Water industry regulator Ofwat has rejected a request by Bristol Water to enter into mediation facilitated by a confidential body on the £203m totex ‘gap’ for wholesale water costs in the firm’s revised business plan.

In a letter to Bristol Water’s Chief Executive Luis Garcia which described the proposal as “well-intentioned”, Sonia Brown, Chief Regulation Officer at Ofwat said:

“Within your representations you made a formal request for Bristol Water and Ofwat to enter into mediation facilitated by a confidential body such as the Centre for Effective Dispute Resolution. You asked for a response by 17 October. This letter provides our formal response. While we understand that the proposal was well-intentioned, as we explained in our meeting on 6 October we do not consider mediation is appropriate.”

The news follows a meeting between Ofwat and Bristol Water to discuss its proposed wholesale water expenditure (totex) over the next five years which took place after the regulator received the firm’s representation on its draft determination on 3 October 2014.

Sonia Brown said that Ofwat agreed that the issue of wholesale costs is very important for Bristol Water and its customers but pointed out that Ofwat’s view of the wholesale water totex was £359m - £203m lower than put forward in the firm’s revised business plan, resulting in a totex ‘gap’ of 57%.  

The letter says that even taking into account the proposed £21 million reduction in the plan between June and October, Bristol Water is “by far the most significant outlier within the sector with regards to wholesale costs. “

Ofwat has rejected the proposed use of mediation to resolve the issues for the following reasons:

i. The use of mediation would not be consistent with the legal framework under which this industry operates. It would be a departure from the long-established regulatory system that has operated for over 25 years.

ii. Ofwat, as an expert independent economic regulator for the industry, has the duty  to conduct the price review and a mediator would have no obligation to be consistent with the statutory duties within which it operates.

iii. The legislation provides for an established appeals body for the price determinations in the Competition and Markets Authority. Moreover, Ofwat’s published timeline establishes that final determinations will be published for all companies on 12 December 2014 and it is unlikely that a mediation process would be able to meet that deadline.

iv. Bristol Water has already been afforded a considerable number of opportunities to put forward a business plan that operates in its customers’ interests.

The letter points out that Ofwat first tested the plan following submission in December 2013 and informed the firm in March 2014 of the significant challenges Ofwat felt it needed to address regarding the planned levels of wholesale expenditure. Following the re-testing of plan over the summer Ofwat then gave the firm advance notice that it still felt you that it had not sufficiently addressed the challenges on wholesale costs and that a very material difference remained.

While the letter acknowledges the steps taken by Bristol Water since 6 August to address the challenges, Sonia Brown comments:

“However, we are concerned that Bristol Water remains in a very different position to all other companies at this stage in the process.”

The Chief Regulation Officer said Ofwat is however willing to consider further engagement with Bristol Water on wholesale costs within the price control process on the basis of four key questions:

1. Why any adjustments to the wholesale water models are appropriate for Bristol Water in the context that Ofwat models satisfactorily explain costs across all 18 companies for whom it regulates prices for water services.
2. Whether there are elements of capital maintenance expenditure within Bristol Water’s totex which are over and above what would be expected to be explained through Ofwat’s modelling.
3. The merit of the cost exclusion claims the firm put forward in other areas, notably for enhancement expenditure such as the Cheddar 2 reservoir.
4. The assessment and assurance undertaken by Bristol Water’s Board to reach its views of risk levels as part of its consideration of wholesale costs.

Sonia Brown told Mr. Garcia that consistent with its commitment to transparency,  Ofwat was publishing the letter to highlight that “we are providing Bristol Water with this final opportunity for additional engagement beyond our published process only because of the scale of the wholesale cost gap.”

She also said that Ofwat may publish any additional material provided by Bristol Water which was not provided as a direct response to a query raised by Ofwat,  including notes of meetings or telephone conversations where appropriate.

It is now up to the regulator decide whether it will consider any new information or evidence presented by Bristol Water as this would be received after the 3rd October deadline which applied to all companies. Sonia Brown concluded by saying that the letter did not pre-empt Ofwat’s final determination and the regulator had yet to fully assess the representations submitted by the water company on 3 October.