The move to totex was intended to herald a new dawn of innovation in the utilities sector – but has it? Utility Week assesses the impact of totex on energy and water companies.

It is just over a year ago that the water industry followed a path blazed by the energy sector when the regulator-mandated shift to totex came into play.

AMP6 has seen the removal of the capital expenditure (capex) and operational expenditure (opex) pots of money, with one single cash allocation taking its place.

It is hoped this shift – alongside the move to outcomes based regulation – will help to encourage innovation, which will in turn help to lower costs to the companies, and ultimately consumers.

The leap from AMP5 and the capex-opex regime to AMP6 and the totex regime has not however led to an instant rise in innovation in the sector – as we discovered in research last year, this is in part because many middle managers in the sector do not acknowledge a link between the two and, more broadly there is considerable uncertainty about how to embrace the new framework for better, more innovative investment planning.

Help may be found by looking to the energy sector – which first saw totex come into play in 2010 in the electricity distribution network’ price control DPCR5, and once again in the RIIO ED1 and RIIO GD1 price controls in April 2013 and April 2014 respectively.

Because this sector has been working with totex for longer, some of what Hydro International UK sales and marketing manager Keith Hayward calls the “considerable inertia among middle managers” in water companies has disappeared and there is shared understanding at both senior and middle management about the role totex can play supporting long term and innovative thinking.

Back in the water sector and Tim Cooper, partner, advisory at Arcadis, says this is not, so far, the case and adds that “it will be clearly beneficial for Ofwat to look at clear incentives” for innovation, above and beyond relying on the totex regime to act as a spur to investment in non-conventional solutions to infrastructure and operational challenges.

Ofgem has already gone down this path – initially with the Low Carbon Networks Fund (LCNF) and then following this up with the Network Innovation Competition (NIC) and Network Innovation Allowance (NIA), which provide funding for the research, development and demonstration of new technologies, operating and commercial arrangements.

These schemes have led to a number of innovation projects and trials going ahead often with totex related benefits – i.e. the ability to avoid grid reinforcement (capital expenditure) while achieving better total operational and financial efficiency through the implementation of smart techniques – such as active network management.

The NIC awarded a total of £62.8 million to innovation projects in November last year, with £22.8 million going to National Grid.

Ofgem has said the projects which benefit from its innovation funding will help to deliver “long term value for money” for consumers – also a clear intention behind the introduction of the totex model which, according to Northern Gas Networks’ operations manager for construction services Richard Hynes-Cooper goes “hand in hand with the ‘I’ in RIIO (Revenue=Incentives+ Innovation+Outputs).

This said, there’s no doubt that it’s the availability of funding that has been the main driver for a recent uptick in innovation activity in the energy sector, rather that the move towards totex. Should there come a time when this funding is withdrawn – it was originally introduced as a time-limited measure – it would be interesting to see the extent to which totex-thinking continued to drive smart, long term solutions to network challenges.

For the meantime however, the two are increasingly seen by energy companies as logical companions in an overall environment of significant change for utilities.

Water Sector Innovation and Perceptions of Totex

Research conducted by Utility Week in Association with Arcadis shows operations leaders in the water sector recognise the need to innovate but are reluctant to embrace the reality of change this requires.

The report is available to download at here

Opinion

Tim Cooper, Partner, advisory, at Arcadis

“There are still opportunities to drive innovation in the water sector – and here is how you can do it.”

It is now nearly six months since the publication of the original Water Sector Innovation and Perceptions of Totex, and on reflection, innovation within the water sector remains limited across the wholesale market and focused on near-term productive efficiency gains. We are not seeing innovation embraced to provide wider benefits obtained through improved allocation of resources or dynamic changes in the way wholesale services are provided. The following are four thoughts on how this might be achieved:

•    Ofwat can use the PR19 process to support innovation and long-term efficiency gains. Clearly the water and wastewater networks will continue to be a series of regional monopolies, however it will be beneficial for Ofwat to look at clear incentives for innovation and long-term efficiency gains, possibly revisiting how Ofgem considered innovation in establishing RIIO.

•    Use commercial models as a catalyst for innovation. All the leading utilities have adopted commercial models which incentivise partners to deliver their capital programme at a typical saving of 20 per cent versus AMP5. However, these models generally do little to incentivise opex savings, with the potential to limit true innovation and support a capex bias. Utilities could consider alternative commercial models which clearly incentivise longer-term efficiency gains and opex only solutions.

•    Improved resilience can be a springboard for innovation. Ofwat is placing increased focus on resilience, while at the same time, the past few months have seen some clear challenges across the sector including flooding and water contamination issues. As a consequence we are seeing several utilities invest in a deeper understanding of asset condition, asset criticality and operational risk. As understanding of the asset base improves, this can combined with data analytics to support innovative network and process solutions as well as a step change in the ability to make informed risk-based decisions, delivering both improved service resilience and major efficiency gains.

•    Think big, start small, kill early, scale fast. When looking to drive innovation, the technology sector and its approach to rapid prototyping is an interesting example to consider – trying new ideas, but not afraid to kill those that don’t work or rapidly roll out those that do. By comparison, the sector remains conservative, taking comfort in large programmes when there is the opportunity to trial innovative approaches in several areas including – energy load levelling, asset management and analytics – at a local level, identifying the most promising and accelerating the rate of innovation.