Tales of the unexpected

Well behind the pack in 2002, Scottish Water at ten has smashed expectations and is taking on new Hydro Nation challenges, says Karma Ockenden.

Ten years can make a lot of difference. Scottish Water (SW) is ten this year and has notched up some remarkable achievements since it was formed (see box, overleaf). Back in 2002, it was a widely berated laggard. Now, it is not only a strong performer in the UK water sector, it is also setting the agenda in a number of areas.

For the past four years it has been under the leadership of chief executive Richard Ackroyd. Although before his time, he recalls the dark days: “When SW was formed in 2002, it didn’t have very many friends. There was a huge amount of criticism from the regulator at the time, who pointed out repeatedly that SW was an underperformer compared with the rest of the UK water industry. The formation of SW was a party politically contentious issue at the time, so there were politicians who would criticise the business. There was quite a lot of media criticism too, fuelled by some very public operational problems – in 2002 there was a crypto scare in Glasgow. So some real low points.”

Asked to name the high point of the past ten years, he says it’s now. “There is no doubt that this has been SW’s best year ever. Pretty much all of the key performance indicators have moved forward in the right direction, some of them by enormous margins.” Scottish Water’s annual report for 2011/12, out last week, supports his assertion.

So perhaps the Scottish Government could not have chosen a better time to broaden Scottish Water’s activities as part of its Hydro Nation plans. The policy concept, set out in a prospectus closing to consultation next week (19 July), is to treat Scotland’s abundance of water as a natural resource capable of having a value to the economy and society, and to exploit it as such while having due regard for the environment. In practical terms, this could translate into the likes of enticing water-intensive industries to relocate in the country and developing Scotland as a “brand” to operate in the global water market.

On 27 June, the Water Resources (Scotland) Bill was introduced, with the overarching aim of developing and protecting Scotland’s water resources in line with Hydro Nation ambitions. The Bill places new duties on Scottish Water specifically: to develop the value of its assets and Scotland’s water resources more generally, and to promote renewables on its assets.

Ackroyd says the policy has already spurred Scottish Water “to do some things we wouldn’t have done”. In particular, it has created an international arm that has already won four contracts, the largest of which is a five-year deal on wastewater in Qatar. Ackroyd realises that going global cuts against the industry trend and he does not plan to repeat mistakes made by English water companies in the past. “You will not find us taking stakes in overseas water projects,” he says. “You will not find us taking on long-term risk.”

What you will find is Scottish Water capitalising on its experience, and selling advisory and consultancy services. Ackroyd says: “The thing we’ve found is that water in most parts of the world is in the public sector and politicians want to keep it in the public sector. They’re really interested in the SW journey over the past ten years, working within the public sector but in a regulated environment that’s incentive based and that measures performance against external benchmarks … So that’s the niche.” He says it is a huge market and the interest is already keen.

Hydro Nation is also at least partially behind SW’s progress on developing renewable energy on its asset base. Most of this development is taking place through Horizons, SW’s old contracting business now recast as its commercial and renewable energy subsidiary. The company has a target of meeting 20 per cent of demand from its own renewables by 2015, and ­Ackroyd says “we’re certainly on track to get 20 per cent by 2015, it may even be more”.

The company is using a range of technologies, including: micro hydro (Edinburgh’s new Glencorse water treatment works has a hydro turbine, one of 40 such projects in the pipeline); photovoltaics on seven or eight sites; and anaerobic digestion (SW is Scotland’s market leader on anaerobic digestion from food and green waste and has another plant planned for next year). It is innovating with a new bit of kit that uses the different pressures on either side of the valves in large mains to generate power – the first unit has been installed, and four more are going in over the next 12 months.

Ackroyd says: “The big step forward that would take us beyond 20 per cent, up to self-sufficiency and even beyond, is wind generation from within our asset base. That’s a longer-term aspiration. We have nine sites that are potential onshore windfarms, two in the planning process with one close to getting permission.”

SW’s Hydro Nation duties bring a new dimension to the old question of the water company’s finances being constrained by only being able to borrow from the Scottish Government. SW certainly raised the issue when it responded to the original Hydro Nations consultation last March.

Squeezed public finances already mean SW’s planned borrowing for 2010-15 has been revised down from £700 million to £580 million, although the company has cleverly been able to manage with less without cutting the capital programme or requesting bill increases, through a combination of higher-than-expected efficiencies and driving hard bargains. “The construction industry has been offering some highly competitive prices,” Ackroyd says. Meanwhile, draft ministerial objectives for the next regulatory period caution: “For planning purposes it should be assumed that borrowing by Scottish Water will be at a lower level to that available in the 2010-15 period.”

Ackroyd admits: “Clearly we need access to capital from somewhere and yes, there’s an element of uncertainty around that, there’s no getting away from it. We have always managed to address it satisfactorily so far and I would expect we will continue to do so.”

Some initiatives will not be a problem. “We do actually have sufficient capital available to do quite a lot of the hydro generation we’ve talked about and the anaerobic digestion,” he says. “We can fund those things through retained profits. For bigger things [like onshore wind] we’ve been working with partners.” And now the Water Resources Bill sets out plans to enable subsidiaries of Scottish Water to borrow from private sources of finance, which could go some way to providing for new obligations.

In the longer term, Scottish independence could offer a solution. “We have an ambition which is very much shared by Scottish ministers to get private finance from debt markets into SW whilst it remains in public ownership … The Treasury and the Office of National Statistics interpret and apply rules in a way that prevents that happening, and that’s clearly an obstacle nobody has yet found a way around. The SNP has a very obvious aspiration for an independent Scotland. In that situation, those rules may well be different … So it may well be possible for SW to borrow in the debt market at some point in the future.”

Looking forward, the next regulatory period looks set to be extended from five to six years, with investment objectives set for two regulatory periods, or 12 years. This would align it with the Water Framework and Flood Risk Management Directives, major drivers for investment. Draft ministerial objectives for 2015 and beyond otherwise point to continuity being the order of the day. Prices have been frozen for the past four years. Ministers say that in the next period charges should remain “affordable and broadly stable” and that the capital programme should be limited to no more than £500 million (at 2007/08 prices) per year”.

A new Customer Forum with the remit to negotiate directly with SW on prices and spending priorities will be in play, though (see feature, page 24). Ackroyd comments: “It’s early days, but it’s already clear the people on it are of independent mind and will pose us some interesting challenges.”

Voice of experience on competition

Having operated as a wholesaler since April 2008, Ackroyd advises English water companies preparing for market opening to:

· Safeguard credit risk: with millions of individual customers, credit risk is spread. “If you envisage a position where there are half a dozen big water retailers, all buying wholesale from the water companies, one of those retailers could have 15-20 per cent of the market. If they default, that’s a huge, huge hit … We’ve already had two examples of small retailers defaulting and having to withdraw from the [Scottish] market, and that’s cost SW sums of money. That credit risk issue is really going to have to be addressed.” Upfront payment or some other kind of security from retailers would benefit wholesalers, although could pose barriers to entry for retailers.

· Develop a wholesale capability: “It’s easy to make an assumption that the thing you need to do is develop a retail capability. Actually what you need to do is develop a retail capability and a wholesale capability. If you have an integrated business, it doesn’t have the ability unless you create it to satisfactorily meet the needs of retailers, which are different from the needs of the ultimate end user.”

Zero to hero: achievements to date

· Customer service: Overall Performance Assessment score more than doubled since 2002.

· Charges: average household charge is now £52 lower than the average in England and Wales; in 2002/03 the average household charge was £30 higher.

· Investment: £5.5 billion.

· Drinking water quality: compliance up from 99.44 per cent to 99.86 per cent.

· Wastewater treatment: compliance has improved by 87 per cent since 2002.

· Leakage: down 44 per cent to 629 million litres a day.

· Sewer flooding: incidents down 61 per cent.

· Real operating costs slashed by 40 per cent.

This article first appeared in Utility Week’s print edition of 13 July 2012.

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