Ofwat has launched a new consultation on proposals to allow Tideway to pass a proportion of increased costs in the order of £200 million from Covid-related impacts on to customers.

Under its licence, Tideway bears 40% of any overspend and customers bear 60% of that overspend. Tideway estimates that its additional expenditure as a result of Covid-19 will be in the order of £200 million, including the costs of delay. Absent a licence amendment, Tideway will bear 40% of this amount.

Ofwat has now provisionally agreed that in respect of the period from mid-March 2020 to 24 July 2020, instead of customers bearing 60% of those costs, customers should bear 85% of them. The proposed licence drafting amendment will also provide that Ofwat may, "in its sole discretion, agree alternative sharing rates for periods after 24 July 2020."

Ofwat also provisionally agreed that Covid-19 expenditure should depreciate at a different rate from the rate that would otherwise apply to an asset with an expected life of about 120 years to support Tideway’s financial resilience in funding additional Covid-19 expenditure.

In addition, the regulator has also provisionally agreed to amend a regulatory date to take into account delay solely caused by Covid-19. Tideway has estimated that the project will be delayed by about 6 months as a direct result of Covid-19.

Tideway - Covid-19 impact “very extensive” for the business and "costs should not be borne by its shareholders"

Tideway approached Ofwat at the start of the Covid-19 pandemic saying that the impact was “very extensive” for the business. Asking that the additional costs incurred as a result of Covid-19 be borne by customers, the company argued that it was not a risk envisaged at the time of licence award and that the costs should not be borne by its shareholders.

Setting out the background to Ofwat’s proposals, the consultation paper says:

“Covid-19 has impacted the Tideway project far more extensively than for any other water or sewerage company, leading to delays in construction and a consequent increase in costs for Tideway.”

Ofwat said it recognised that Covid-19 “had had and will have a much more significant impact on Tideway than on other companies in the sector”, but considered that Tideway should not be wholly insulated from additional costs and must bear a proportion of those costs.

By comparison with typical large water and wastewater projects, the Tideway project is of a scale significantly higher both in terms of cost and complexity.

The paper says the three main drive sites face significant operational constraints - they are at least half the size of a typical “efficient” tunneling site because of the central London location. Social distancing measures in such constrained worksites have significantly impacted Tideway’s ability to operate at full capacity. Public transport restrictions on staff normally using public transport have also prevented sites operating at full capacity.

Tideway engages three Main Works Contractors (MWCs) on modified target cost NEC3 contracts.

At the start of the pandemic, about 95% of Tideway’s operations shut down. In response Tideway put a number of measures in place to mitigate risks to the project, including:

• An agreement to underwrite the costs of the MWCs and their supply chain for the period from mid-March to end of April 2020.
• Putting an ‘emerging cost approach’ for the period from 1 May to 24 July 2020 in place whereby it did not distinguish between Covid-19 costs and productive costs. In return, the MWCs agreed to a lower fee for that period.

On 24 July 2020, the emerging cost period ended and from 25 July 2020 the conditions of the NEC3 contracts in place prior to the emerging cost period were reinstated. This meant that the MWCs were no longer protected from operating conditions impacting performance and the risk of performance was once more subject to the cost sharing arrangement in the contracts.

The consultation paper says Tideway’s cost and schedule performance has continued to be impacted by Covid-19 operating conditions, which has “predominantly resulted in construction activities taking longer to complete and increased delay cost." Tideway also says that while social distancing constraints remain in place, it will continue to operate at a reduced efficiency.

Ofwat has recognised the continued impact of delay due to Covid-19 after 24th July on Tideway. However, the regulator said the costs are more difficult to estimate and that it would “only agree alternative sharing arrangements if Tideway could demonstrate …that it has been able to differentiate Covid-19 impacted costs from other costs.” In addition, Tideway’s shareholders would have to bear a proportion of any Covid-19 costs.

Proposed amendment to enable Ofwat to set alternative sharing rates between customers and shareholders for the period after 24 July 2020 

The proposed licence drafting will set out the alternative customer sharing rate for that initial period and will provide that Ofwat may, in its sole discretion, agree alternative sharing rates for periods after 24 July 2020. “This flexibility is considered necessary to enable Ofwat to set alternative rates for the period after 24 July 2020 once better evidence becomes available on Covid-impacted costs for that period”, the paper says.

In addition, it will also enable the regulator to take into account “the impact of further waves of Covid-19 and associated additional construction costs related to Covid-19 that may arise in the medium to long term.”

The drafting provides that Ofwat may determine “the proportion of Covid Expenditure to be borne by the Infrastructure Provider, such proportion not to be less than 15 percent and not to exceed 40 percent” and to determine the period in respect of which that proportion will apply.

The regulator is now seeking comments on its proposed amendments to the conditions that attach to the project licence of Bazalgette Tunnel Ltd, which trades as Tideway. Ofwat said the amendments are needed to give effect to:

• an alternative sharing rate between Tideway and Thames Water’s customers for Covid-19 impacted costs on the Thames Tideway Tunnel project;
• a different depreciation rate for Covid-19 impacted costs
• an amendment to a regulatory milestone date to take into account the delay caused to the project by Covid-19, although the amendment is only likely to be introduced later, once the extent of delay (if any) is known. Tideway has estimated that the project will be delayed by about 6 months as a direct result of Covid-19. Currently the Planned System Acceptance Date is set in the licence as a fixed date, namely 28 February 2027. The change is considered necessary because if acceptance of the completed asset is not achieved by that date, Tideway will incur a penalty.

If the proposed amendments are made, Ofwat anticipates they will come into effect in June 2021.

Deadline to submit responses to Ofwat is 7 May 2021 – click here to download the consultation paper.

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