The Competition and Markets Authority has published the latest submissions in its current Bristol Water PR14 inquiry – responses to its own Provisional Findings (PFs) from Bristol Water, Ofwat, Thames Water, the Consumer Council for Water and South West Water.

The CMA is now inevitably facing a further tug of water between the water company and the industry regulator. Bristol Water is warning that the proposed level of bill is too low to achieve sufficient revenues and the reduced amount for totex maintenance does not allow for a sustainable investment strategy. Ofwat in turn is calling for the CMA to go further to reduce the cost allowances in the PFs. It also wants the CMA to take steps to make certain there are no perverse incentives for companies to appeal against Final Determinations in the future to ensure that redetermination is not a one way bet.

The review also has important implications for future Price Reviews - Thames Water is now asking for clarity in the CMA's final determination that its review of Ofwat's cost assessment for Bristol Water should “not be understood to confer views on the appropriate cost assessment approach and form of totex modelling for other companies.”

Bristol Water: level of average bill is "too low to achieve a sufficient level of revenue"

In a lengthy and detailed 211 page submission, whilst welcoming the CMA’s decision of the CMA to take a critical look at the cost assessment methodology used by Ofwat for PR14, Bristol Water has once again restated its concerns about the CMA’s initial findings, including:

• The level of average bill set in the PFs at £159 during AMP6 prior to inflation is too low to achieve a sufficient level of revenue
• The totex allowance, whilst improved from Ofwat’s FD14, is insufficient given the scope of activities that must be carried out to meet customer expectations regarding levels of service and achieve the right balance of risk;
• The reduction in the amount of totex allowed for maintenance does not allow for a sustainable investment strategy, contrary to good practice in the industry and customer wishes; and
• The allowance for enhancement fails to take due regard of the views of other regulators
• The proposed allowance for the weighted average cost of capital (WACC) is below Bristol Water’s cost of debt and equity and is insufficient, therefore, to secure that a reasonable return on investment can be earned.

Commenting in its Executive Summary, Bristol Water says:

“Our Business Plan proposals deliver reductions in bills for customers, and even with some adjustments to the PFs the level of that decrease is likely to remain the largest in the industry. We note that whilst customers will always have concerns about bill levels, customer interests are not always best served by targeting the lowest possible bill level. Such an approach creates a significant risk of underfunding, with implications for current and future customers in terms of serviceability and greater costs in the future.”

Bristol Water said financeability ranks top in the order of importance in the issues raised in the context of the impact of the PFs, followed by a revenue level which has been set too low compared to relevant benchmarks. The response says the revenues allowed are too low when compared to a range of benchmarks, and imposing an immediate 19% reduction from the bill levels set by the Competition Commission (CC) in 2010 is not comparable to any reasonable benchmark, including the average 5% decrease in bills across the industry.

For the scope of expenditure included in the PFs, the appropriate bill level is shown to be c.£173, which would represent a 12% reduction from Bristol Water’s 2014/15 average household bill.The water company said its customers would be comfortable with a bill level of c. £173 for the PF’s scope of expenditure.

On wholesale totex, the response says:

“Whilst we agree with the CMA’s conclusion that Ofwat’s cost assessment for Bristol Water was compromised by its approach and models, and accept the CMA’s decision to make use of its own econometric models, we consider that the overall level of wholesale totex allowance in the PFs of £429m is too low.”….

“Our customer research shows that customers strongly rejected a potential plan that included reductions in bills at the expense of reductions in the levels of maintenance. Inclusion of a sufficient level of cost to support the right level of operating expenditure and maintenance is, therefore, critical. Overall, we consider that the CMA’s approach has resulted in a cost estimate that is below the efficient level of expenditure Bristol Water requires to deliver the outcomes included in the CMA determination.”

The response also flags up what are described as Bristol Water’s “serious concerns regarding the credibility and robustness” in a report prepared for the CMA by Aqua Consultants to advise on aspects of the water firm’s planning approach, as well as the content of its wholesale totex Business Plan proposals. It also refers to reviews of the Aqua Report by CH2M Hill and KPMG which conclude that the Aqua Report contains errors and flaws of approach and analysis.

Bristol Water said it also noted that the CMA has been keen to emphasise that the review process should not be seen “as a ‘one way bet’ for Bristol Water necessarily resulting in a better outcome than FD14.” However, it added:

“Whilst we welcome the different methodological approaches to Ofwat that the CMA has adopted, the CMA has otherwise adopted a more challenging position on many issues than FD14. We are concerned that the CMA may have focused its attention on challenges to areas of potentially higher expenditure comparative to previous periods, rather than looking at everything in the round.”

Ofwat: CMA must ensure there are no perverse incentives for companies to appeal

In contrast, while also welcoming aspects of the Provisional Findings, Ofwat’s own response says it  considers that the CMA needs to go further to ensure that customers’ interests are protected, commenting:

“We recognise that in the Provisional Findings the CMA has gone some way to protecting customers. But based on the evidence, and the CMA’s own analysis, we consider the CMA should do more.”

Further steps the regulator now wants the CMA to take include:

• reducing cost allowances below the level in the Provisional Findings and more in-line with Ofwat’s  Final Determination;
• updating all elements of the cost of capital, including taking into account BRL specific information that was not available to Ofwat at the time of the final determinations; and
• ensuring there are no perverse incentives for companies to appeal. This is best achieved by taking further steps, supported by the evidence, to ensure that the redetermination is not a one way bet.

CCWater – “broadly supports” CMA’s overall package

The Consumer Council for Water’s response says it “broadly supports” the CMA’s overall package. However, the customer watchdog wants the CMA to give further consideration to its proposal on the cost of capital, which is above what CCwater’s consultants had advised – and what Ofwat had concluded, was sufficient to finance water companies “given the low risk industry they operate in.” CCwWater also expressed its concern over the effect of the removal of the Rowberry service reservoir on Bristol Water’s Southern Resilience Scheme, commenting:

“In research undertaken by CCWater and water companies over many years, customers have repeatedly stated that their top priority is a safe abnd reliable supply of water. It was on that basis, together with clear evidence from the company about its customers’ views, that we supported the inclusion of the Southern Resilience Scheme within in Bristol Water’s Business Plan.”

South West Water: Ofwat faces wider challenge due to wider variety of opex and capex investment needs

South West Water’s response to the CMA’s PFs has flagged up the wider challenge that Ofwat now faces in assessing the efficiency of company plans where there is a wider variety of opex and capex investment needs (often driven by past investment decisions and local geographic and environmental factors), with the need for the industry to focus on outcomes rather than output variables, commenting:

“Standardised outputs are becoming less useful in an industry where maturity means that direct cost comparisons become harder, particularly where best practice suggests companies look to changing external impacts such as land use to improve water quality at source, rather than in end of pipe physical solutions.”

Thames Water: CMA's FD  should not confer views on cost assessment approach and totex modelling for other companies

Thames Water has taken the response as the opportunity to express its own wider concerns over the retail price control methodology used by Ofwat in the 2014 Price Review. “Given that companies raised a number of concerns over retail price controls during the course of PR14, both formally and informally, we believe, that it would be helpful for the final determination to be particularly clear on the extent to which the CMA has reviewed and endorses (or otherwise) the retail price control methodology.”, the response says.

Thames also wants the CMA to look at two further areas where it considers clarification would be “helpful in the CMA's final determination to avoid constraining the approach at future price reviews unnecessarily”:

• the use of totex models to calculate cost allowances; and
• setting performance commitments using horizontal approaches.

The response says that while all companies except Bristol Water accepted the final determination in the round, it can be seen from companies' published submissions that many companies were concerned about aspects of the retail price controls, including, but not limited to the lack of input cost indexation and simplicity of the underlying analysis.

Thames says that many retail costs are directly proportional to or closely related to the retail revenue that has to be collected, pointing out that these will all increase over time as the wholesale charges rise with RPI and the addition of the Thames Tideway Tunnel Infrastructure Provider (TTT lP) revenues.

Referring to its own company-specific factors, the response says efficient retail businesses operating in Thames Water's area will face additional costs for dealing with greater population transience and collecting the TTT lP revenues, together with regional wage effects.

“An efficient retail competitor trying to compete in Thames Water's area would face the very real impact of these factors, among others, and so in our view they should have formed part of the retail price control, but did not. Our understanding from the provisional findings is that the CMA has adopted Ofwat's retail price controls without material scrutiny or challenge, as a pragmatic approach to Bristol Water's price determination.”, Thames’ response says.

The water company said it would welcome clarity in the final determination as to the extent to which the CMA has reviewed and endorses (or otherwise) the retail price control methodology, which “we do not consider provides a reliable methodology for determining efficient costs for individual companies.”

Thames Water also has some interesting points to make on Ofwat's econometric totex models and the CMA's alternative cost models, commenting:

“lt appears to us that the CMA has taken a comprehensive approach to assessing Bristol Water's totex allowance, using a combination of approaches including top down econometric models, bottom-up assessments of base totex and bottom up reviews of enhancement expenditure.”

“We noted that part of the case presented by the CMA on Ofwat's models is that the observed 17% difference in Ofwat's basic cost threshold and Thames Water's business plan is "suggestive of problems with the econometric models in respect of Thames Water''. This statement on Ofwat's models for Thames Water does not seem to be underpinned by a similarly comprehensive top-down and bottomup assessment of costs or review of evidence for Thames Water.”

The response says that the CMA has stated in its provisional findings that its "focus was on the cost assessment for Bristol Water, and we have not sought to examine Ofwat's cost assessment for other companies in any detail". In line with this, Thames Water is now asking for clarity in the CMA's final determination that its review of Ofwat's cost assessment for Bristol Water should “not be understood to confer views on the appropriate cost assessment approach and form of totex modelling for other companies.”