Water industry regulator Ofwat has written to United Utilities challenging it to to justify a £760 million gap it has identified between the water company’s re-submitted AMP6 Business Plan and its own assessment of efficient wholesale costs.

Ofwat has set out its concerns in a detailed 16 page analysis of United Utilities’ wholesale wastewater price control.

Key issues flagged up by the regulator on UU's wastewater special costs claims where the water company has either only achieved a partial pass or a fail against its assessment criteria include:

National Environment Programme phase 3 and 4 bathing water intermittent discharge projects

United Utilities has made a special factor cost claim on the basis that its statutory obligations requiring investment to comply with the revised Bathing Water Directive need atypical and more costly solutions than Ofwat’s cost models allow for. The total of the cost exclusion claim is for £181 million (£1.2 million of opex and £179.6 million capex).

Ofwat has allowed £77.888 million for the claim – a difference of £102.9millionand assessed UU’s  robustness of cost estimate as a partial pass, with the scope and costs assured by Halcrow, and Franklin and Andrews (F&A). The regulator said it appears from F&A’s analysis that United Utilities’ wastewater infra-IPES costs are 9% above industry average and wastewater non-infra IPES costs are 8% above industry average, commenting:

“The 10% efficiency challenge United Utilities has applied to its costs will therefore only ensure costs are marginally below average and it is not clear that the costs represent efficient levels.”

National Environment Programme phase 5 (Water Framework Directive)

United Utilities has made a special cost factor claim for its NEP phase 5 schemes. The total value of the claim is for £235.4 million consisting of:

• £85 million to meet tighter ammonia standards at 16 sites (some of which also require tighter biochemical oxygen demand (BOD) and/or phosphorus standards);
• £21million to meet tighter phosphorus standards (only) at seven sites (five through dosing, two through new treatment process);
• £86 million to provide storage to reduce spill volume and frequency at 18 sites; and
• £43 million early start on an estimated AMP7 programme of about £798 million.

Against the assessment criteria Ofwat has scored this as a partial pass in terms of need, commenting:

“The revised submission clarifies that the overall proposed investment of £235 million includes £43 million described as 'AMP7 early start programme'. No other company has proposed such a programme and had United Utilities made it clear in its December business plan then we may not have assessed the 'need' criterion as a pass at the risk based review.”

“Without further explanation of scheme detail or justification for the AMP7 (2020-25) early start programme (which is larger than the entirety of some companies’ AMP6 (2015-20) WFD programmes) we have scored the NEP phase 5 programme as a partial pass on need.”

Ofwat has failed UU in terms of robustness of cost estimate, saying:

“Our own analysis of the costs raised the following concerns. Phosphorus removal (11% of AMP6 Managing Uncertainty programme excluding AMP7 transition of £43 million). We considered company costs for schemes delivering only phosphorus removal normalised by population equivalent served, and also by river length improved. In both cases United Utilities perform poorly in cross-industry comparisons and appears to be less efficient than the industry average.”

“Storage schemes (45% of defined AMP6 programme). Only two other companies have storage schemes in their Managing Uncertainty programmes. We have one other company's data by scheme of storage volume and cost. United Utilities' schemes are considerably more expensive for providing the similar storage volumes.”

"United Utilities comments that specific environmental conditions in the North West contribute to United Utilities' costs being higher than other companies'. We can see why this would mean that storage schemes are required, but do not consider this would make a scheme more costly than a scheme of the similar size installed in another company's area. We could find no specific independent assurance of the NEP phase 5 costs proposed by United Utilities."

National Environment Programme phase 5 shellfish schemes

United Utilities’ special cost factor claim is for £35.4 million for shellfish schemes which were excluded from NEP phase 4. The costs for the shellfish schemes consist of five locations where additional storage is required and two sites needing ultraviolet disinfection.

Ofwat has failed UU on robustness of cost estimate, commenting:

“….we have scheme specific information on storage volumes and business plan capex for other companies. United Utilities' costs look considerably more expensive than those for other companies providing similar storage volumes. Without specific and robust assurance on the costs of the shellfish storage schemes we conclude that there is insufficient evidence on the efficiency of these costs.”

Atypical, integrated AMP5/6 large project solutions – Davyhulme

United Utilities has made a special cost factor claim for work on its Davyhulme waste water treatment works, valued at £162 million. The project proposes to addresses AMP5 Freshwater Fish Directive (FFD) and AMP6 WFD / NEP phase 4 obligations, including:

• tightening of ammonia consent from 3mg/l to 1mg/l;
• addressing the impact of population & trade growth;
• capital maintenance particularly focused on the inlet works; and
• measurement of flow to treatment.

The claim is split across three categories of expenditure:

• base £72 million
• quality £39.3 million
• supply / demand £51.7 million.

On the assessment criteria, Ofwat has failed the cost claim on the grounds of need, commenting:

“Although there is a statutory requirement from AMP5 for the ammonia consent reduction, we are failing the need criteria. The majority of the costs for this claim are allocated to capital maintenance, however we could find no explanation for the allocation between cost categories. In addition, while there is evidence of a need for compliance with a regulatory ammonia consent to be complete by February 2016, this proposed scheme is not planned to be completed until autumn 2017.”

It has also been failed in terms of whether it is the most cost beneficial solution. Ofwat said:

“This has been classified as a fail on the basis that the AMP5 obligation is unlikely to be met in time and because 44% of the claim is for capital maintenance which accounts for almost all of the forecast capital maintenance for the next 25 years.”

“In addition, Halcrow raises a concern that although the chosen option is lowest whole-life-cost, there remains a question over whether the entire capital maintenance element (£72 million) is required during the next AMP.”

Atypical, integrated AMP5/6 large project solutions – Oldham and Royton

United Utilities has made a special cost factor claim of £105 million for work at Oldham and Royton waste water treatment works - split between base of £61 million and quality of £44 million. Ofwat has failed the claim on both the grounds of need and robustness of cost estimate, while allowing it a partial pass on whether it is the most cost beneficial solution.

Trunk mains network reinforcement not subject to developer contributions

United Utilities has made a special cost factor claim of £24.6 million for two projects to reinforce the trunk network where it claims it cannot recover costs from developers.  Ofwat has failed the claim in terms of need, commenting:

“While United Utilities has provided some evidence about the specific new development planned within the areas where they intend to provide the trunk network reinforcement, it has failed to demonstrate that an efficient company could not recover a greater proportion from the developers than set out in its plan. There is no ring fence of grants and contributions to provide infrastructure for a specific area, and it is not clear that the two sites should be considered in isolation from expenditure and contributions for all new development in United Utilities’ region.”

Base total expenditure - "claim potentially has implications for other companies"

United Utilities' special cost factor claim for base costs is for £145.4 million and has 3 elements:

• a high proportion of combined sewers
• high levels of tertiary treatment, evidence from June return 2011 data showing load receiving tertiary treatment as compared to other companies, plus a chart showing length of river length improved by EA region from 1993 to 1996, and
• high levels of network storage capacity, evidence from AMP5 industry expenditure data.

Ofwat said that given the generic nature of the factors that United Utilities cites, the claim potentially has implications for other companies. As a result the regulator has also looked at wider information and analysis as well as considering the evidence provided by the water firm.

Ofwat has assessed the claim as a partial pass in terms of need – partly based on the fact that in relation to non-sewer infrastructure “the company appears to have many more assets than other companies, and, the impact of this on costs would appear to warrant further investigation.”

However, the regulator has failed it in terms of robustness of costs, commenting:

“….two companies with higher proportions of load subject to tertiary treatment in 2010-11, Northumbrian Water and South West Water have both submitted Plans which we have judged as containing an efficient level of costs   …….from United Utilities ' June return for 2010-11, taking account of the size band of works, it is not clear that its opex unit costs are actually higher for tertiary treatment than secondary treatment.”

United Utilities now has the option of reconsidering its plans in these areas or providing further evidence to Ofwat to support the cost claims.

Click here to read Ofwat's analysis in full.