Super model

London's new supersewer will be ring-fenced from Thames Water in a new delivery model that could be applied elsewhere for utility mega projects. Richard Threlfall explains to Karma Ockenden

It’s a whopper. With a price tag of £4.1 billion, the Thames Tideway Tunnel “supersewer” is an infrastructure project to dwarf typical water infrastructure projects. Thames Water alone would struggle to pay the £600 million or so a year needed to fund the tunnel during the construction phase, estimated to run from 2016 to 2022/3. The public purse pretty much only has loose change left. And structures such as public-private partnerships or public finance initiatives typically stretch to only about a quarter of the funds the Tideway Tunnel needs. So it is pretty much a choice between dumping the sewer or finding a new way of financing it.

According to Richard Threlfall, head of KPMG’s infrastructure, building and construction business and lead Tideway adviser to Thames Water for more than two years, ditching the tunnel is out of the question. It is needed both for environmental reasons and to free London from the constraint of outdated sewerage so that it can economically flourish. The detail has yet to be worked out, but the Tideway team has developed a new finance and delivery model that potentially could be transferred to other mega projects in other sectors.

While being Thames Water’s adviser, Threlfall sees his role as broader – “as taking responsibility for finding a solution that allows the scheme to be delivered and financed,” he explains. “I see myself as acting as a go-between between Thames Water, government and Ofwat to try to build some consensus and common understanding about what it takes to deliver a scheme of this sort, because it’s not simple.”

This approach has been successful so far. After considering the full spectrum of options, the team has settled on a model for the construction phase that, on paper, is workable for all parties. “You have to have a bespoke system to support this project,” Threlfall says. Noting that the normal regulated model has been hugely successful at connecting low risk, low return capital to infrastructure build, he says the Tideway Tunnel is too much of a departure to proceed under the straightforward price control system.

Not only is it hugely expensive, but all risk is concentrated in a single project rather than being split between lots of smaller schemes. “To be saying ‘I’m putting my money on the table, and if one thing goes wrong in this project, I’m dead’ – no sane investor is going to do that,” Threlfall says. Moreover: “It’s not a normal construction job. It’s not quite the same as digging a hole in a high street and replacing a piece of pipe.”

The bespoke delivery system worked out for the project comprises three key elements:

· All risk is ring-fenced into an independent delivery vehicle. This is the way mega projects such as Eurotunnel, HS1 and the Olympics were handled. For the Tideway Tunnel, the intention is to set up a company completely separate from Thames Water – in fact, Thames may not even have a stake in it, although it is very likely that it will act as tunnel operator. “So you’re concentrating all the project risks, all of the mitigations, all the project protections, all the project financing, all the project funding, into one vehicle,” Threlfall explains. It will be subject to the next two elements of the model.

· Bespoke regulatory treatment. This would be designed to give investors certainty and confidence that the basis for their investment would not change with five-year regulatory periods, and would likely contain provisions for returns within the construction period. “[As an investor] you can’t wake up one morning and have the regulator decide after you’ve finished that actually £1 billion of the money spent was not spent efficiently,” says Threlfall. Ofwat would not necessarily make a determination for the tunnel as it does for wider investment. There would be options – for example, cost of capital could be opened to competitive tender.

· Government support. This would not take the form of a public subsidy – the government has no appetite for that – but of contingency support if certain risks materialised or certain things happened. According to Threlfall: “I think you would struggle to find any example anywhere in the world where that scale of private investment [c£4 billion] has been raised for a single infrastructure project and there hasn’t been a significant level of government underpinning.”

Collectively, these three elements will amount to a new model for infrastructure delivery. The contracting bit will be traditional – the plan is for that to borrow heavily from Crossrail, where work was tendered in discrete0 packages and contractors at every tier of delivery were incentivised to outperform target costs. But the “top bit” will break new ground. “The company structures, the way in which this asset has to sit within a regulated utility environment and the way it has to interact with the government’s support mechanisms – that will be new,” says Threlfall. “It will be unprecedented in the UK. It will be unprecedented anywhere in the world.”

Target investors for the Tideway Tunnel are by and large existing utility investor types – pension funds, sovereign wealth funds, increasingly the Chinese – plus capital market debt. So, of crucial importance to the model is not straying too far from what they already know and love about UK utility regulation.

Threlfall elaborates: “We have the precedent of the regulated water system. The trick really in trying to make a deliverable model for this scheme has been to draw on as much as the market’s existing comfort with that structure as we can, adjust it as necessary for the reasons we’ve just described, add in the government support as necessary, to present to the market something they recognise as being not dissimilar to a normal regulated asset… It’s about calibrating a level of intervention that gives investors confidence that, okay, it’s a risky project but they’re not going to lose their shirts on it.”

For the London customer, the tunnel is expected to cost an average £70-£80 per household per year. While extra costs will be unpopular with customers, Threlfall notes that London bills are well below the national average.

Regulators and government are already showing interest in using the model, or at least some aspects of it, in other sectors. The Flood and Water Management Act provides legislative underpinning for single assets to be ring-fenced from existing utilities. Threlfall points out: “That wasn’t designed merely to deal with Thames Tideway. In fact it wasn’t designed specifically for Thames Tideway. It was designed with a view to a number of other projects.”

The energy sector, with its multi-billion pound investment needs, is an obvious candidate. As negotiations continue between EDF and the government to find a way forward on a new nuclear power station at Hinkley, it is clear the Tideway Tunnel is not the only large infrastructure project with financing challenges. Threlfall concludes: “If we do this right, we will create a precedent that will allow other pieces of the UK’s nationally significant infrastructure to be delivered and financed over the coming decades.”

This article first appeared in Utility Week’s print edition of 22nd February 2013.

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