Water industry regulator Ofwat has confirmed it has modified the licence condition for the water only and water and sewerage companies enabling it to increase the funding that it can recover from companies to carry out price reviews.

The move has enabled Ofwat to treble the cap on additional fees for the recovery of the 2014 price review by increasing the element linked to companies’ turnover from 0.1% of each company’s turnover to 0.3%.

In addition to being allowed to charge fees for its ongoing costs, Ofwat is also able to charge a fee for the extra costs of carrying out the five-yearly price review.

The current cap of 0.1% in companies’ licences allows the regulator to recover around £9 million over five years to fund the 2014 price review. The increase in the cap equates to an additional £18 million - Ofwat has previously said it is not proposing to recover the full amount of funding allowed by the proposed modification but that it was considered “prudent to set the cap at 0.3% to allow some headroom.”

The regulator has sought the additional funding on the grounds that the PR14 price review is significantly different to those it has carried out previously.

The modification will allow Ofwat to have a one-off licence fee increase in 2014-15 to meet the costs of PR14 and then to reduce the fee for 2015-16, once the price review process is complete. However, Ofwat said the modification itself will remain in place after 2014-15 in order to avoid another modification process, if it becomes necessary to once again increase fees, as it moves towards the 2019 price review.

In its Annual Report for 2013-14, Ofwat said the significant changes in its approach to the 2014 price review and the scale of assurance required to guarantee its delivery had led to an increase in its costs. This meant that the cap on the fees Ofwat can charge for the price review process in companies’ licences was insufficient to allow it to recover the costs of carrying out the 2014 price review. During the year Ofwat had to address a significant and – unforeseen- financial overspend of £5.6 million.

The annual report attributed the overspend to the 2014 price review which involves substantial change in how Ofwat regulates the water sector, stating:

“ The new methodology was published on 25 July 2013, and therefore did not align with the budgetary cycle, meaning that the total costs of delivering the new methodology could not be fully understood at the time the 2013-14 budget was set. “

Commenting in the accompanying report the Comptroller and Auditor General at the National Audit Office is required to make on Ofwat’s financial statements, Sir Amyas C E Morse said:

“When preparing for the 2014 price review, Ofwat’s new senior management team identified that the Department lacked the necessary skills and capacity to complete the required work effectively. The Board therefore agreed that Ofwat should develop an outsourced delivery partner role to provide greater flexibility to deliver the review.”

“The partnership arrangement was put out for tender, which was subsequently won by PricewaterhouseCoopers. As well as lacking the necessary skills and capacity, Ofwat had also failed to include budgetary cover for the partnership element of the price review exercise when it agreed its budget with HM Treasury to cover its published forward programme covering the financial years 2011-12 to 2014-15. The value of the delivery partner contract to support the price review, which will be incurred in 2013-14 and 2014-15, is up to £6.45 million.”

The annual report also set out details of fees being paid by Ofwat to PricewaterhouseCoopers (PwC) its Delivery Partner for PR14. The contract includes two incentive payments intended to secure good value for money from the Delivery Partner contract – Ofwat has provided for £701,000 which represents the estimated maximum possible incentive payment due to PwC upon satisfactory completion of the risk-based review, which concluded on 4 April 2014.

From 2015-16 onwards Ofwat will also be subject to a settlement imposed by HM Treasury through the Comprehensive Spending Review. The regulator will need to deliver significant efficiencies and cost reductions as a result of being required to operate within a much tighter budget.