Smoothing investment cycles in the water sector 13 July 2012 Mark - - PowerPoint PPT Presentation

Water today, water tomorrow

Smoothing investment cycles in the water sector 13 July 2012 Mark Worsfold, Chief Engineer, Ofwat

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Agenda

Prime Ministers views of infrastructure Future Price Limits Framework update Smoothing investment cycles in the water sector

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Prime Minister on infrastructure

Investment in infrastructure produces real, tangible assets that can earn a return, and yet no government has really solved the problem of how to finance the infrastructure we need within the public spending constraints that we

• bviously have….

…Now, Britain already has a long and successful track-record of regulating infrastructure providers such as the water industry, and now we need to go much further and faster in opening up the financing of our infrastructure. So, we’re encouraging the appetite of investors, both at home and abroad, for investment in British infrastructure; taking advantage of our stability and our

• pen markets….

…But we now need to be more ambitious. We should be asking ourselves, ‘Why is it that other infrastructure’ — for example, water — ‘is funded by private sector capital through privately owned, independently regulated utilities, but roads in Britain still call on the public finances for funding? David Cameron, 19 March 2012

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Future Price Limits statement and next steps

Published 15 May Documents published: Statement From principles to price setting - next steps Appendix 1 - Impact assessment; and Appendix 2 – Summary of responses Publication preceded by: Consultation Workshops Published papers

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Framework statement – statement of principles

We will target our price control regulation appropriately We will develop clear, simple and effective incentives that drive allocative, dynamic and productive efficiency We will set price controls in a way that gives companies ownership and accountability for delivery of what customers want and need We will use our risk-based approach to focus regulation where it matters and reduce any unnecessary burdens We will continue to regulate in a way that is transparent and predictable We will design and use our regulatory tools in a way that is future proof and capable of adapting to support the sectors

Future price limits

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Water today, water tomorrow Wholesale control Retail control Changes to cost assessment

Companies deliver and customers influence

• utcomes

Other wholesale activities Network plus sub-limit Treatment and transport

• f water and wastewater

Contestable market Non- contestable market

Customer challenge groups

How the framework meets the external agenda

Gray, OFT, supply chain, innovation – Cave and others

Approach Challenge

Increase innovation Reduce the burden Smooth the investment cycle Sustainable long-term focus Address capex bias / behaviour Cross – regulator working Cave, OFT Gray, Govt Supply chain, Govt Gray OFT, EA Gray, Govt

Outcomes

• Incentives

support

• utcomes
• Customer

engagement

• Water trading

and AIM

• Totex approach
• Simplifying the

business plan process

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The FPL framework statement – Long lasting principles

The framework statement sets out a direction of travel We will: create binding retail and wholesale controls begin to create a new framework for access prices hold companies to account for delivering the outcomes customers and society want expect companies to involve their customers fully in their plans develop tools such as totex and menus that can support

• utcomes and sharpen incentives

adopt measures to support water trading and resource efficiency The ‘next steps’ document shows how we will continue to engage with stakeholders before the consultation on the next price review in autumn 2012.

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2011 2012 2013 2014 2015 2016

Timeline to the 2014 price determination

Government Market reform projects Ofwat price review Companies

Customer engagement – Direct – Customer challenge groups Bridging work FPL to method-

• logy

Determinations – Draft – Final Price review methodology – Consult autumn 2012 – Final spring 2013 Ofwat Customer Advisory Panel input Business plans Customer challenge groups report to Ofwat New bills April 2015 Customer engagement – post- draft determination Water trading contract and guidance Water White Paper Market codes, architecture and contracts in place Market systems testing

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Draft Water Bill Welsh Govt strategy Possible Act

David Gray review

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16 The impacts of cyclicality are a recognised issue in the water sector

“The extraordinary degree of cyclicality in business flows from

the water companies to the sector supply chain, which appears to be largely a response to the price review process, is obviously undesirable. It is hoped that the proposals to make regulation less intrusive and give companies more

• wnership of their business plans will improve the position,

but it may also be necessary to consider some more proactive approaches in the shorter-term.” David Grays review of Ofwat in 2011

Improving infrastructure delivery

Government’s commitment to infrastructure Updated the National Infrastructure Plan 2011 Infrastructure a key feature of the Growth Review and Autumn Statement Established the new Infrastructure Cabinet Committee Exploring new approaches to funding infrastructure investment Implementing the Infrastructure Cost Review Published the infrastructure pipeline alongside the public sector construction pipeline

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Improving infrastructure delivery

Infrastructure Cost Review UK civils costs consistently in upper quartile Potential savings of 15% to 20% identified (£2 billion to £3 billion annually) Key implementation objectives: Pipeline visibility and certainty Supply chain engagement Competition/procurement models Focus on cost and risk (not budgets) Engineering standards Infrastructure data/benchmarking ...need to change client and industry behaviours

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Mitigating against cyclical investment

Infrastructure Cost Review, IUK (December 2010) “…even in the regulated sectors, the five yearly reviews are creating a line of uncertainty in investment around the review point which means that potential efficiency savings continue to be lost” Review of Ofwat and consumer representation in the water sector (July 2011) “The extraordinary degree of cyclicality in business flows from the water companies to the sector supply chain, which appears to be largely a response to the price review process, is obviously undesirable”

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Mitigating against cyclical investment

Joint IUK/OFWAT study To understand and expose the causes and drivers of peaks and troughs in the investment cycle in the water sector and to consider the changes all players in the sector can make to reduce its impact

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What is the regulatory cycle of expenditure?

Key considerations What actually is it? What impact is it having? How did the study work ? What did it find ? What are the challenges that we need to look at ?

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Cyclical investment since privatisation

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Setting the scene – What is the cycle

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A perfect storm

During the last price review period (AMP4, 2005-10), a combination of factors made the situation worse… The regulatory capping of capital expenditure during the period The fall in the Construction Output Price Index (COPI) The alignment of Scottish Water’s price review control period with England and Wales companies The increase of capital maintenance in years 2 and 3 to get to a stable serviceability position

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So why does this matter ?

3-5% costs due to redundancies and staff costs alone Equates to £660m to £1.1bn over the five years Costs customers £5 to £6.50 on an average bill at the end of the five year period Estimated jobs impacted are 40,000 with loss of skills, training and impact on health and safety. We all recognise the need to take action in this area.

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In an ideal world

Companies’ expenditure profiles would have been smooth across each of the five-year periods We have carried out some simple analysis to measure ‘Amplitude’ based on a scoring system in which a company receives the highest score for having spent 20% of its five- year total in each year This analysis has allowed us to: Identify companies with least and most smooth expenditure profiles by way of a amplitude score (over three AMPs) Consider those companies with the greatest/smallest share of the current AMP5 programme The results are quite interesting…

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The most efficient companies have smoother profiles

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Who is managing this best ?

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Smoother profile <0.1 Amplitude ratio score dvw, prt, vea, vse brl sbw, ses WSX, vce NES More uneven profile >0.4 0.3 - 0.4 0.2 - 0.3 0.1 - 0.2 cam, sst SRN TMS, NWT SWT, sew WSH, YKY SVT Proportion of AMP5 Final Determination programme ANH <1% 1-5% 5-10% 10-15% >15%

Joint study between Ofwat and Infrastructure UK

To understand and expose the causes and drivers of peaks and troughs in the investment cycle in the water sector and to consider the changes all players in the sector can make to reduce its impact Three water companies selected – ANH, NWT and SRN – based on the amplitude of their cycle and their share of capital programme Discussions with their company representatives involved in capital investment planning Separate discussions with selected supply chain contractors, non-executive directors, directors and investors

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Joint study between Ofwat and Infrastructure UK

Scope of the study Discussions about the problem Causes, drivers of expenditure patterns Timings Governance arrangements Effects on the supply chain Relationships, communications Visibility of workloads Risk and contingency Innovation What should be done about it? Does a smooth profile = economic and efficient delivery? A specific regulatory incentive or can it be addressed via a combination of other mechanisms?

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Changing capital programmes through PR09

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Who is managing this best

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Quality enhancement outputs

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Themes arising from the study

No single silver bullet to solve this No one party has created this effect and no one party has a vested interest to continue it. As a regulator we remain concerned on the issue and continue to look at how changes can be made to help reduce this effect.

• Early start programme
• Overlap programme
• Capital incentive scheme

But we also recognise that more needs to be done, the question is what will be most effective and who would bear the risk of this ?

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Themes arising from the study

Key contributing factors: An embedded culture of cyclical investment; Effective and timely decisions not being taken; The need to improve planning approaches to investment programmes; Poor transition planning across price review periods; and A lack of a visible pipeline clearly communicated to the supply chain.

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So what are the issues ?

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What next?

What is still to do ? Compile and publish joint IUK/Ofwat report – next few weeks Reflect outcome in the future price limits methodology for consultation in the autumn British Water/WaterUK meeting on 11 September to engage with wider water companies and supply chain

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