The drain strain

The cost private sewer transfer has imposed on water companies is slowly emerging. Nigel Hawkins looks at whether IDoKs are likely

Among many other issues, Ofwat’s immensely complex proposals for the next periodic review will deal with the financial implications of the transfer of private sewers to sewerage companies. This ownership switch took place on 1 October 2011, when the responsibility for many – though not all – private sewers and lateral drains was transferred from individual householders.

In effect, there are two cost implications for a typical sewerage company. First, there is the capital expenditure element that will arise, especially when such sewer pipes need to be replaced – many are old and in a poor condition.

Presumably the value of these newly acquired sewer pipes will be incorporated within each company’s regulated asset base (Rab) as part of the next periodic review, due in April 2015. If so, companies will expect a financial return, which will help to finance any related investment expenditure.

Second, there are operating costs. No doubt the 2014/15 periodic review will incorporate an estimate of these costs so firms will be compensated financially for taking on assets whose ownership they may have preferred to avoid.

In dealing with these cost implications, some companies have indicated they want financial compensation ahead of the next price review. As such, they would be obliged to apply for an Interim Determination of K (IDoK) – a route previous experience has shown to produce an uncertain outcome.

Pennon-owned South West Water, for example, is expected to make an IDoK submission later this year (see box for how the transfer has affected South West’s costs). At its recent City analysts’ meeting, Ofwat confirmed that it needed any submissions by the autumn if adjustments were to be made for the 2014/15

financial year.

Others are adopting a “let sleeping dogs lie” approach for now and focusing instead on securing a favourable five-year periodic review outcome in 2014/15, under which they will expect a full and fair allowance for the additional costs. This may in part be with an eye to Westminster Village, where the issue of soaring utility prices has moved up the political agenda – particularly as the water sector, with its defensive earnings profile, has done rather well during the recession (certainly compared with other struggling sectors, such as housing and retail). Furthermore, persistently higher than expected inflation has given water companies a boost that many other sectors operating in a competitive environment must envy.

At present, the available data on private sewers is poor, which partly explains why Ofwat has been loath to adjust its financial model to take account of the recent changes. Operating private sewers is a messy business – sorting out the regulation and financial processes relating to their transfer will be equally messy.

Nigel Hawkins is a director of Nigel Hawkins Associates which undertakes investment and policy research

Private sewers: the bill so far

South West Water: Private sewer transfer has added more than 4,700km of sewers to the company’s asset base – more than doubling its sewerage network at a stroke. Last summer, South West confirmed it expected to incur additional annual operating costs of between £2 and £5 million along with a further £4-£6 million of maintenance costs, some of which may be categorised as infrastructure renewals expenditure. South West has also tentatively identified a private sewers capital expenditure upgrade bill of around £44 million, which presumably will be scrutinised during the periodic review. These figures are not insignificant when set alongside South West’s underlying annual pre-tax profit of c£140 million, excluding the Viridor contribution.

United Utilities: In its November interim results, the company said the transfer had given rise to additional operating costs of £3 million in the first six months of 2012/13. It had spent £6 million on infrastructure renewals covering private sewers over the same time period, and an additional £8 million had been incurred through enhanced capital expenditure. In cash outflow terms, this combined bill would be c£35 million on a full-year basis.

This article first appeared in Utility Week’s print edition of 12th April March 2013.

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