Water industry regulator Ofwat has launched a new consultation on the 2014 price review on the utilities’ business plans for the period 2015 to 2020 – which appears to be running under a remarkably tight deadline.

The regulator has itself acknowledged the short timescale - Ofwat said the consultation on wholesale issues ”requires a shorter consultation period than normal. We will supplement the consultation with engagement with key stakeholders..”

  The new consultation, one of the most complex ever undertaken by the regulator, follows closely on the back of Ofwat’s July consultation on retail price controls which closed on 24^th August. Ofwat is now seeking views on proposals for wholesale price controls and a variety of different incentives mechanisms.

 While the regulator will continue to use RCV and RPI tools at least until 2020, Ofwat says the other incentives are now needed “to encourage the companies to think more innovatively (‘dynamic efficiency’) and… to manage water resources better (‘allocative efficiency’).”

The regulator’s specific aims for the wholesale control include preserving investor confidence in the water and sewerage sectors and maintaining financeability, revealing better information on which the companies and regulators can act and finding better ways of incentivising efficiency in resource use, innovation and in network operation, maintenance and development.

It will be interesting to see whether Ofwat’s stated aim of regulating “in a more flexible, adaptable way that is capable of evolving to enable companies to deliver for their customers, the environment and their owners in the light of … future challenges” can be achieved by what at first glance appears to be a very complex approach.

Key incentives proposals outlined

 Ofwat’s proposals are currently concentrated on financial and non-financial incentives. Under financial incentives, the companies would stand to gain or lose financially depending on their delivery of the incentivised outcome. Level of the financial penalty could be predefined or subject to regulatory discretion

Under non-financial incentives, companies would stand to gain or lose but not in financial terms e.g. reputationally or procedurally ie subject to greater/lesser regulatory scrutiny.

The regulator has excluded relying solely on non-financial measures – in Ofwat’s view this would provide relatively weak incentives for companies and risk providing insufficient assurance to customers. This is seen as “particularly relevant in the early stages of moving to an outcomes-based approach.”

The primary consultation document sets out the following areas which Ofwat is targeting and its proposals to develop packages of incentives.

More scope to innovate and outperform - Cost performance incentives

Better water resource efficiency - Water trading incentives

Abstraction incentive mechanism (AIM)

Better network management - Network plus incentive and network management incentive

 The proposals are set out in a formidable array of documents – including a lengthy 82 page primary consultation paper accompanied by a plethora of supporting documentation in the shape of six technical appendices and related research studies.

The clear implication is that all should be read in order to understand Ofwat’s thought processes, why some proposals have been ruled in and others ruled out, why others are potentially in the running but not immediately applicable to the 2014 price review – but could be on the cards for 2020. The primary document alone requires hours of careful reading, even for stakeholders with a close interest and detailed understanding of the issues.

Important implications for stakeholder engagement

While the water companies are undoubtedly the primary stakeholders in the consultation, other interested bodies, including environmental organisations and customers, will doubtless want to comment.

The consultation raises important concerns around stakeholder engagement, not least of which is whether the water companies will be expected to consult with their customer challenge panels on the issues addressed in the consultation in the very limited time available. One would assume that this should be the case given that the outcome will be one of the primary drivers in the 2015-2020 business planning process.

Particular proposals which flag up how much the industry could change with significant implications for both the water companies and their stakeholders alike, include:

• As new resource and network markets develop, Ofwat expects water and sewerage networks to extend beyond individual companies’ existing boundaries. Existing and new market participants will need appropriate information in order to participate effectively in these markets. To make that participation possible, Ofwat says that as a first step, existing companies will need to make available additional information about their network and treatment activities.
• In future, companies will need to identify opportunities for connecting their networks with those of neighbouring companies. They will also need to develop co-ordinated operational processes involving different water resource suppliers.
• Whether any options could be introduced over time through more than one price review period, to reduce the risk associated with implementing them.
• Whether to allow trade-offs between over and under delivery – where the water companies could in certain circumstances trade off over delivery in one area with over delivery in another, or trade-offs over time (potentially between different price control periods).

  On trade-offs, there is currently no indication how over-delivering on an individual output could be offset by under-delivery in another, how such decisions would be reached, who would take them and whether the water companies would be required to consult with stakeholders on the options. The consultation paper simply states:

“At this stage, we have assumed that the company would wish to set out the proposed criteria for allowing trade-offs in its business plan following customer engagement. There may be circumstances that justify discretion during the life of the price control.“

Too much information in too short a timescale?

 The 31 questions in the main consultation paper (many of which are open-ended) – are predicated by the ability to process, assess and analyse the possible implications of the Ofwat proposals. The limited time available simply doesn’t seem to offer potential consultees time to do them justice – especially if the water companies themselves need to consult further down the stakeholder chain. Ofwat is also planning to publish an information notice to address stakeholder requests for clarification over the roles of customers, customer challenge groups, and other stakeholders in the business planning process.

Add in Ofwat’s invitation for feedback on outstanding issues and interrelationships, even where they are not covered in the consultation, openness to suggestions from stakeholders on other possible options, its intention to make the results of joint work with a number of companies it is currently carrying out on different aspects of the incentives publicly available during the course of the consultation for further comment - then surely a longer timescale is required?

Next steps

 Ofwat is continuing to carry out further work both with the companies and consultants to develop elements of the proposals via an ongoing programme of engagement with stakeholders, which includes a stakeholder workshop on 19 September 2012; and one-to-one meetings with each company and other key stakeholders. The regulator is due to consult on the price review methodology this autumn, and will then set out its final methodology in spring 2013. Deadline for responses to the consultation is 28 September 2012.

2020 and beyond

Looking beyond the upcoming review, Ofwat is also planning to include specific incentives to reveal information and evidence to help improve and evolve the way it regulates when setting price controls in 2019.

The regulator is proposing that the initial focus of its incentives in the period 2015-20 should be on “encouraging companies to reveal relevant information on their network optimisation and management processes in a more structured way.” The consultation paper says that encouraging companies to organise this information and make it available – particularly as markets develop in England – will benefit customers and the water and sewerage sectors as a whole. Ofwat’s focus will be on information that will be particularly relevant to the early development of markets for resource and network services, including:

• costs and cost drivers; and
• the approaches companies take to optimise and manage their networks.

Given that Ofwat says that the most effective package contained in its proposals is dependent on companies providing high quality information in their business plans, surely there is a strong case for requiring, rather than encouraging, provision of the relevant information in the first place.

Click here to download the primary consultation document

Click here to access the technical appendices and associated research papers