Thames digs deep for tunnel

The Thames Tideway Tunnel will be delivered by a standalone company, but that doesn’t mean Thames Water won’t also have to invest massive sums of money, as Karma Ockenden explains.

Early last month, a little under a year since the specified infrastructure project (SIP) regulations came into force on 28 June 2013, the secretary of state for the environment declared that the Thames Tideway Tunnel qualifies as a “specified infrastructure project”. In a nutshell, this means the scheme – which would ordinarily be undertaken by sewerage incumbent Thames Water – satisfies the requisite tests (see box, right) for it to be delivered by a third party.

Thames is charged with marshalling a far from insignificant £1.4 billion of preparatory work, but the bulk of the delivery, valued at £2.8 billion, is to be put out to tender. The successful bidder will be designated as the “infrastructure provider” responsible for the project, and licensed and regulated accordingly.

The intention of the SIP regulations is to protect incumbents and their customers from particularly large or complex projects that could jeopardise business-as-usual services – and to deliver such projects for the best value for money. However, the exact extent of Thames Water’s role in the project – what “preparatory work” looks like – is unclear.

In its December business plan for 2015-20, Thames included £508 million of expenditure within its wholesale plan for the Tideway works. In the revised plan it submitted at the end of June, this figure had soared to £655 million. This was principally on the back of higher construction and programme management costs, which arose because Thames is picking up work originally earmarked for the infrastructure provider.

The infrastructure provider licence award is not now expected until autumn 2015, so Thames is taking on more to prevent too great a delay in the tunnel’s final completion date (see table, above).

In another development in its June revised business plan, Thames Water has agreed to Ofwat’s preference for an entirely separate price control for its Tideway Tunnel wholesale costs. This, both parties concur, will ensure that Thames’s non-Tideway Tunnel wholesale activities are comparable to those of other companies. It will also make it is easier to ensure that Tideway costs are demonstrably efficient, and that progress reporting and delivery accountability for the tunnel is clearer.

Included within the scope of the tunnel price control will be:

•    development, land and compensation costs;

•    programme management and category 2/3 construction works;

•    Thames’s integration team (co-located with the infrastructure provider), supportive assurance resources and insurance costs;

•    depreciation and return on existing Tideway Tunnel-related regulatory capital value (AMP4 and AMP5 tunnel costs);

•    the marginal tax impact of the tunnel;

•    activities that would have been undertaken by the infrastructure provider but which Thames will now carry out to mitigate the delay in the overall programme (notably, design and mobilisation work for the IP category 1 works);

•    incremental Ofwat fees caused by the Tideway tunnel.

Thames commits to: procure an infrastructure provider; undertake the construction activities (category 2 and 3 works) included in its business plan; procure the necessary land for the tunnel and comply with obligations consistent with its Development Consent Order application; engage effectively with the infrastructure provider both in terms of integration and assurance; comply with the relevant project compensation policies; and limit the extent of delays on the overall programme timeline.

That said, the project carries high levels of ongoing uncertainty, which Thames describes as “above and beyond anything faced by the rest of the industry”. Consequently, its plan also proposes a package of special uncertainty mechanisms, including “a change mechanism to deal with transfers of scope between us and the infrastructure provider on a consistent basis and to deal with overall changes in the scope of the programme”.

So while the SIP regulations in theory prohibit an incumbent undertaking an infrastructure project once it has been “specified”, exactly where the line between the allowed preparatory work and the actual delivery work lies is more hazy – and clearly subject to practical as well as theoretical considerations.

Why the Tideway Tunnel qualifies as an SIP

Under the SIP regulations, the secretary of state may only “specify” an infrastructure project if he or she is of the opinion that a) it is of a size or ­complexity that threatens the incumbent undertaker’s ability to provide services for its customers; and b) specifying the infrastructure project is likely to result in ­better value for money than if it was delivered by the incumbent.

The Tideway Tunnel is the government’s preferred route to ensuring compliance with the Urban Wastewater Treatment Directive. It will run 25km along the River Thames between Acton and Abbey Mills and intercept 34 combined sewer overflows, diverting their surface water and sewage contents to treatment rather than allowing it to discharge into the river.

Regarding part a), the secretary of state considered four types of risk: scale risk, construction risk, management risk, and regulatory risk. He determined the Tideway would form 30 per cent of Thames’s £11 billion 2015 regulatory capital value should it undertake the project, and that peak annual expenditure would be between £500 million and £900 million. Such a concentration of risk in a single project would increase Thames Water’s risk profile compared with its normal undertaker role.

Moreover, the construction risk profile of the tunnel would be far higher than the company’s normal construction works; the project would straddle normal five-yearly regulatory cycles; and it would put significant stress on Thames Water’s management and governance arrangements.

Consequently, the Department for Environment, Food and Rural Affairs says: “The scale and risk profile of the project make it likely that if it were undertaken by [Thames Water] without government intervention, [Thames] would have its credit rating downgraded, probably to sub-investment grade, and would be unlikely to be able to raise sufficient finance to remedy this and meet its licence conditions at a cost that would be acceptable to customers.”

Regarding part b), the secretary of state concluded that allowing an infrastructure provider to deliver the project would likely lead to better value for money for customers; the project’s higher than usual risks would affect the entirety of Thames Water’s business and so would increase the cost of financing for all of the company’s investments.