Water industry regulator Ofwat has confirmed that the five yearly price review process will stay for the time being – despite criticism from a number of quarters, including the adverse impacts on the water industry supply chain.
Ofwat’s Chief Executive Regina Finn told financial analysts at its regular six monthly City briefing that it would continue to set price controls on a five year cycle for the time being. Critics have said the five year AMP cycle has created a stop-start approach to investment and spending with adverse impacts on the supply chain. The five year cycle is also relatively short term compared with the much longer timescales of the Strategic Direction Statements and Water Resource Management plans the water companies are required to produce.
Interestingly however, Ms. Finn also said that Ofwat’s new approach to give the water companies more freedom to innovate in ways that benefit their customers and investors would enable them to do this “by taking a longer term approach to planning their operating and capital spending, which will help avoid the peaks and troughs in the investment cycle.”
Commenting on the Water White Paper, Philip Fletcher, who has yet to stand down as chairman pending the appointment of a successor by the Government, said that while Ofwat welcomed the Water White Paper inevitably some aspects of the White Paper still remained “somewhat open”.
The regulator does not see the value in giving Ofwat a primary duty on sustainability - a possibility currently left open in the White Paper - and expressed concern that it would “simply inject uncertainty into the regime”.
On the upcoming Price Review, Mr. Fletcher said that when price limits were set in 2014, Ofwat would make financial adjustments for the performance of companies against the Service Incentive Mechanism, providing strong incentives on companies to continue to drive improvements in their performance under SIM for the remainder of the current AMP5 price review period.
On finance, he said the sector continued to attract investment, evidenced by the recent acquisitions of Northumbrian, Bristol and Cambridge water companies, while companies had continued to access debt finance at very competitive rates.
Thames Tunnel faces challenges on efficient financing
Philip Fletcher also flagged up Ofwat’s work on the Thames Tideway tunnel, a project “endorsed by the Government”. He commented that the tunnel brought with it a number of challenges, not least the need for the project to be financed efficiently at a time of uncertainty in the wider financial markets.
Regina Finn – Ofwat approach is evolution not revolution
Commenting on the Water White Paper, Regina Finn said Ofwat was now in the process of reassessing its original impact assessment and the underlying cost benefit analysis for its future price limits proposals which outlined efficiency savings in a range of between £1 billion and £2.5 billion,. The impact assessment that accompanied the White Paper had a central estimate of net benefits of £2.2 billion over 30 years.
Ms. Finn emphasised how the themes in Ofwat’s strategy and in the future price limits framework consultation aligned “very closely” with the themes in the Water White Paper and that the proposals in the Water White Paper and Ofwat’s own Framework paper complemented one another.
Regina Finn said that Ofwat recognised that the price setting process itself had become increasingly complex and burdensome and that as complexity had grown, the risk of “unintended consequences” had increased. Ofwat now intended to make the price review process simpler and to reduce the regulatory burden on companies while ensuring that the regulator instead focussed attention on the things that are important for customers.
Ofwat is now planning to remove some of the process steps required in previous price reviews – for example the companies will not be required to produce draft business plans.
Ms. Finn said Ofwat’s approach to change was “evolution not revolution” in order to provide a structure that is the most efficient and effective and therefore delivers benefits to customers and to investors.
White Paper merger proposals could restrict water companies' flexibility to deliver
Regina Finn expressed Ofwat’s concern that the White Paper proposals restricted the flexibility of the companies and that what it contained in the area of retail mergers would prevent companies from actually engaging in retail mergers and delivering the economies of scale they might deliver to customers now.
On abstraction, Ms. Finn said Ofwat was proposing to use an environmental incentive to discourage water being taken from where resources are already overstretched to avoid damage to the environment –the Abstraction Incentive Mechanism (AIM).
Timeline and next steps
Ofwat now plans to hold a number of workshops in the first half of 2012, including workshops on the proposals raised in White Paper and the Draft Bill expected early next year to address any issues with the draft legislation. During 2012 and 2013 the regulator will also work on the architecture of the retail switching system to deal with 1.1 million non-household customers.
For the 2014 price review, Ofwat will publish the consultation on the methodology in autumn 2012 and the final in spring 2013. Ofwat is aiming to leave longer between its draft and final determinations in the light of the fact that the water companies will no longer be expected to submit draft business plans.
Regina Finn commented:
“We are very conscious that until the Bill is introduced into Parliament and completes all its stages we can only make “prudent preparation” for its implementation. “