CMA locks horns with Ofwat on leakage

Ofwat sent a clear message to all water companies when it set a 15 per cent leakage reduction challenge for AMP7: after decades of stagnant progress fixing leaks must be a top priority.

The Competition and Markets Authority (CMA) has diverged from the regulator’s firm stance by allocating an extra £192 million and changing incentive mechanisms, but how far will that improve performance and does it undermine Ofwat’s challenge?

The CMA last week published its preliminary redeterminations for Anglian, Bristol, Northumbrian and Yorkshire, which included gains for the companies on the cost of capital but overall support for Ofwat’s approach to incentives.

The industry has long been harangued for its failure to make progress on leakage, causing Ofwat to come down hard with tough commitments for 2020-25. These were not disputed by appellants, who recognised the importance of the challenge but requested extra funding to reach that point.

Ofwat’s position was that the 15 per cent reduction should be funded from base cost allowances.

All four disputing companies said such a reduction would not be possible within their set allowances. Northumbrian said it would cover the shortfall from its own resources while Anglian, Bristol and Yorkshire each requested enhancement totex allowances.

Recognising the urgency of investing to improve, the CMA provisionally allowed Anglian an additional £93.7 million comprising £25.7 million added to base costs and £68 million enhancement.

The CMA allocated Bristol an extra £4.839 million of which £539k is base cost adjustment and £4.282 million enhancement.

Yorkshire has been permitted £93.3 million totex enhancement.

Northumbrian’s allowance will remain as set by Ofwat.

Incentives

One criticism of PR19 was that incentive mechanisms were “too much stick, not enough carrot” with companies and sector commentators suggesting the system was skewed towards failure.

The CMA removed enhanced outcome delivery incentives (ODIs) for leakage due to concerns that overstretching on leakage would not represent value for money for customers.

Ofwat set two tiers of penalty rates; tier 1 applied to companies that had been granted both base and enhancement spending (Anglian and Bristol). The enhancement allowance would be returned to billpayers if a company maintained but did not improve its leakage performance. Tier 2 will be applied to all companies to penalise any whose performance dropped below status quo.

The CMA supported Ofwat’s approach to leakage performance commitments but modified the two-tier system. Anglian, Bristol and Yorkshire have all been allocated enhancement funding so underperformance will be subject to a tougher penalty on their performance against the status quo, and a lower penalty for underperformance against additional performance.

A flat rate penalty has been proposed for Northumbrian because it did not request enhancement allowance.

Was it necessary?

Ofwat’s challenge to the water companies was very upfront – after 19 years of little improvement it pushed hard to see a step-change in performance.

In the past year the sector achieved a 7 per cent leakage reduction and leakage detection technologies and techniques have flourished, which suggested the challenge was working and the PR19 goals would be comfortably achieved.

Several companies overhauled their approach to leakage reflecting that business as usual was no longer acceptable to customers, companies or the regulator.

By allocating more funding based on evidence of historic performance and costs it could be argued that the CMA has misunderstood or disregarded Ofwat’s stance that past performance was inefficient and undermines the challenge laid down by the regulator.

It begs the question why the CMA felt the need to make changes when there was already strong indicators the 15 per cent leakage reduction could not only be met but exceeded.