.ofwat.gov.uk/regulated- companies/improving-regulation/future-price-setting-for-2020/water-2020-working-groups/

Actions from July meeting By Whom

Minutes: Ofwat to circulate the minutes to group members for comment. Comments should be sent to Hanif Jetha.

Ofwat, Group members

Ofwat to share calculations presented during the form of control item. This has been sent round to group members alongside the draft minutes. If you have any comments or want to discuss please contact Peter Hetherington. Ofwat Canal and River Trust to update group on status of paper on raw water transfers Darren Leftley Access pricing sub group to prepare materials to update the next water resources working group meeting on progress Access pricing sub group Presentations for future working groups: Ofwat is looking for volunteers to present and facilitate discussions at future working groups. Among others topics available include:  Resilience (in September);  Cost assessment for water resources (in September)  Form of control;  RCV allocation for water resources;  Bid assessment framework; and  Incentives for trading/interconnection. If you are interested in this or other topics please contact Peter Hetherington. Group members

Project management

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Cost Assessment for Water Resources David Young September 2016

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Water Resources Cost Assessment – Format of the session

1. Why we need cost assessment for water resources 2. What is Cost Assessment 3. Options for PR19 4. Issues 5. Breakout Sessions 6. Next Steps

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We introduced separate binding controls for water resources and sludge

• On 25 May we published our decision document “Water 2020: our regulatory

approach for water and wastewater services in England and Wales”

• We decided to introduce separate binding controls for water resources and for sludge

in PR19

• The separate controls will support the development of markets and help ensure a

level playing field between incumbents and third party entrants. It will also limit cross subsidy risks

• Separate binding controls means we will have to set allowed expenditure in these

areas for the first time!

• This, in turn, means we will need to develop an approach for cost assessment in

these areas

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What is cost assessment?

• In every price review Ofwat sets an efficient expenditure allowance for the water

companies for a period of five years.

• Cost assessment is an extremely important and material component of price reviews
• In PR14 our approach to cost assessment was based on top-down benchmarking of

historical costs and special cost factors adjustments

• Specifically, we developed benchmarking (econometric) models on the basis

statistical relationships between historically incurred costs and ‘cost drivers’, as reported annually by companies. The models provided an initial cost baseline

• The initial cost baseline were then subjected to “special cost factor” adjustments,

which are factors that impact company costs but are not captured in the model (e.g. a very large capital scheme such as building a new reservoir)

• But there are other approaches to cost assessment, such as bottom up assessment

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Let’s think about cost activities and their drivers…

• What are the drivers of each cost?
• Is the driver under management control?
• Is the cost fixed or variable in the short run?
• Is the cost fixed or variable in the longer run?
• Is the cost material?

Note: The allocation of costs in the table is for illustration only and may not strictly coincide with RAG rules.

Operational costs Maintenance costs Enhancement costs Abstraction charges New source identification and development Catchment management Abstraction rights Power costs (of pumping) Operation of pumping stations Maintenance of pumping stations Building pumping stations Operation of boreholes Maintenance of boreholes Building boreholes Operation of dams and impounding reservoirs Maintenance of dams and impounding reservoirs Building dams and impounding reservoirs Procuring bulk raw water?

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Top-down wholesale Top-down water resources Top-down water resources + treatment Bottom-up Benchmarking of what? Wholesale totex (as in PR14) Water resources costs Water resources + treatment costs Unit cost per asset type? How will we set efficient allowance? Estimate an efficient wholesale totex first, and carve out a portion for water resources subsequently The benchmarking model will directly estimate an efficient level of water resources expenditure Estimate an efficient level of WR+treatment expenditure first, and split out a portion for water resources subsequently An engineering assessment of (capital) costs per unit of capacity for different water resource asset combined with a separate assessment

• f overhead and other
• perational costs

Potential approaches for setting efficient water resources expenditure*

* Other options may be considered

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Further issues to consider

• RCV protection – we said will protect RCV as of 31 March 2020. Investment to

enhance water resources beyond 2020 will be incurred at risk. What are the implications for Cost Assessment?

• How do we assess maintenance going forward?
• Are their implications for special cost factors?
• Boundary
• do we have a clear and consistent boundary between water resources and

Network Plus activities?

• Cost allocation of overheads – are there any issues with the assessment of
• verhead costs allocated to water resources business units?
• Separation of treatment and water resources
• Heterogeneity in water resources – companies use very different water resource
• assets. This makes benchmarking of costs across companies more challenging

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Heterogeneity in water resources

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% ANH NES UU SRN SVT SWT TMS WSH WSX YKY AFW BRL DVW PRT SBW SES SEW SSC

Water Resources Assets in 2016

Impounding reservoirs Storage reservoirs River abstractions Boreholes (excl. MAR schemes)

• To what extent is the mix of assets under management control?

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Break Out Session ‒ pros and cons ‒ how the option deals with issues set out on slide 10

Group 1 Group 2 Group 3 Group 4 Top-down wholesale Top-down water resources Top-down water resources + treatment Bottom-up Benchmarking of what? Wholesale totex (as in PR14) Water resources costs Water resources + treatment costs Unit cost per asset type? How will we set efficient allowance? Estimate an efficient wholesale totex first, and carve out a portion for water resources subsequently The benchmarking model will directly estimate an efficient level of water resources expenditure Estimate an efficient level of WR+treatment expenditure first, and split out a portion for water resources subsequently An engineering assessment of (capital) costs per unit of capacity for different water resource asset combined with a separate assessment

• f overhead and other
• perational costs

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• We thank you for your input and thoughts today
• We will continue to work with the Cost Assessment Working Group to

develop our approach to water resources

• We will consider establishing a cost assessment sub-group dedicated to

Water Resources. We will extend invitations to this if taken forward. Next Steps

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Access prices for bilateral water resources providers in England Update to Water Resources Working Group September 2016

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The issues we said we needed to resolve

Deriving access prices from cost information Form of pricing Distribution and transport costs Treatment Volumetric? Mixed? Capacity? How to deal with leakage? Raw water or treated water price? Average or specific transport costs within an area? Price for transporting

• ut of area?

Who treats water? Account for DWI requirements and double treatment? How to use AICs? Redundancy? WACC Link with controls?

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Modelling results Some preliminary modelling conducted Clear conclusions

• Whole life costs are important
• Certainty of access price an issue
• Scope of schemes will be important

Four key areas to focus on

WRMP Business plans Access Prices

What schemes to include? Translating cost information into access prices? How to deal we security of supply? What is the scope for entry?

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Schemes to consider for access prices  Should it be all schemes in WRMP or just water resource schemes?

AMP6 AMP7 AMP8 AMP9 AMP10

 How long will the compensation payment be available for?  Should short-term and long-term schemes be treated differently?  How can different schemes be compared?  How will demand management and leakage schemes be treated and how will this work with separate controls?

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Using cost information to set access prices

What analysis/modelling will be required?

Companies are compensated under the price control. How do we create a level playing field for access prices?

WRMP Business plans Access Prices

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Security of supply How to assess the relative size of the risk (e.g. headroom)?

• Is headroom a measure of the scope of

entry companies could afford to lose? What is the role of special administration arrangements?

• Should alternative providers have

special administration? How do companies ensure resilience?

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Scope for entry Bidding markets allow alternative providers to provide all schemes Bidding markets provide water to all customers Bidding markets decouple retail market risk Will bilateral entry be less attractive than bidding market? How do we ensure bilateral markets can work?

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Exercise

• 1. What elements other than price will need to be in a contract?
• 2. If you were selling water what would you want/need?
• 3. If you were buying water what would you want/need?
• 4. Would either be different depending on the scale of water being traded?

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Licencing update Peter Hetherington September 2016

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Market information platform update Ian Pemberton September 2016

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Reminder - Outputs from WRMP TAG exercise on information needs Buyers: Information Platform

• Location

− Water resource zone − Wider geographical context?

• Price (Fixed / variable)
• Timing of deficit
• Input specification

− Treated / Raw − Potable / non-potable − Peak / average volume required

• Environmental data required to demonstrate

sustainability, no deterioration etc.

• WRZ constraints / demands

− Population, PCC, Leakage − PWS network information − Water efficiency uptake − Obligations to buyers in Water Act

• Infrastructure availability for water transfer

Sellers: Bid Assessment Framework

• Location (NB demand / leakage management
• ptions are not geographically constrained)
• Offtake locations
• Restrictions on use

− Abstraction conditions − Other legal constraints

• Availability – years, seasons, option purchase
• Cost
• Deployable Output - Annual / Daily / Peak
• Security of supply / resilience

− Different drought return periods − WRMP dry year conditions

• Environmental impact (EIA / SEA)
• Quality
• Treatment requirement
• Vetting requirements – Name & financial

viability / credibility of seller, proof of ownership

• Carbon footprint of supply
• Maintenance regime
• Relationship with other stakeholders e.g.

NGOs / Farmers

“database should enable third parties to propose demand as well as supply side options”

• Must •Should •Could

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Reminder - Data underpinning supply-demand projections

2015 2025 2040

Leakage Population PCC

= = =

Deficit Incremental cost

Supply – Demand Per capita consumption Population projection Leakage Incremental cost of preferred option

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Coal Authority – Example of Web Based Information Platform http://mapapps2.bgs.ac.uk/coalauthority/home.html

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The Role of Brokers

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Australian Model

• Do we want broker(s)?
• Who should that be?
• Will there be entrants to the broker

market?

• Will it evolve over time?

http://www.nationalwatermarket.gov.au/ https://www.watertradingaustralia.com.au/ https://www.waterexchange.com.au/cms/index.php Some Useful Links (not exhaustive list)

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• WaterLitix is just one example of third party data

analysis and trading services offered in the US.

• Data will be less detailed and sophisticated in

England and Wales but there is still scope for innovation Reminder – The Role of Brokers – WaterLitex example www.waterexchange.com/waterlitix/

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Capacity discussions update Ian Pemberton September 2016

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Discussions held in August – focus on capacity of a source

Water Resource Raw Water Transport Water Treatment Abstraction licence Historical Minimum Conveyance Treatment Capacity

Volume (Instant,

Daily, Annual

‘Capacity’ defined as the lower of each of the components

1) EA Diagram

(c) WATER RESOURCES PLANNING TOOLS 2012 Report Ref. No. 12/WR/27/6)

2) Water Resource Business Units

(as defined in RAGs)

3) Capacity Calculation

Raw Water Storage Yield

Reduction for Climate Change

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Further thinking – Physical distinction of capacity Water Resource Water Resource Raw Water Transport Raw Water Transport Raw Water Storage Water Treatment Raw Water Transport Raw Water Transport Capacity

• The appropriate yield needs to be incorporated into capacity
• Our definition of capacity will need to be taken in the context of our wider decisions in water

resources, form of control for example, and cannot be taken in isolation

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Potential use of WAFU to define capacity WATER RESOURCES PLANNING TOOLS 2012 Report Ref. No.12/WR/27/6 WAFU (own sources) = 1FP- 2FP+3FP+4FP)…………………………...(1) where: 1FP is DO that incorporates yield gain from production side & resource management options (Includes Transfers) 2FP is reductions in DO

3.3.9 Other reductions in deployable output A company may also have to consider reductions in deployable output as a result of other causes. These include

• perational decline or loss of source due to
• long term pollution,
• build up of nitrates,
• pesticides or
• ther water quality issues.

3FP is outage allowance – suggest outside Capacity 4FP is process losses suggest outside Capacity

In our May decision document we suggested linking capacity to WAFU and this is one potential approach we are exploring

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Targeted incentives: The abstraction incentive mechanism (AIM) September 2016

Mike Pocock Ilias Karapanos

Abstraction Incentive Mechanism – Methodology & Reporting

29/09/2016

Contents

• AIM Objective
• Sources proposed under AIM
• Triggers & Baseline abstractions
• AIM sources & Assumptions
• AIM reporting for Q1 of 2016-17
• Discussion

AIM Objective

• Abstraction Incentive Mechanism (AIM) has the objective of

encouraging water companies to reduce the environmental impact of abstracting water at environmentally sensitive sites in low flow periods

• AIM has come in force in reputational form since the 1st April 2016
• Affinity Water have put forward a total of 23 groundwater sources to

be included in AIM

AIM Sources as submitted to Ofwat in Sept. 2015

Source Group Licence Number Avg. Ann. Licence Max Daily Licence 2015 DO AMP6 SR AMP7 SR Environmental Benefit NEP further sites NETHERWILD Clay Lane 28/39/28/336 40.91 28.00 30.00 No No Yes BRICKET WOOD Clay Lane 28/39/28/336 27.28 14.00 15.00 No No Yes CHESHAM Individual 28/39/28/104 5.22 7.09 5.22 6.00 No No Yes AMP5 sustainability

• perating agreements

OUGHTON HEAD Individual 28/39/28/339 4.55 6.55 4.10 5.22 No No Yes SLIP END Individual 06/33/14/36 5.46 6.82 0.00 0.00 No No Yes WELL HEAD Individual 06/33/13/10 2.27 2.27 1.15 1.15 No No Yes OFFLEY BOTTOM Individual 06/33/13/09 1.14 1.14 0.00 0.00 No No Yes PRIMROSE Individual 9/40/4/497/G 3.00 4.00 3.00 3.00 No No Yes BUCKLAND MILL Individual 14/033 4.00 4.00 4.00 4.00 No No Yes DENGE GRAVELS Denge 9/40/5/71/G 9.04 15.00 4.65 9.04 No No Yes AMP6 Sustainability reduction sites BOW BRIDGE Kensworth 28/39/28/130 6.82 11.37 5.82 5.82 Yes N/A Yes AMERSHAM Missenden 28/39/28/334 7 18.18 7.00 12.00 Yes N/A Yes WHITEHALL Whitehall 29/38/03/42 22.73 30.46 15.00 28.00 Yes N/A Yes FULLING MILL Digswell 29/38/02/46 9.09 9.09 5.60 9.09 Yes N/A Yes MARLOWES Gaddesden 28/39/28/335 20.47 4.74 4.74 Yes N/A Yes PICCOTTS END Gaddesden 28/39/28/335 15.72 15.72 Yes N/A Yes HUGHENDEN Individual 28/39/25/47 2.28 2.27 1.60 1.75 Yes N/A Yes AMP7 Sustainability reduction sites DIGSWELL Digswell 29/38/02/46 11.37 11.37 7.88 7.88 No Yes Yes CHALFONT ST.GILES Missenden 28/39/28/334 4 4.55 4.00 4.50 No Yes Yes HOLYWELL

• St. Albans

28/39/28/337 9.09 8.20 9.09 No Yes Yes MUD LANE

• St. Albans

28/39/28/337 11.37 10.03 11.37 No Yes Yes PERIWINKLE LANE Individual 28/39/28/401 4.99 5 4.19 4.19 No Yes Yes RUNLEYWOOD (CHALK) Individual 29/38/01/09 9.55 9.55 6.30 6.30 No Yes Yes

AIM Taskforce Methodology – Triggers

• AIM trigger is set based on a specific environmental trigger identified

through the EA’s Restoring Sustainable Abstraction (RSA) assessments, NEP investigations or other EIA work

• In cases where sources under previous or currently ongoing NEP

investigations, we have adopted the EFIs as set out by the EA

• If no triggers yet agreed, the Q95 flows have been adopted as the

best indicator of low flow conditions

• In the majority of cases, the potential impact on the surface water

body is the River, so the trigger is set in the downstream gauging station

• The length of the record for each gauging station or groundwater

level monitoring point is defined by the data availability and data

• quality. The Q95 or Q70 values were adopted from the CEH website

AIM Taskforce Methodology – Baseline Abstractions

• Baseline abstraction values were calculated based on the average

abstraction during the historic period when river flows or groundwater levels would have been at or below the AIM trigger

• Duration of the abstraction record chosen as the period between the

1st April 1995 and the 31st March 2015

• Most representative of current and future abstraction patterns, as

the distribution network constantly evolves and pressure on sources may fluctuate accordingly

• If extended further back, the uncertainty on data quality would

increase as flow meters were not always available, with abstraction being calculated based on pump hours

• This 20 year period includes a number of low flow periods (1997,

2003, 2005, 2006 and 2012) with some of them having demand restrictions and others being unrestricted

• Long enough record to incorporate different types of droughts and

also smooth out abstraction values that may be very low due to site

• utages

AIM Triggers

AIM Triggers

AIM Abstractions

Source Catchment Combined AIM baseline (Ml/d) AIM baseline (Ml/d) Average Deployable Output (Ml/d) Operational Site Target (Ml/d)

Bricketwood Colne 37.16 18.65 14.00 15.00 Netherwild 18.51 28.00 27.00 Well Head Hiz 0.84 0.84 1.15 1.70 Oughton Head 5.03 4.43 4.10 4.55 Offley Bottom 0.60 0.00 1.00 Digswell Mimram 7.53 7.53 7.88 8.00 Fulling Mill 5.34 5.34 5.60 5.60 Bow Bridge Ver 0.00 0.00 0.00 0.00 Holywell Ver 17.72 10.29 8.20 8.00 Mud Lane 7.43 10.03 10.00 Marlowes Gade 20.14 4.42 4.74 4.70 Piccotts End 15.72 15.72 15.00 Amersham Misbourne 10.38 7.51 7.00 7.00 Chalfont St Giles 2.87 4.00 4.00 Whitehall Beane 19.00 19.00 15.00 15.00 Chesham Chess 4.08 4.08 5.22 5.22 Hughenden Hughenden 1.46 1.46 1.60 1.80 Periwinkle Lane Upper Lee 9.94 3.36 4.19 4.50 Runleywood Chalk 6.58 6.30 6.30 Slip End Rhee 3.62 3.62 0.00 4.50 Primrose Dour 6.50 2.50 3.00 2.50 Buckland Mill 4.00 4.00 3.50 Denge Gravels Denge 6.00 6.00 4.65 5.00

AIM Assumptions

• For sites that are due for Sustainability Reductions, the AIM trigger

will only apply until the Reduction has been implemented. If there is no low flow period until the Reduction is in place, the AIM will not apply

• Post 2023 (AMP7 SRs) the AIM sources will reduce from 23 to 10
• If sources are in the same catchment and have the same AIM

trigger, then the combined abstraction baseline will apply to allow

• perational flexibility and cover outages
• If augmentation scheme is in place, the AIM will only apply to the

volume into supply and not to river support

• If site outages during historic droughts, these were screened out in
• rder not to skew the results
• 2 sites (Fulling Mill & Whitehall) where voluntary reductions have

been implemented until formal SRs are in place

• These AIM abstractions are thought to be robust based on the

current knowledge of the catchments and the historic and future use

• f the sources under low flow conditions

AIM Reporting – Q1 of 2016-17

• During Q1of 2016-17, the background groundwater levels were

tracking the Long Term Average (LTA) values despite the seasonal recession

• River flows in the majority of the catchments that the AIM sources

are located, were above the AIM triggers

• The only exceptions were Hughenden Stream (at High Wycombe

gauge) and the River Lee (at East Hyde gauge) where flows reached at or were below the AIM trigger for the duration of the first quarter of 2016-17

• The majority of AIM sites had a lower abstraction than the AIM

baseline in Q1 even if AIM did not apply. This is mainly linked to the lower than average demand and a number of planned and unplanned outages that took place during this period.

• A periodic review will be undertaken on a quarterly basis to report on

AIM performance and validate the AIM triggers and baseline abstraction values

Water Resources position

AIM Abstractions

AIM Performance

As specified in the AIM guidelines document from Ofwat, the AIM performance is measured based on the difference between the actual and the baseline abstraction, multiplied by the number of days when flows were at or below the trigger threshold. AIM performance in Ml = (average daily abstraction during period when flows are at or below the trigger threshold - baseline average daily abstraction during period when flows are at or below the trigger threshold) * length of period when flows are at or below the trigger threshold.

AIM Performance

• Hughenden Stream was one of two catchments that experienced

low flows for some time during Q1of 2016-17. Flows were at or below the trigger for a total of 74 days (out of 91) and the average abstraction from Hughenden source during the 74 days was 0.72Ml/d

• When applying the equation above to measure the AIM

performance for Hughenden for Q1 of 2016-17, the volume in Megalitres (Ml) is -55.05. The negative figure signifies an improved performance as average abstraction is lower than the baseline

• Periwinkle Lane and Runleywood Chalk sources situated on the

Upper Lee catchment, the AIM trigger was reached for a total of 18 days (out of 91). Using the same equation as above, the AIM performance is -110.48 Ml, since abstraction at both sites was significantly lower than the AIM baseline when the trigger was on

AIM Performance

• For the 3 AIM sources that the trigger was reached during Q1 of

2016-17 the combined AIM performance measure was -165.53 Ml

• It suggests that the company met and exceeded the AIM baseline

figures for this quarter, which is mainly linked to the overall low demand and planned or unplanned outages at the 3 sites

• Following the first review of the AIM triggers and baseline

abstractions it appears that they are robust and representative of the catchment status

• The validity of the triggers and baseline abstraction is constantly

monitored and the next AIM performance review will take place in October 2016 for Q2 of 2016-17

Thank you for Listening – Any Questions?

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The AIM going forwards Jon Ashley September 2016

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Coverage of the AIM in 2016-17 The AIM started in reputational form on 1 April 2016 The AIM currently applies to 13 of the 17 water companies

Company Abstraction sites impacting WFD Band 1, 2 and 3 sites which Ofwat sent to companies in October 2013 (from Environment Agency list) Sites water companies propose for AIM from 1 April 2016 or later (as at October 2015) Affinity Water 80 23 Severn Trent Water 64 Anglian Water 49 2 Southern Water 46 4 Thames Water 33 5 South East Water 25 2 Yorkshire Water 16 2 Wessex Water 15 1 Sutton and East Surrey Water 14 South Staffordshire Water 13 2 Northumbrian Water 9 1 Portsmouth Water 2 1 United Utilities 2 4 South West Water Dŵr Cymru Bristol Water Dee Valley Water

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Reporting for 2016-17

We require all 13 water companies to report their performance on the AIM in their annual performance report to Ofwat from 2016-17 onwards. Companies need to report: 1. AIM performance in Ml; and 2. Normalised AIM performance = AIM performance / (baseline average daily abstraction * length of period when river flows are at or below the trigger threshold) Companies can provide contextual information around their AIM performance so that customers and stakeholders can understand a company’s AIM performance better.

Possible Annual Performance Report table on the AIM Company

Abstraction site (these can be anonymised if necessary) 2016-17 AIM performance in Ml 2016-17 normalised AIM performance Cumulative AIM performance 2016-XX Cumulative normalised AIM performance 2016-XX Contextual information relating to performance on the AIM Ml Ml A I I I I B I I I I C I I I I … I I I I Total C C C C

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The reputational impact of the AIM

The quality of AIM reporting will contribute to our assessment of companies’ reporting and their level of variable assurance through our company monitoring framework. We will publish AIM performances after companies have submitted their annual performance reports (i.e. after July 2017). We expect to consult with the AIM Taskforce on the particular details of how we publish AIM performance. To enhance the reputational impact of the AIM, we will collate the companies’ AIM performance on our website including the contextual information that companies provide, where relevant and appropriate. This will allow customers and stakeholders to compare companies’ performance while taking appropriate account of the environmental challenges that affect their regions and other information relevant to putting their companies’ AIM performances into context.

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The timeline for the AIM

November consultation

• n outcomes

PR19 Methodology consultation AIM taskforce report July 2017 Sept 2016 November 2016 July 2015 Past Future PR19 Methodology statement December 2017 First APRs which include the AIM AIM guidelines AIM consultation November 2015 February 2016 First publication of AIM results

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Issues to consider for the future of the AIM

Should the AIM have financial incentives attached to it? And how should these be calculated (short-run marginal cost, environmental value, willingness to pay)? Should the AIM be a performance commitment which we require all companies (for which we think there is an abstraction issue) to have? In November we will be consulting on some aspects of our approach to outcomes at PR19. Some points relevant to the AIM are: Would a bespoke approach to incentives to reduce environmentally-damaging abstraction based on local engagement be preferable? Will there be any issues with abstraction after 2020 that other processes are not dealing with? What has the experience of the AIM and other related outcome delivery incentives told us about their effectiveness so far this price control period?

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Targeted incentives: Water trading incentives Peter Hetherington September 2016

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• What is water trading?
• Water trading over time
• Why water trading?
• The policy context
• The PR14 water trading incentives
• The scope of the PR14 incentives
• Trading and procurement codes
• The future of water trading incentives
• Company view 1: Welsh Water
• Company view 2: Thames Water
• Group discussion

What we will be covering

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What is water trading

• By water trading we mean the appointed water company responsible for

supplying water in an area buying it from someone else (either a neighbouring appointed water company or third party) rather than developing its own water resources. This is also known as a ‘bulk supply’

• The water can be raw or potable as convenient
• Typically the contract is of long duration, to justify investment and fit with the

water resource planning process. But it doesn’t have to be, and sometimes trades are done to help overcome short-term problems such as droughts

Case study: Bournemouth Water and Wessex Water supply agreement In 2009, Bournemouth Water identified the need for an East/West link main to increase the resilience of its water network, at a cost of around £6 million, which was considered too high. In parallel, Wessex Water needed additional capacity in the Poole area to improve resilience in the event of an unexpected outage. Bournemouth and Wessex jointly explored alternative approaches to meet their resilience

• bjectives by maximising the use of existing assets and water resources in the Poole,

Bournemouth and Christchurch areas. In 2013, they signed a water supply resilience agreement, which allows the transfer of up to 15 million litres of water a day as well as enabling mutual support in the case of an emergency. Bournemouth’s investment was around £5 million less than the original projected cost. Wessex made savings of £34 million through a combination of the trading agreement with Bournemouth and other improvements to the network.

See Towards Water 2020 – policy issues: promoting markets

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Water trading – some perspectives Every year companies submit data to Ofwat on their bulk supplies and special agreements. To support our December 2015 consultation we carried out analysis on the 2013-14 register Water trading – some facts Question 1: Based on this register, what percentage of bulk supply contracts were agreed before privatisation? A) 35% B) 52% C) 68% Question 2: Based on this register, what percentage of bulk supply contracts were for potable water? A) 54% B) 77% C) 95% Question 3: Based on this register, by how much have bulk supply exports increased as a percentage of total distribution input since 1997? A) 0% B) 4% C) 8%

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Water trading over time

Source: Water companies’ June returns, PR14 data and Ofwat’s bulk supply register, 2013/14

Figure: Bulk supply exports as a percentage of total distribution input

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Good for the environment

• Water trading both within and between existing companies will

tend to move water from areas where it is more plentiful, to areas where it is scarce and the environment is under pressure Good for customers

• Water trading can reduce the cost of water resources (e.g. by

reducing the need for new resources) and hence reduce bills.

• Interconnection of separate water supply systems gives access

to more sources and makes the supply to the customer more resilient against shortages and technical problems Good for the water sector

• If water companies can reduce their costs through water trades,

they receive a share of the gains

• There may be profitable opportunities for incumbent companies

and other people to provide water in new innovative ways Why water trading

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The policy context

Water 2020 – water resource planning and third party options, South East Water and Frontier Economics, July 2015 Water trading – scope, benefits and options, Deloitte for Ofwat, December 2015 The Welsh Government Guiding Principles for Developing Water Resources Management Plans (WRMP’s) for 2020, Welsh Government, April 2016 Final Water Resources Planning Guideline, Environment Agency and Natural Resources Wales (produced in collaboration with Defra, Welsh Government and Ofwat), May 2016 Guiding principles for water resources planning for water companies operating wholly or mainly in England, Defra, May 2016 Water resources long-term planning framework, Water UK, July 2016

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The PR14 water trading incentives

Export incentive – allows an exporter to retain 50% of the lifetime economic profits of an

• export. This is subject to a cap
• f 100% of economic profit in

2015/16 to 2019/20 Import incentive – gives importers a payment equal to 5% of the costs of water imported during 2015/16 to 2019/20. This is subject to a cap

• n total annual import incentive

rewards of 0.1% of water activity turnover in any year of the control period Trading and procurement codes – in order for a company to receive a water trading incentive payment at PR19 it must show that it’s trade complies with an Ofwat-approved trading and procurement code “To encourage better, more sustainable use of water resources we are introducing targeted incentives to encourage efficient water trading.” Ofwat, PR14 Final Methodology

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The scope of the PR14 incentives

Transaction Rationale

• 1. Export from a large appointed

water company to a small appointed water company* The motivation for the export incentive was to overcome the artificial barriers to water trading between large appointed companies. We do not have evidence of artificial barriers to trading that have prevented new appointee sites from receiving supplies. Therefore, at this stage we are not proposing the extension of export incentives to these circumstances.

• 2. Import to a small appointed water

company from a large appointed water company Almost all new appointee sites are served by a bulk supply import to the small appointed water company. As in (1) above we do not have evidence of artificial barriers to these arrangements and in any case the small appointed companies typically have incentives for efficiency created by their relative price controls.

• 3. Import to a large appointed water

company from a small appointed water company Large appointed water companies are eligible for an import incentive for an import of water from another large appointed water company. We consider our water trading incentives would unintentionally bias the market in favour of large appointed water companies if the import incentive did not also apply to imports from small appointed water companies to large appointed water companies.

• 4. Export from a small appointed

water company to a large appointed water company Small appointed water companies are not subject to our full price control regulation and are typically able to retain all the profits from an export to a large appointed water company. The introduction of export incentives would also add unnecessary complexity to new appointees’ simplified price controls.

• 5. Import to a small appointed water

company from a third party We do not have evidence of artificial barriers to small appointed water companies importing water from third parties. In any case the small appointed companies typically have incentives for efficiency created by their relative price controls.

• 6. Export from a small appointed

water company to a third party Small appointed water companies are not subject to our full price control regulation and are typically able to retain all the profits from an export to a third party. The introduction of export incentives would also add unnecessary complexity to new appointees’ simplified price controls.

• 7. Import to a large appointed water

company from a third party Large appointed water companies are eligible for an import incentive for an import of water from another large appointed water company. We consider our water trading incentives would unintentionally bias the market in favour of large appointed water companies if the import incentive did not also apply to imports from third parties to large appointed water companies.

• 8. Export from a large appointed

water company to a third party If an export from a large appointed water company to a third party is not a regulated activity then the appointed company can keep all the profits from such an export subject to compliance with our transfer pricing rules. Therefore the export incentive does not apply in these

• circumstances. If an export from a large appointed water company to a third party is a regulated activity and the sale results in a genuine

water trading activity – such as the sale of water to an intermediary that then trades the water on outside of the appointee’s authorised area

• then the water trading incentive would apply.
• Outside of appointed company to appointed company transactions we held a consultation in February on the appropriate

scope of the PR14 incentives

• These decisions were confirmed in the Reconciliation Rulebook
• See Clarification of the application of the PR14 water trading incentives to small appointed water companies and third parties

*By small appointed water companies we mean water undertakers that, because of their size, are not subject to full price controls. This currently means Cholderton and District Water Company and five new appointees: Albion Water, Independent Water Networks, Peel Water Networks, SSE Water and Veolia Water Projects.

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Trading and procurement codes

“we have considered carefully how best to protect customers and secure efficient trades … through the use of caps … and through trading and procurement codes which will require companies to be transparent about water trading, allowing for assurance on whether trades are efficient.” Ofwat, PR14 Final Methodology

A trading and procurement code must, at a minimum, make sure:

The trades must be in operation during PR14 (they could be agreed from July 2013). Contract lengths must be shown to be reasonable. Procurement must be on a non-discriminatory basis. Proof must be provided that there has been no artificial ending and then starting of trades. Trades must be between unrelated entities (separate ownership). The supplies need to be obtained through a competitive process. The trades should be transparent, an audit report

• f compliance will need to be prepared and be

available to Ofwat. The trades must be both economically rational and environmentally sound. Reassurance should be provided on the assessment of costs. Approach to trades should be consistent with WRMP approach and any differences should be explained.

The full requirements for a code are set out in Appendix 3 of the Final Methodology, Dŵr Cymru and Thames Water are the only companies to have approved codes so far

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As set out in the May decision document (see section 2.4.1 of Appendix 3) we are assessing the following options for water trading incentives in developing our PR19 Methodology:

• 1. No incentives for water trading
• 2. Rolling over the PR14 incentives to PR19
• 3. Whether caps are needed and their appropriate levels
• 4. Strengthening the PR14 incentives

We want to explore these options with you today and have invited Dŵr Cymru and Thames Water to share their thoughts on water trading and these options. The future of water trading incentives

N.B. We will need to ensure that we do not create biases or distortions in appointees’ choices between the two main routes to market that we have identified: bidding markets to supply other wholesale companies and bilateral markets to supply retailers

Thoughts on water trading incentives

Daniel Davies Ofwat Water Resources Working Group 29 September 2016

Broader context

• Purpose of water trading is to improve efficiency (not an end in itself)
• Should improve allocation of resources and provide benefits to

customers

• If markets working effectively, benefits to both parties arise
• ‘Incentives’ are about distribution of gains between trading parties and

their customers

• Incentives as a potential market distortion
• Water trading incentives are paid for by customers
• Savings would otherwise be passed on to customers earlier

Market failures – why not more trading?

• Primary duty on companies to protect security of supply
• Companies prioritise long-term security of supply over commercial deals
• Water companies’ property rights over water are incomplete
• Intervention by environmental regulators is costless (for regulator)
• Can be seen as incentivising hoarding behaviour
• Uncertainty regarding future input prices
• Upstream access to resources are administered, not subject to mkt forces
• Prices may be subject to future upheaval.
• Abstraction payments may actually be lower in water scarce areas

How to make water trading market work better?

• Gains from trade should reflect actual differentials in opportunity cost of water

to different companies

• Need to look at how water is valued
• Water 2020 is a move in the right direction.
• AIC as basis for compensation payments (for bilateral markets)
• Regulators and governments need to work together to address regulatory

barriers to trade

• Address imbalance in current emphasis on long-term trades
• Facilitate short-term trades, rather than focusing only on perpetual agreements

Trading incentives at PR19

• Not in favour of strengthening incentives
• Unlikely to increase trading significantly, for reasons outlined above
• Not in favour of extending duration of incentives (for imports)
• As above, and not in the interest of customers
• Would prefer to see new approach that addresses broader issues

Phillip Dixon Market Development Manager

Trading incentives

29 September 2016

Contents.

• What have we done?
• What are we looking to do?
• The role of incentives in the future.

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The story so far.

• Been trading since 1960s (London WRZ net exporter of water, >100 Ml/d)
• 12 licence trades since privatization, ~150Ml/d
• TWUL already looks at trading options as part of WRMP engagement

− OJEU notices in 2012, 2015, 2016 − Lobbying potential traders − WRSE and WRE − Company-company liaison − Review of abstraction licences within Thames catchment

• Led to new supply-side (and demand-side) solutions in AMP6 from entrants and

incumbents in WRMP14 – approximately 50 Ml/d of third party supplies

• Trading & Procurement Code May 2016

− Good to formalize what we already do − Opens the door to incentive payments at PR19

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The story continues.

• Continue to search for resources, refresh the activity we have done before
• Not much spare water to trade in Thames region

− One or two more potential private licence trades − Looking further afield (transfers from outside catchment) − Bear in mind that inter-catchment transfers are costly and complex

• Where spare water exists, needs to be when and where needed

− Courage Brewery, Reading – WRZ in surplus, EA could claw back licence − Aylesford paper mill – High cost, not good value for customers compared with other

• ptions, EA could claw back licence

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Future incentives.

• Ofwat proposes higher rewards, kept for longer
• Trading incentives are welcome but fairly low in absolute value
• Would stronger incentives change behaviour significantly?

− Too early to tell? − May result in repeated, more detailed searches for resources, but higher search costs − Be wary of distorting value of trades with higher rewards − Need to judge value of further work to secure diminishing returns

• Other ways to encourage trade

− Recognise importance of interconnectors (and storage) – W.UK study − Don’t put investment at risk − Greater certainty around EA policy on invasive and non-native species, DWI policy on transferring water of differing qualities − Reduce likelihood of licence clawback by EA (give with one hand, take with the other) − Abstraction reform, release water for trading

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Questions for discussion

Questions for discussion

• What are the groups views on the policy options Ofwat set out in

May?

• Why have more companies not applied for a trading and

procurement code?

• If retained, what would be an appropriate level for the cap on

trading incentives? (import and export)?

• Have the PR14 incentives gone far enough to ‘kick start’ the

market for water trading? In particular the import incentive?

• How do ensure that the incentives we propose do not distort

appointees’ choices between the two main routes to market that we have identified: bidding markets to supply other wholesale companies and bilateral markets to supply retailers?

• Is there a need to consider the regulatory treatment of

interconnection?

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Regulatory accounts consultation: Water resources boundary Peter Hetherington, Simon Harrow September 2016

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The timeline so far

December 2015 - Water 2020 consultation

• A separate price control for water resources is proposed

March 2016 – Targeted review of sludge and water resources report (CEPA)

• Based on visits to the WASCs only
• Conclusion for water resources was “Although the RAGs are broadly clear on the start and end-points of

each water business unit, they do not give completely clear direction on some specific cases. As a result the most suitable treatment is currently unclear to companies …. There have also been some instances where we consider the RAGs to be clear, but companies have not allocated costs or assets in a way which is consistent with them.” p4 June – July 2016

• Discuss the boundary at both water resource working groups
• Hold bi-lateral meetings with a number of companies to discuss tricky issues e.g. adits, springs

April – May 2016 – follow meetings with WOCs

• Follow up meetings were held with the WOCs following the CEPA methodology

May 2016 – Water 2020 decision document

• Confirm we will introduce a separate price control for water resources
• Provide initial thoughts on the boundary and discuss linking it to the abstraction licence and note that we

will work with stakeholders to develop a set of amendments to the RAGs August 2016

• Based on the feedback from the group, the findings from the CEPA report and discussions at Delivery Board

add significant clarifications to the RAGs to ensure consistency in application across companies. The RAG consultation was published on 17 August. September 2016

• Receive and analyse responses

Based on the CEPA findings we were expecting changes to occur

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What are we trying to achieve?

Water resources boundary

• In our December consultation, we

proposed a separate binding price control for water resources, and we confirmed this decision in our May document

• A separate price control is a

targeted and proportionate response to limitations of the existing wholesale price control framework water resource market development

• The realisation of benefits from

markets is an important part of the case for separate price controls, but not the only element.

• Separate price controls are also

likely to help in developing better targeted regulatory incentives, and in increasing the focus on water resources

• To meet our objectives for the

separate control and avoid distortions we need good quality accounting information on water resources that is consistent in scope across companies

• The RAG is the mechanism through

which we ensure companies are reporting their water resources assets and costs consistently

Weirs and fish passes Abstraction meters Reservoirs Boreholes River abstractions Pre treatment assets

Figure: Overview of water resource assets (not exhaustive)

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Responses on the water resources boundary

• There was general agreement with the updated water resources definition
• Two companies specifically stated that the guidance was more clarification

rather than an actual change in definition

• However:
• ten companies reported that the new boundary would result in changes

to the assets in water resources

• f these ten, six provided reallocated MEAV values, our analysis of this

has shown the materiality of the change for some companies is significant

• The key driver of the change in assets in water resources is in the

treatment of reservoirs. In particular in relation to pumped storage reservoirs and the implications of our approach of linking water resources to the abstraction licence

• Southern/south eastern located companies are the most impacted as

they are least likely to have catchment filled reservoirs and more likely to rely on large pumped fill ones (that do not have abstraction licences)

This is the focus of the rest of the pack

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Our August definition of reservoirs

• The updated RAG 4.06 defines a water resources reservoir as one of:
• Reservoirs, springs and lakes with an abstraction licence – dams, control

rooms, valves, sluices

• Reservoirs filled by catchment rather than abstracted water from another

water body

• Reservoirs/other storage assets without an abstraction licence where the

function of the asset is to support a flow condition or abstraction at another point as part of a recognised scheme

• All other raw water reservoirs fall into raw water storage (network plus)
• This matches the recommendations from the CEPA March 2016 report

Source: Targeted review of sludge and water resources, CEPA, March 2016 Figure: Overview of CEPA recommendations

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Balancing versus strategic storage reservoirs

• The responses have highlighted that there are significant reservoirs that do not

have abstraction licences and do not have natural catchments. Under our current definition these are captured under raw water storage

• However the current definition does not capture the distinction between:
• Balancing reservoirs - the function of the reservoir is to support the raw

water distribution network. Such balancing reservoirs that only have a small amount of storage in relation to the demands placed on them (generally a few days) and provide enough temporary storage to support a constant rate to and from the water treatment works. They may allow some resilience in storage for very short amounts of time for pump

• utages or pollution events
• Strategic storage reservoirs - these reservoirs are used to store the

abstracted water for an average summer or even drought periods to provide storage to meet demand when the abstraction stops due to low river levels. In essence they are providing additional water resources by providing storage, these reservoirs may be large enough to supply very long periods of time (potentially years) without further abstraction Our view is that a distinction should be made between these two types of reservoirs, with strategic storage reservoirs being captured under water resources to capture their fundamental role as a water resource, rather than a balancing

• asset. We set out how this can be achieved in the next slide

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How to capture the distinction between balancing and strategic storage reservoirs

• Out view is that it is possible to

capture the distinction between balancing and strategic storage reservoirs by adding a further clarification to the RAG

• The clarification will be based on

the amount of storage that the reservoir provides

• We are proposing to use 15 days
• f storage as a benchmark in line

with water planning guidance (15-45 days used for emergency storage)

• We also considered the merits of

linking the definition to statutory reservoirs captured under the Reservoirs Act and all raw water reservoirs

Figure: Proposed new decision tree for reservoirs Raw Water Reservoir Asset Does it have an abstraction licence? Water Resources – Raw Water Abstraction Yes Does it have a natural catchment? No Does it support another abstraction? No Does it have >15 days storage? No Yes Yes No Raw Water Distribution – Raw Water Storage Yes

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Revised example – raw water storage

No catchment or abstraction licence <15 days storage (e.g. storage = 200Ml, average supply to treatment works = 25Ml/d)

There are 4 key points:

• At Point A – Raw Water is abstracted from the River and supported by pumping assets. Any operating costs for assets

supporting abstraction are included within this activity.

• At Point B – a reservoir exists to release water back to the river in order to maintain flow conditions at Point E and is fed

Raw Water from the river by a pipe. The reservoir also has some natural catchment thereby adding to the water levels. Furthermore the reservoir has an abstraction licence.

• At Point C – there is a gravity abstraction process supported by weir, fish passes and gauging station. Any operating costs

for assets supporting abstraction are included within this activity

• At Point D – there is a reservoir, without a natural catchment but is fed from the river abstraction. The reservoir has no

abstraction licence of its own. Furthermore it does not flow back to the river, but instead is used to maintain continuation

• f supply to the treatment works (acting as a buffer against low river flow or poor quality) – this is quantified by calculating

that it has <15 days supply in storage

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Other consultation responses De Minimus Rule Request for clarifications Request for revised examples

• Treatment works pre-treatment transferred to Water Resources
• Classification of abstraction meters and all assets upstream of a

pump/controlling structure

• Split of operating costs for a borehole pumping station
• Transfer licence moving raw water from one location back to the environment
• Remove “with some natural catchment” from pumped storage example
• Include a compensation only reservoir example with no abstraction

downstream

• Consulted on whether a de minimus rule for length of pipe to be considered raw

water distribution should be introduced (to avoid capturing small pipes)

• The majority of respondents were against this change citing complexity and the

need for a firm boundary

• No agreement on the length

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Questions for discussion

• 1. Will the revised RAG, flow chart and revised examples assist the

classification of Water Resource assets?

• 2. Can you think of any examples of where the 15 day storage rule

may inadvertently transfer balancing assets incorrectly? How many assets are likely to move?

• 3. Is there a better way of classifying Water Resource reservoir

assets versus Raw Water Distribution storage assets?

Deadline for the further responses is Friday 7 October, please e-mail simon.harrow@ofwat.gsi.gov.uk and peter.hetherington@ofwat.gsi.gov.uk

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Actions and agenda for the next meetings Colin Green September 2016

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Future meetings Planned meetings - 2016 There are two further meetings of this group in 2016:

• Tuesday 1 November
• Tuesday 13 December

All meetings will be held in Birmingham, dates for future groups are under review Future topics

• Form of control
• Demand side utilisation risk
• RCV allocation for water resources
• Regulatory treatment of interconnection
• Bid assessment framework
• Risk based review
• Market information database
• Resilience

Confirmed topics for November

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www.ofwat.gov.uk Twitter.com/Ofwat

Thank you and questions