South East Water has challenged key aspects of Ofwat’s draft determination on the company’s five-year AMP7 business plan for the period 2020 to 2025.

The water company has published a detailed and lengthy response and provided further evidence in support of the plan. This follows the publication of the draft determination by Ofwat in July to which it asked the company to re-examine a number of areas contained in the plan.

Paul Butler, Managing Director of South East Water, said:

“We maintain our plan is highly ambitious. The performance commitments we have set ourselves will be very challenging and are firmly rooted in our customer expectations of us.

“We have improved a number of our performance commitments as part of this process so that we address Ofwat’s challenge to us, and indeed all water companies, to collectively push the entire water sector towards stretching and in many cases upper quartile performance.”

The assessment of the cost of delivering the plan remains a major area of concern for South East Water. The company maintains that Ofwat’s draft determination would result in a significant reduction in funding that it has proposed to enable it to:

• Ensure water supplies are resilient to future challenges
• Reduce leakage levels to levels never achieved before in the water industry
• Provide the all-round service customers have told us they expect.

Paul Butler continued:

“We have welcomed the challenge and scrutiny of our plan by Ofwat. It is an important part of the regulatory process to set prices for a business that provides an essential product and service.

“However, for both the Initial Assessment of Plan and Draft Determination stages we have meticulously reviewed Ofwat’s documentation and critique of our plan so that we are able to provide further evidence and/or justification for the decisions we have made.

“The document we have published today articulates why we are retaining the key components of our original plan.”

Balancing challenge and ambition with greater risk and deliverability

In its response, South East Water said:

“We maintain that our plan is the most ambitious we have ever produced. The performance commitments we have set ourselves are challenging, especially as we operate in a region that is in serious water stress with a growing population.”

“We have improved a number of our performance commitments as part of this process to address Ofwat’s challenge to us.”

However, the water company said it has “ largely retained” its Business Plan position on the Outcome Delivery Incentives (ODIs) that underpin its performance commitments for three important reasons:

• To reflect customers’ priorities and views
• To prevent the detrimental impact of collective risk; and
• To maintain a fair balance between its customers and the company

Commenting on customers’ priorities, the response says customers’ views had shaped:

• the performance commitments
• the stretch of the targets that it would need to achieve for each performance commitment
• the design of the incentive rates – including caps and collars – which would attract underperformance penalties and outperformance payments
• the improvements in levels of service that they were willing to pay for

The response says:

“In essence, our package of ODIs reflected the emphasis and importance our customers placed on critical aspects of our performance and service. …

“However, Ofwat’s Draft Determination has removed many aspects of our customers’ important input to our ODIs. ….

“Challenging the industry to improve its performance is commendable, but we maintain that if Ofwat sets performance commitments and ODIs at the Draft Determination levels, without any link back to operating conditions or customer preferences, it creates unsustainable risk – not just financial but reputational too.”

South East Water also said it predicted more water companies would “inevitably fail” the performance commitments included in company Draft Determinations than they do now.

“The resulting headlines will be that more of the sector is failing when in fact the actual performance levels will be improving year-on-year, but are still falling short of Ofwat’s unrealistic expectations of a “virtual upper quartile” company. This will dent public trust and confidence in a sector that is already facing challenges around these critical areas.” The response says.

According to the water company, Ofwat’s approach of using simple, individual comparisons on each ODI measure creates a Draft Determination that fails to recognise the impact of collective risk, which South East Water said it maintains is “a flawed approach.”

Ofwat has taken policy decisions with significant cost impact but little evidence of how that decision takes into account operational realities

On costs, the response says:

“We maintain that the cost modelling approach Ofwat uses to set price limits is inferior to our methods at an individual company level.”

“More generally, we remain concerned that in some key areas, such as leakage, Ofwat has: 

• taken policy decisions that have a significant cost impact but with little evidence of how that decision takes into account operational realities, good regulatory practice or is supported by the same robust level of customer evidence that water companies have and are required to demonstrate
• ignored our good starting position in terms of lower leakage levels as a result of our customer metering and proactive pressure management inititatives, and which means additional leakage savings will be challenging to achieve without sufficient funding”

The water company has also refused to comply with Ofwat’s requirement for further board assurance on whether the business plan is financeable, including on the possible further downward pressure on the cost of capital, commenting:

“We do not believe it is either appropriate or possible to provide specific assurance on whether our plan would remain financeable on a notional and actual basis when Ofwat may still make further material interventions in its Final Determination.”

Click here to read the response