Ofwat has released a report it commissioned in early 2025 from Mott MacDonald which reviews how UK regulators currently set capital maintenance allowances and identifies opportunities to strengthen Ofwat’s approach for PR29.

The discussion paper was commissioned with the aim of understanding and reviewing the current approaches taken by the UK utility economic regulators to determining capital maintenance allowances.

The report - Determining Capital Maintenance Allowances - Proposed approach for Ofwat at PR29 April 2025 - assesses practices across the water and energy sectors and proposes a future framework that combines econometric benchmarking with forward‑looking asset health information.

It aims to identify areas for improvement for Ofwat and propose solutions which could be implemented for its 2029 price review (PR29) to help ensure that capital maintenance expenditure allowances are sustainable in the long-term.

The paper includes reviews of approaches undertaken by the Water Industry Commission for Scotland (WICS), Northern Ireland Authority for Regulation (NIAUR) and the Office of Water Services (Ofwat). Together the regulators cover all UK water companies.

Mott MacDonald has also included the approach implemented by the Office of Gas and Electricity Markets (Ofgem) for comparison. The specific recommendations have been provided for Ofwat only for implementation at its next price review in 2029.

Since the 2014 price review, Ofwat has used econometric models estimated using historical data and considers company and regional variables, complemented with the cost adjustment claim process, which allows companies to request additional allowances for company specific factors or for forward-looking cost drivers that may not be reflected in historical data.

However, the models use a limited historical time series and therefore may not account for major interventions needed infrequently on large strategic assets (aka ‘lumpy’ expenditure), the report says, going on to comment:

“Some water companies in their PR24 business plans raised concerns that base allowances were unlikely to sufficiently fund the future requirements of asset investment to continue to provide resilient services. The models do not directly consider asset condition or remaining asset life. This means that if the companies fail to provide sufficient evidence in their price review cost adjustment claims, allowances may not be sufficient to meet the immediate asset investment needs.

“There is however room for improvement to determining more accurate future capital maintenance allowances to take better account of lumpy expenditure and future asset health needs. This can be achieved through triangulation of allowances between those determined by econometric modelling and forward-looking Asset Health Investment models.”

According to Mott Macdonald, the asset health models will need to be developed from company data on asset criticality, condition, future operating conditions and remaining life. In addition, Ofwat will need to engage with the water companies and engineering consultancies in order to

• develop criteria for asset criticality
• measure asset condition
• measure future operating condition.

Ofwat will also need to form a sector level view of expected asset lives and develop a unit cost database.

The approach proposed will require close collaboration with the sector and take time to develop and implement. However, it is less complex than the NARMs approach adopted by Ofgem and therefore is more likely to be successfully implemented.

Mott MacDonald also suggest it should be focused on the most critical assets and that other assets e.g. standby assets, may not need as much investment or could just be replaced on failure, which would be a more efficient asset management approach.

“Ofwat could assume that the allowance for non-critical assets, for example, is 50% of investment needs for critical assets”, the report suggests.

Mott MacDonald say it should be possible for companies to report this data for key asset groups in time for PR29 and that over time, the information could be refined and improved to provider a richer dataset.

The proposed approach is simply to measure condition for key asset groups directly at regular intervals, this would work alongside the Outcomes approach. Change in condition over time would indicate if investment is being targeted appropriately.

The discussion paper says the proposed approach is conceptual and will require further development and testing with the sector to ensure that the data requested will achieve the desired objectives. The paper includes a proposed approach to determining remaining life of an asset.

Click here to download the discussion paper in full