Water industry regulator Ofwat has flagged up organisational capability as the major risk in relation to the delivery of its work programme, in particular getting the right skills and experience, together with planning, budgeting and programme management.

The comments come in the publication today of Ofwat’s Annual report and accounts for the period 1 April 2014 to 31 March 2015.

In his introduction to the report, Ofwat Chairman Jonson Cox described the period as “a challenging but successful year for Ofwat” commenting:

“When I took over as Chairman, I was struck by the absence of trust between the regulator and the regulated, and by the breakdown in dialogue between the parties. I was also worried that public confidence in utilities can be fragile….”

“At the same time, we were worried that the dialogue with companies was too much about their financial interests, with much less mention of the customers’ perspective – even though we must all go the extra mile with customers, who have no choice of provider.”

“Since then, I am pleased to report that the sector and Ofwat have made real progress.”

Protecting customers and company accountability among key achievements

Achievements highlighted for 2014-15 include protecting customers. The report says that the decisions taken during the year as part of the 2014 price review will mean that average water and wastewater bills in England and Wales will fall by about 5% ‒ or £20 ‒ before adjustments for inflation, between 2015 and 2020; and that by 2020, customers will benefit from substantial improvements in areas of service that really matter to them.

On company accountability, the report says outcomes from Ofwat’s work during 2014-15 to ensure that service providers are accountable to their customers included:

• the 18 largest monopoly companies received 27,000 fewer written complaints in 2013-14;
• encouraging Thames Water to commit to pay a package worth £86 million to customers and the communities it serves following an investigation; and
• improved experience of customers of developer services.

Ofwat’s work on improving monopolies over the period included:

• announcing that customers contacting their water company in the previous year (2013-14) received an improved service from them;
• £130 returned million to customers where companies underperformed on customer service; and
• companies’ costs for delivering services between 2015 and 2020 reduced by more than £1 billion. Overall, the companies put forward £45.7 billion of expenditure and Ofwat allowed only £44.3 billion. This included returning £150 million to customers where companies failed to deliver investment in 2010-15 that customers had already paid for.

The regulator’s work programme also contributed to the preparations to allow all non-household customers in England to choose their supplier for retail water and wastewater services by April 2017, while its work on resilience and sustainable development included the development of a package of effective rewards and penalties that aligned the interests of company management and investors with the interests of customers.

In the Chief Executive’s section of the report Cathryn Ross drew attention to the significant role of the sector in setting up the new market in England that will allow all non-household customers to choose their water and wastewater retailer and to make sure that the market delivers benefits to those customers. “There are lessons that must be learned from experience in other sectors if trust in this nascent market is to be maintained and grow.” she said.

“A leaner, more focused, efficient and effective organisation on a much tighter budget”

On the regulator’s operational activities, the report says significant progress was made on transforming Ofwat into a leaner, more focused, efficient and effective organisation that can operate within a much tighter budget for 2015-16 onwards. The regulator is now subject to a settlement imposed by HM Treasury through the Comprehensive Spending Review  from 1 April 2015 - its core budget for 2015-16 has been confirmed at £21.3 million.

Ofwat’s expenditure in carrying out its work for the period covered by the report was £ 29.1 million, compared with £27.9 million in 2013-14. During this time Ofwat saw a significant reduction in staff numbers  – with 136 full-time equivalent staff in place at 31 March 2015 compared with 191 in 2013-14.

A provision of £385,000 was held to cover the costs of compensation payments due in 2014-15 under Ofwat’s Business Transformation programme. £319,000 of which was used during the year. There has also been a further increase to the provision of £251,000 to cover further exits in 2015-16.

As part of the programme Ofwat has also downsized on office space. In early April 2015, Ofwat completed the exchange on a new property operating lease in order to re-gear two of the four floors occupied at its existing premises in Birmingham. As a result, an £808,000 contractual lease exit charge was payable to its landlords in June 2015.

The new lease will halve Ofwat’s current accommodation footprint in Birmingham and has the potential to contribute a net overall saving of £3.5 million to Ofwat’s accommodation budget over its seven-year term.

£1.8m spend on Tideway Tunnel activities

Ofwat also continued to review progress of the Thames Tideway Tunnel, working with the UK Government and Thames Water to set up the practical, legal and regulatory frameworks that will allow the scheme to be delivered by a separate infrastructure provider. “This will help ensure that Thames Water’s customers pay no more than necessary for the scheme” the report says.

Ofwat has established a Thames Tideway Tunnel Committee, chaired by Jonson Cox, to support the full Board on this programme of work.

Ofwat’s administrative costs during 2014-15 for its work on the Tunnel amounted to £1,779,000 – funded by £1.8 million collected from Thames Water Utilities under two special licence fee charges.

Outcomes based approach already delivering results

Commenting on the outcomes and 522 performance commitments drawn up by the water companies, the report says Ofwat made sure that companies consulted customers about how performance against their individual commitment levels should be rewarded or penalised. This means that:

• companies can earn a reward for doing better than their commitments (where customers said they were willing to pay more);
• companies will be penalised financially if they fall short; and
• customers are protected no matter what happens.

Overall, the rewards are worth about £800 million to the sector while the penalties are worth about £2 billion.

The report also highlights the shift from capex and opex to the single pot of total expenditure ‘totex’ approach adopted for the 2014 price review. The report says this means that companies can choose the best solutions to deliver the outcomes to which they have committed, rather than on specific schemes from:

• investing in new infrastructure;
• maintaining existing infrastructure; or
• adopting other solutions.

According to the report, the evidence suggests that this is already working - Environment Agency estimates that in its latest 25-year plans for balancing the supply and demand for water about 50% of the schemes that water companies proposed were to reduce demand for water (‘demand-side solutions’), such as water efficiency and reducing leakage. In the past, about 90% of the schemes that water companies proposed were to increase supplies (‘supply-side solutions’), such as building new reservoirs or boreholes, or taking more water from rivers.

PwC paid £613K as incentive payment for 2014 Price Review work

In July 2013, Ofwat entered into a contract with PwC as its Delivery Partner for the 2014 Price Review. The contract included two incentive payments intended to ensure satisfactory performance from the Delivery Partner contract. As a result of the incentive mechanisms a provision of £700,000 which represented the maximum possible incentive payment due on satisfactory completion of the risk-based review, was created in 2013-14.

Following completion of an assurance exercise, Ofwat’s Board approved a payment which was lower than the maximum incentive payment as a result of which £87 thousand was written back in 2014-15. A second incentive payment was made in 2014-15 which did not require a provision as it related only to work begun and completed by the Delivery Partner during 2014-15.

The report says the operation of the Delivery Partner contract will be reviewed as part of a "lessons learned" exercise on the price review.

Major risk to Ofwat delivery is organisational capability

The report flags up organisational capability as the major risk in relation to Ofwat’s delivery  of its work programme, in particular:

• getting the right skills and experience: Ofwat says it needs to take advantage of the period between the conclusion of the 2014 price review and the 2019 price review to provide opportunities for staff to learn and develop in line with organisational needs.
• planning, budgeting and programme management: with ever-tighter resource constraints Ofwat needs to improve its capability and discipline in programme management, especially in relation to forward planning and budgeting.
• ongoing organisational change: the transformation programme is not yet complete and Ofwat is set to undergo further change in the coming year

The report says the regulator’s Senior Leadership Team also devoted significant attention during 2014-15 to learning lessons from the need, mid-way through the 2013-14 financial year, to increase Ofwat’s 2013-14 and 2014-15 budgets to address an under-estimate of the delivery costs of the 2014 Price Review.

Looking ahead, the report says Ofwat will be looking at where there may be scope for more extensive use of markets to enable a wider range of choices in how services are provided at every step of water and wastewater service delivery.

The report describes the forthcoming Retail Market Opening in 2017 as “a complex multi-stakeholder programme on a tight timescale” to which it has devoted considerable effort in during the year to build, maintain and manage relationships with the other key players. The Water Act 2014 will introduce competition in England into wholesale - ‘upstream’- water and wastewater services after 2019.

Click here to download the Annual report and accounts 2014-15 in full