Ofwat closes gap with Thames on PR19

Ofwat has published its long-awaited final determinations (FD) on PR19, in which it conceded to significant compromises with Thames Water but stayed firm in the face of opposition from several other major players in the sector.

The FD covers the business plans for the next five years (AMP 7) and amounts to a spending package of £51 billion.

It sets out the lowest allowed return on capital since privatisation – at 2.96 per cent for the whole business and 2.92 per cent for wholesale controls. Meanwhile the cost of equity has been cut from 4.5 per cent to 4.2 per cent.

The regulator also confirmed that companies would be incentivised to find innovative solutions to the challenges facing the sector. As part of this, £200 million will be made available through an innovation competition.

Ofwat chief executive, Rachel Fletcher, said: “Today we’re firing the starting gun on the transformation of the water industry backed by a major investment programme to deliver new, improved services for customers and the environment and resilience for generations to come. Now water companies need to crack on, turn this into a reality and transform their performance for everyone.

“They will be investing the equivalent of an extra £6 million each and every day to overhaul services, strengthen their infrastructure and improve our natural environment. And at the same time, customers’ bills will fall by an average of £50 before inflation.”

Meanwhile, Ofwat director David Black told Utility Week that chief executives had been in “listening mode” when they received news of the determinations.

The FD shows a mixed picture for the companies in the slow track and significant scrutiny categories.

Ofwat has taken what appears to be a bespoke approach to Thames Water, almost matching the firm’s revised totex proposal with a reduction of almost £800 million. The regulator has also allowed Thames to bid for an extra £480 million of resilience funding but has warned that strict checks and balances will need to be met or the money could be returned to customers. It has also cautioned that the firm’s shareholders will be expected to put their hands in their pockets to contribute to the investment.

Thames was one of the firms believed to be considering a Competition and Markets Authority (CMA) referral if things didn’t go its way. Today it released only a perfunctory statement confirming that it was studying the detail, with its peers following suit. Any firm seeking to appeal has until the middle of February 2020 to do so.

Anglian is another company which was vocal about the challenges of Ofwat’s draft determinations (DD). The regulator has since revised its expectations on totex but there remains a gap of £744 million. Others facing a chasm between their view of reasonable totex costs and Ofwat’s include Yorkshire (£370 million difference),   Southern (£235 million) Northumbrian (£156 million)  and Wessex (£141 million).

Three companies – Severn Trent, South West and United Utilities – had their business plans “fast-tracked”in the summer, meaning they have been passed largely unchanged.

Here is a summary of Ofwat’s responses to those in the slow-track and significant scrutiny categories:

WATER AND SEWERAGE COMPANIES

Thames

The sizeable gap from the DD over totex has largely been closed, with Ofwat increasing the allowance by £795.7 million – to £9.3 billion. The move means that just an £8 million difference remains between the regulator and company.

Thames will be expected to cut bills by 7.1 per cent in real terms compared to the company’s proposed 2.8 per cent reduction. This is a further significant reduction on the level in the DD, which set a 10 per cent bill reduction target.

The FD also allows Thames £1.5 billion for improvements to service, resilience and the environment.

It makes two further conditional allowances relating to water supply infrastructure in London – £180 million to investigate risks to resilience and the mitigation of risk to water supplies in north east London and up to £300 million to improve the performance of the capital’s water network. Ofwat stressed that both amounts were conditional on Thames delivering an agreed scope of work through a gated process and that the money would be returned to customers if a clear and well-thought-through plan was not delivered. In relation to the £300 million, the regulator also insisted that Thames shareholders would be expected to make a “significant contribution”.

Total allowed revenue has been set at just under £10.3 billion, compared to the £10.7 billion Thames had requested.

The firms Key Performance Commitments (KPC) include a 20.4 per cent reduction in leakage on a three-year average basis. This is a return to the company’s earlier estimate and wipes out the 25 per cent commitment in the DD. The company will also be expected to deliver a 6.3 per cent reduction in per capita consumption over the AMP, as well as a 30 per cent reduction in pollution incidents (to 19.5 incidents per 10,000 km sewer) and a 36 per cent fall in internal sewer flooding incidents to 1.34 incidents per 10,000 connections. Ofwat has also demanded a 53 per cent reduction in water supply interruptions by 2024/25 to 5 minutes.

On its bespoke performance commitments, Thames will be expected to increase the average annual availability of pumps in network catchment sewage pumping stations from 96 per cent to 98.5 per cent, to disconnect 65 hectares of surface area from the combined sewer system and to increase the amount of renewable energy it produces to 9.3 per cent.

The likely range of returns from outcome delivery incentive package equates to a return on regulatory equity range of between -1.68 per cent and +0.76 per cent.

In its draft determination, Thames proposed an alternative to its gearing outperformance mechanism, which Ofwat rejected on the grounds it did not provide equivalent benefits for customers. The regulator has amended its own mechanism to include a transition period

Anglian

Ofwat has demanded a reduction in bills of 10.5 per cent by 2025 – down from 12 per cent at DD but still significantly higher than Anglian’s suggestion of 1.4 per cent.

The final determination allows wholesale totex of £5.3 billion – which remains £744 million away from the company’s decision, despite nudging up £232 million since the DD.

The FD allows £1.4 billion to invest in improvements to service, resilience and the environment.

Total allowed revenue is just over £6.1 billion for the period – compared to the company’s request for just under £6.8 billion.

An allowance has also been made for £24.8 million to support long-term drought resilience as well as £9.4 million towards the Elsham treatment works.

The company’s KPCs include a 16.4 per cent leakage reduction on a three-year average basis, a 5.6 per cent cut in per capita consumption by 2024/25, pollution incidents down 33 per cent to 19.5  per 10,000km of the wastewater sewer and 21 per cent reduction in internal sewer flooding incidents to 1.34 per 10,000 sewer connections. The company has been set a 55 per cent reduction in water supply interruptions, to 5 minutes.

Bespoke commitments include a 6 per cent reduction in external sewer flooding incidents by 2024/25 and a 10 per cent reduction in operational carbon emissions by the same point.

The likely range of returns from outcome delivery incentive equate to between -1.93 per cent to 0.77 per cent.

Yorkshire

The FD sets a bill reduction target of 8.7 per cent compared to 10 per cent in the DD and the company’s proposed 0.8 per cent cut.

Wholesale totex costs are set at £4.165 billion – £142.7 million higher than in the DD but £370 million lower than proposed by Yorkshire.

The company has been allocated £905 million to improve service, resilience and the environment.

Allowed revenue is set at £5.14 billion, compared to a request of just under £5.4 billion from Yorkshire.

When it comes to KPCs, Yorkshire will be expected to achieve a 15 per cent leakage reduction on a three-year average basis. It will also have to show a 9 per cent cut in per capita consumption over the five years, a fall of 41 per cent in pollution incidents to 19.5 incidents per 10,000km of the wastewater sewer and a 47 per cent  drop in internal sewer flooding incidents to 1.34 incidents per 10,000 connections. Its target on water supply interruptions is to reach a level of five minutes by 2024/25.

The company also has a number of bespoke commitments, including a 30 per cent increase in the number of hectares of land conserved and enhanced by 2024/25, a 25 per cent reduction in exernal sewer flooding incidents per 10,000 connections, a 34 per cent drop in complaints about drinking water quality and 742 additional kilometres of rivers improved.

The range of returns from outcome delivery incentive is estimated to be between -2.46 per cent and +2.95 per cent.

Southern

Ofwat has increased the reduction in customer bills it expects Southern to achieve over the next five years. At DD, the level was set at 14 per cent but that has now increased to an 18 per cent cut. This compares to the company’s proposal of 6.7 per cent.

The FD allows wholesale totex of £3.4 billion – up £64.3 million from the DD but still £235 million off Southern’s expectation.

A further £855 million has been allocated for improvements to service, resilience and the environment, while an additional allowance of £84.9 million has been included for strategic water resource development to support long-term drought resilience.

Looking at the total allowed revenue for the period, Ofwat has approved just under £3.7 billion (a slight reduction on the DD), compared to the company’s request of just over £4.1 billion.

On KPIs, Southern will be expected to achieve a 15 per cent leakage reduction on a three-year average basis,a  7.2 per cent drop in per capita consumption by 2024-25, a cut of 33 per cent in pollution incidents – to 19.5 incidents per 10,000km of the wastewater sewer – and the same level of reduction in internal sewer flooding incidents – to 1.34 incidents per 10,000 connections. It will also be expected to achieve a 19 per cent fall in water supply interruptions over the five years.

Bespoke commitments include a 30 per cent reduction in external sewer flooding incidents per 10,000 connections, a 13 per cent increase in total renewable electricity and a 13 per cent reduction in customer complaints regarding the taste and odour of their drinking water.

Overall, the likely range of returns from outcome delivery incentive equates to a return on regulatory equity range of between -1.64 per cent and +0.58 per cent.

Northumbrian

A significant difference remains between Northumbrian’s DD totex representation and Ofwat’s. The regulator conceded £23.3 million in spending allowance to £2.7 billion –  leaving a shortfall of £156.1 million.

Northumbrian will reduce customer bills by 25.6 per cent compared to its proposed 21.3 per cent reduction. Ofwat’s figure remains unchanged from the DD.

The company has been allowed £352 million to invest in improvements to service, resilience and the environment.

Total allowed revenues are set at £3.4 billion in the FD, compared to £3.5 billion requested by the company.

On its KPCs, Northumbrian will be expected to achieve an 18.5 per cent leakage reduction for the Essex and Suffolk region and 11 per cent for the Northumbrian region on a three-year average basis. For the company as a whole, this means at least a 15 per cent reduction from PR14 performance commitment levels. It will also be expected to achieve a 5.3 per cent reduction in per capita consumption by 2024/25, as well as a 22 per cent reduction in pollution incidents to 19.5 pollution incidents per 10,000km of the wastewater sewer and a 43 per cent reduction in internal sewer flooding incidents to 1.34 incidents per 10,000 sewer connections.  A level of 5 minutes has been set for water supply interruptions.

Bespoke performance commitments include a 26 per cent reduction in external sewer flooding incidents by 2024/25, a 3 per cent increase in the percentage of designated bathing waters in the company’s northern operating area that are classified annually as Good or Excellent and a 28 per cent reduction in greenhouse gas produced by the company.

The likely range of returns from outcome delivery incentive equates to a return on regulatory equity range of between –1.54 per cent  and +1.36 per cent.

Welsh Water

Bills will fall in real terms by 9.4 per cent over the next five years, as opposed to the 5.5 per cent suggested by Welsh Water and the 14 per cent indicated in the DD.

The FD sets a totex budget of £2.95 billion – £150.1 million  higher than the DD but still £163.4 million shy of Welsh Water’s position.

The regulator and the company were almost aligned on allowed revenue – with Ofwat’s figure coming in at £3.73 billion.

Welsh Water will be expected to deliver at least a 15 per cent leakage reduction and a 6.3 per cent drop in per capita consumption by 2024/25. Pollution incidents will have to drop 33 per cent – to 19.5 incidents per 10,000km of the wastewater sewer, while internal sewer flooding incidents will have to come down by the same percentage to 1.34 incidents per 10,000 connections. The company has a goal of a 58 per cent reduction in water supply interruptions by 2024/25 to 5 minutes.

Specific commitments include a 25 per cent reduction in external sewer flooding incidents per 10,000 connections, an increase in the number of lead pipes replaced from 1,400 in 2020-21 to 7,000 by 2024-25 and an increase in participants to its educational activities (70,000 in 2020/21 to 75,000 in 2024/25)

The likely range of returns from outcome delivery incentive package equates to between -1.03 per cent and +0.61 per cent.

Wessex

The FD requires Wessex to cut bills by 13 per cent over the period – down from the original 15 per cent target – but still considerably higher than the company’s 5.9 per cent suggestion.

Wessex will be allowed to spend just under £2.1 billion on totex – still £141.1 million less than it had requested but £74.7 million higher than Ofwat had suggested at the DD. Wessex will also be allowed £509 million to invest in improvements to service, resilience and the environment and a further £4.2 million for strategic water resource development to support long-term drought resilience.

The final allowed revenue figure is just under £2.4 billion compared to a request of just over £2.5 billion from Wessex. Ofwat has shifted almost £100 million since the DD.

KPCs require at least a 15 per cent reduction in leakage from PR14 performance commitment levels and a 0.9 fall in per capita consumption. Wessex will be expected to reduce pollution incidents by 11 per cent – to 19.5 per 10,000km of the wastewater sewer – and cut internal sewer flooding incidents by 16 per cent. Ofwat has charged it with a 59 per cent reduction in water supply interruptions –  to 5 minutes

When it comes to bespoke performance commitments, Ofwat has set the expectation of a 10 per cent reduction in external sewer flooding incidents, a 13.7 per cent fall in annual gross greenhouse gas emission from operational services and  37 catchment based partnership projects to improve natural capital.

The likely range of returns from outcome delivery incentive equates to between -1.35 per cent and +0.98 per cent.

Hafren Dyfrdwy

The FD sets out the requirement for Hafren Dyfrdwy to cut average bills by 3 per cent, compared to the company’s proposed 1 per cent drop. Ofwat has increased this from 2 per cent at DD.

The wholesale totex limit has been set at £165.6 million – £700,000 higher than the DD and £3.2 million higher than the company’s latest representation. The FD allows Hafren Dyfrdwy £15.6 million to invest in improvements to service, resilience and the environment.

Final allowed revenue for the period has been set at £127.9 million, compared to the company’s view of £129.4 million.

The company must achieve at least 15 per cent leakage reduction and a 4.2 per cent reduction in per capita consumption. It must also cut pollution incidents by 39 per cent – to 19.5 incidents per 10,000km of the wastewater sewer and internal sewer flooding incidents by 23 per cent. It will be expected to secure a 58 per cent reduction in water supply interruption incidents to 5 minutes.

Bespoke performance commitments include an 11 per cent increase in the percentage of struggling to pay customers supported through tailored schemes, a 6 per cent reduction in sewer blockages and 230 lead pipes replaced.

The likely range of returns from outcome delivery incentive package equates to between -2.30 per cent and +0.48 per cent.

WATER ONLY COMPANIES

Affinity

Ofwat has narrowed its expectation of bill reductions to 5.5 per cent, compared to 12 per cent at DD and the 1 per cent proposed by the company.

The final determination allows wholesale totex of £1.4 billion – £46.7 million higher than at DD and £19.6 million lower than the company had put forward.

The regulator has decided on a figure of £1.46 billion for final allowed revenue, compared to the £1.56 billion requested – a shift of just over £100 million since the DD.

The KPCs set out an expectation of a 20 per cent cut in the leakage rate on a three-year average basis, as well as a 12.5 per cent reduction in per capita consumption by 2024/25. Water supply interruptions must be slashed by 17 per cent by the end of the price control period.

Bespoke performance commitments include a 29 per cent reduction in the impact of disruption because of unplanned interruptions to IT services by 2024/25. The company will also be expected to cut complaints about appearance, taste and odour by 7 per cent, complete eight environmental improvement pilot projects and maintain the British Standards Institution (BSI) standard for accessible service.

The likely range of returns from outcome delivery incentive equates to between -2.93 and  +0.77.

South East

The FD cuts average bills by 7.2 per cent in real terms compared to the company’s proposed 0.6 per cent reduction.

The wholesale totex limit has been set at £917.9 million – £32.7 million higher than in DD and £107 million lower than stated in the company’s representation. The FD also allows South East Water £162.4 million to invest in improvements to service, resilience and the environment.

Final allowed revenue for the period has been set at just under £1.2 billion, compared to the company’s view of just over £1.2 billion. Ofwat shifted by £70 million between DD and FD.

The company must achieve at least 15 per cent leakage reduction and a 7.2 per cent reduction in per capita consumption. It must also show a 50 per cent reduction in water supply interruptions and a 2 per cent drop in unplanned water treatment works.

Its bespoke performance commitments include a 32 per cent drop in the number of complaints about water appearance by 2024-25 and a 68 per cent reduction in the amount of greenhouse gas emissions produced per megalitre of treated water by 2024-25.

The likely range of returns from outcome delivery incentive package equates to between -1.80 per cent and +0.47 per cent.

South Staffs

The company has been tasked with cutting bills by 10.3 per cent by 20205, compared to its target of 8.9 per cent.

Its wholesale totex has been set at  £572.5 million – £29.7 million higher than at DD but £10.6 million lower than the company’s representation.

Final allowed revenue for the period has been set at £618 million, compared to the company’s view of £648 million.

The company must achieve 15 per cent and 13.8 per cent leakage reduction on a three year average basis respectively on the South Staffs and Cambridge regions. It must also secure a 1 per cent and 6.3 per cent reduction in per capita consumption by 2024-25 in the South Staffs and Cambridge regions respectively. It has also been tasked with finding a 29 per cent reduction in water supply interruptions by 2024/25 – to 5 minutes.

The likely range of returns from outcome delivery incentive package equates to between – 2.90 per cent and +1.46 per cent.

Bristol

The FD sets out the expectation that bills will reduce by 14.8 per cent in real terms over the next five years. This compares to the company’s request of a 5.4 per cent drop.

Ofwat has increased Bristol’s allowance for wholesale totex by £24.1 million – to £420.4 million. This remains £31.8 million less than the figure requested by the company after the DD.

In terms of total allowed revenue, the FD landed on a figure of £553.3 million, compared to the £603.5 million Bristol requested.

The FD allows Bristol £29.9 million to invest in improvements to service, resilience and the environment.

In terms of KPCs, Bristol will be expected to achieve a 21.2 per cent leakage reduction on a three year average basis, a 6.3 per cent drop in per capita consumption and a 59 per cent reduction in water supply interruptions to five minutes.

The company also has some bespoke performance commitments – including a 54 per cent reduction in customer contacts about drinking water appearance, a 29 per cent fall in properties at risk of receiving low pressure and a 13 per cent increase in local community satisfaction.

The likely range of returns from outcome delivery incentive equates to between -2.15 per cent and +1 per cent.

SES

Ofwat has stuck firm with its 15 per cent bill reduction target, despite SES proposing 7.1 per cent.

The regulator has allowed SES £254.6 million of wholesale totex – still £12.7 million lower than the company’s position but up £29.8 million on the DD.

The final allowed revenue was £301.5 million – someway off SES’ position of £313.1 million.

KPCs include at least a 15 per cent reduction in annual level of leakage by 2024/25, a 6.6 per cent reduction in per capita consumption and a level of 5 minutes for 2024-25 for water supply interruptions.

Bespoke performance commitments include 15 per cent increase in the share of customer contacts, including enquiries and complaints that are resolved on first contact and a 71 per cent increase in the number of projects completed to deliver the outcomes associated with the Water Industry National Environment Programme.

The likely range of returns from outcome delivery incentive package equates to between -1.01 per cent and +1.28 per cent.

Portsmouth

Ofwat has set Portsmouth a target of cutting bills by 5.4 per cent between 2020 and 2025, compared to 12 per cent in the DD. The company had originally proposed 4 per cent.

The totex budget has been set at £176.2 million (excluding Havant Thicket related expenditure – subject to a separate business plan), which is actually £9.1 million higher than the company suggested and £3.4 million above the DD figure. Ofwat has also allowed Portsmouth £18.8 million for improvements to service, resilience and the environment.

The total allowed revenue has been set as £192.8 million, compared to £193.8 million suggested by the company.

Its KPCs include reducing leakage by 15.2 per cent on a three-year average basis and per capita consumption by 6.3 per cent over the next five years as well as reaching  a level of five minutes for 2024/25 water supply interruptions.

Bespoke performance commitments include a 9 per cent cut in water appearance complaints and a 74 per cent reduction in the number of customers who receive, or are at risk of receiving, pressure below the minimum standard.

The likely range of returns from outcome delivery incentive equates to a return on regulatory equity range of between –1.64 per cent to +1.28 per cent.