Former Ofwat Chief Executive Cathryn Ross has raised the question of whether the Price Review process - the regulatory framework of five-year price reviews for the water sector - is still fit for purpose.

Now the Strategy and External Affairs Director at Thames Water, Cathryn Ross was giving the first lecture of the 2022 season of the Beesley Lectures following an invitation to speak on the topic ‘Beyond PR24: is the price review framework fit for purpose’

She introduced her lecture by saying:

“There is certainly a palpable discontent with things water. I left Ofwat in 2018 and spent the intervening years looking after regulation for BT Group. Since returning to the industry last year, it struck me that frustration with the sector has tipped into anger.”

“This anger manifests itself in different ways. You would have had to be living in a hole this summer not have seen a vast array of headlines ranging from drought, to sewage in rivers and on beaches, dividends, ownership, executive pay. And to be clear, while some companies do better than others, this was a sector-wide onslaught.”

Water sector is not delivering on “things that, as individuals and as a society, we believe are fundamentally important”

According to the former Ofwat Chief, “the root cause is quite simple” and lies in the fact that the water sector is not delivering on “things that, as individuals and as a society, we believe are fundamentally important.”

The discontent is focussed on two key areas, she said - environmental stewardship and resilient water and drainage services.

Commenting on environmental stewardship, she told her audience the fact that waste water companies discharge untreated sewage into rivers is not new news, saying:

“.and we don’t do it because we sit in some palatial head office somewhere an decide on a whim to pull a giant lever that sends the sewage straight from the pipe, bypassing treatment, to dump it in the river.”

She went on to explain that the discharges happen “as a result of the sewage treatment system operating in the way it was designed to operate. Typically in this country – and…the less fortunate legacy of Bazalgette’s otherwise amazing and visionary creation of London’s sewerage network – we combine drainage and sewerage.”

Pointing out that in the Thames Water network usually just under 50% of what passes through a sewage treatment works is rain, not sewage she said:

“this means that, when it rains a lot, the works are overwhelmed. And the network does what it was built to do. Which is, to avoid the sewage backing up through the sewers and ultimately into people’s homes – the excess that the works does not have the capacity to treat – is discharged (with some minimal filtering) into a river.”

However, she went on to warn that “the whole phenomenon is substantively worse now than it used to be” for the following reasons:

• we are getting more torrential rain than we used to.
• water companies and their regulator) have allowed growth – population increase, new developments –accommodated by eating into the headroom that previously existed in the system
• because rainwater and “other stuff that shouldn’t be in sewers” does get into the sewers

Turning to service resilience, she suggested that the second area in which the sector has fallen short is investment in resilience of the basic, essential services the sector provides – a reliable supply of wholesome drinking water and effective drainage.

In addition, the basic supply demand balance equation has not been helped by leakage. Thames Water “absolutely recognise” that the company it needs to do more to tackle leakage – however, during the current drought it has “had to run to stand still.” In addition, the drought had also caused more problems with pipes - the hot dry weather had dried out the ground, causing pipes to crack and joints to rupture.

Despite that fact that the utility has more than 500 people –more than ever before – working day in and day out to find and fix leaks, together with using innovative new technology to do some of the work, it was “still hard yards” she added.

“Need to focus on flooding” in light of more extreme rainfall

Cathryn Ross also referenced the “need to focus on flooding” in the light of more extreme rainfall bringing with it the increased risk of flooding.

Referring to two events in London last July when on two separate occasions certain London boroughs experienced “the kind of rainfall that is supposed to happen every less than once a century”, she commented:

“Our network, our assets, did what they were supposed to do. Our waste water system operated within the tolerances it had been designed to and maintained to.”

As a result, more than 1000 properties were flooded, mostly – around three quarters - as a result of the 12 July storm. “The level of concern, and mobilisation, following the July flooding last year is telling us that people expect action to address this risk,” she added.

She warned that the way we live, in particular the extent of development – not only new developments, but extensions, patios, paved over front gardens, and all the attendant impermeability – is a massive exacerbating factor.

"Whatever the water companies can do won’t be enough .. a reset, a reboot, of the system is now needed"

She went on to say that “whatever the water companies can do won’t be enough” and that “a reset, a reboot, of the system in which we operate” was now needed.

“And when I talk about a reboot of the system, I’m really talking about a different approach by government and by the regulator,” she explained.

Saying that “there is no doubt that some of us need to fix the basics”, she emphasised that “the reality is that we could fix all those basics and still not be in a good place to deliver against people’s expectations when you think about what’s coming in the future.”

“We need to continue to invest in our assets and to make the best, most efficient use of them we can. Which means looking at those assets, that ‘grey’ infrastructure alongside, blue/green infrastructure, and alongside customer behaviour - making better choices about which we deploy in pursuit of the outcomes that customers and citizens care about. We need to do this taking account of whole life costs, not only in a financial sense, but also in respect of natural and social capital.”

"Company investment appraisal processes do not systematically enable and encourage decisions to be made that drive creation of public value rather than least cost delivery"

However, while water companies have “even been doing some of this” it was not mainstream – she commented:

“My understanding is that company investment appraisal processes do not systematically enable and encourage decisions to be made that drive the creation of public value rather than least cost delivery of a customer outcome (or even output).”

Saying that while this “isn’t easy to operationalise”, it was “exactly what we are moving to at Thames Water”.

“ An approach to decision making that will drive us to deliver our core services in a way that creates public value, for example through choices we make about biodiversity, energy intensity and energy sources …Indeed, we have agreed with our shareholders that we will privilege the creation of public value over shareholder returns, provided that our shareholders can expect a reasonable and sustainable return.

“Arguably this reverses some of what has been seen in the industry since privatisation. In the past, the value created in the sector was too often hoovered up by shareholders and shuffled offshore while the environment was given short shrift and customers got what they were ‘willing to accept’.”

Significant investment in infrastructure also required

However, she went on to warn that despite a greater focus on public value, more nature-based solutions, more customer behaviour change, this would not be enough to future proof water and waste water services and that significant investment in infrastructure was also required.

“It is increasingly clear that we will need major investment in infrastructure as well. All of this good stuff can reduce the need for new infrastructure, it can make sure we are building new (grey) infrastructure only in the right place and at the right time. But it cannot remove the need for it.”

“Working with other companies in the south east on water resources, two of the three options which keep coming up as likely to be needed involve construction of large new infrastructure.”

According to Ross, Thames Water’s reconfiguration of the London system in the 1990s had resulted in one heavily dependent on pumping which is massively energy intensive and “we need to replumb London.”

Thames Tideway Tunnel which will become operational in 2025  “would have been completely overwhelmed by rainfall that fell on London last July“

However, she cautioned that the answer could not be to build “bigger and bigger sewers”, pointing out the Thames Tideway Tunnel which will become operational in 2025 “would have been completely overwhelmed by the rainfall that fell on London last July.“

Instead, the solution was sustainable urban drainage on a massive scale - London would need more than 7000 ha of SUDs - roughly 50 Hyde Parks – and the city needs to become a massive sponge.

She went on to explore the issue of where the necessary investment would come from , saying that investors are “very keen to put more cash up to build more stuff as long as they can see a return that compensates them for the risk they are taking” and that “a lack of investor appetite really is not the problem.”

She went on to highlight the as-yet unbuilt Abingdon reservoir first proposed by Thames Water in 2009.

“In reality the problem is that it is just too difficult to get stuff done. Take the Abingdon reservoir. This was part of Thames Water’s business plan for the 2009 price review. Ofwat rightly sets a high bar on demonstrating need because it’s an expensive bit of kit.”

“Lots of hurdles to get over, lots of tests to be passed. Lots of process. Lots of politics. Lots of reasons to delay, if not actually to reject the scheme.”

“And yet, on the National Infrastructure Commission’s figures, in Thames Water’s region alone we will need 1 billion extra litres of water a day by 2050. And the reservoir could take more than 10 years to build. If we had it today, we would not have a hosepipe ban.”

Tideway Tunnel financing - same approach could also be taken for future projects

She also drew attention to the considerable timelag between the initial proposal for the Thames Tideway Tunnel scheme which will be completed in 2025 before construction work finally started in 2016 - 20 years after that initial study concluded it was needed. Ofwat itself had also assessed the scheme as “poor value for money” in 2007.

Ross commented:

“The sheer length of time the whole thing took to from need, to scoping, to planning, to procurement to delivery is staggering. But aside from that, Tideway these days is seen – rightly – as a highly successful project.”

She went on to commend the associate set of legislative changes- the Special Infrastructure Project Regulations - that provided for a separately licenced entity with a discrete regulatory treatment, saying that the same approach could also be taken for future projects.

“The regulations opened the way for a bespoke approach to risk allocation on the project – with the long tail of effectively unpriceable risk being borne by the taxpayer, within a long term regulatory regime,” she explained, adding:

“ if government wants major investment to underpin resilience of services and improve theenvironment, there are tried and tested ways it can secure this.”

"Government needs to take on role of Chief Knocker-Together-of-Heads”

According to the ex-Ofwat CEO, the Government now needs to set out a strategic vision for the sector and to agree the major infrastructure delivery programmes that are needed to provide for the country’s water and waste water needs “for the next century, not just the next 5 years.”

“Crucially, recognising the profusion of regulatory bodies whose statutory duties and remits might not otherwise dispose them to enabling these programmes, Government needs to take on the role of Chief Knocker-Together-of-Heads.”

This would also require regulatory changes and it made “no sense at all to apply a regulatory reset every five years to what will inevitably be programmes of work that will take multiple control periods to plan, enable and delivery. “

In her view, some of the work required will big, complex single projects while others would take the form of a suite of interdependent smaller projects.

She added:

“Some of it may be better delivered (or owned or operated) by companies other than existing water companies.”

“And the greater the difference in work and approach to that of the traditional water company model, the less well it lends itself to the sort of cross-sector comparative tools that Ofwat relies on in price controls.”

Saying that a different approach was needed, Ross again referenced the Thames Tunnel approach, suggesting that “some of the bones of this exist in the Tideway model” and “there are useful regulatory approaches and tools that can be borrowed from Tideway too.”

The choice of delivery model was among the key features Ross highlighted, including the role of competition in the design, build, ownership and operation of whatever is to be created, “choices which would then open up the possibility of different financing options.”

In a post-PR24 world, she suggested, Ofwat would continue to set 5 yearly price controls for what could be considered the BAU operations of existing water companies (which could include smaller scale, in-period in-company enhancement schemes). However, a series of ‘strategic enhancement programmes’ could be overlaid on top of this. These would be set over the longer term and on the basis of more programme-specific approaches, possibly with some of them specified nationally rather than water company by water company, which could “unlock more opportunities for innovation or supply chain capability building.”

“Financing is not the issue”

In her view, “financing is not the issue” – instead, it was rather “a sense of national mission, relentless knocking together of heads and barrier busting by government.”

It was also “a willingness on the part of the regulator to keep what works about the current regime – a BAU price control on the basis of comparative regulation – but to complement that with a framework to enable a number of genuinely strategic enhancement programmes that will deliver the step change in resilience we need over the coming decades. “

She concluded by calling for the combination of “long term clarity on need and regulatory approach with specific regulatory design choices that reflected the nature of each programme. Which would in turn unlock efficiency and innovation, potentially including through competition.”

Finally, she said a sense of urgency was also needed, commenting:

“One thing I’ve learned over the past 20 years or so, most of them spent working in or around regulators and government, is that there are always reasons to delay.”

Click here to read Cathryn Ross' speech in full