Ofwat water resources working group 29 September 2016 Trust in water 1
Agenda No Item Time (minutes) Lead Colin Green 1 Welcome and introductions 10.00 (10m) Peter Hetherington Cost assessment for water resources: 2 10.10 (60m) David Young introduction and discussion 3 Break 11.10 (5m) All Access pricing for bilateral markets in England 4 11.15 (60m) Mat Stalker – sub group update and discussion Project updates: Peter Hetherington - Licencing (verbal update) 5 12.15 (15m) Ian Pemberton - Market information platform Ian Pemberton - Capacity discussions 6 Lunch 12.30 (30m) All Jon Ashley Targeted incentives: The abstraction incentive 7 13.00 (60m) Mike Pocock mechanism Ilias Karapanos Peter Hetherington 8 Targeted incentives: Water trading incentives 14.00 (60m) Daniel Davies Phillip Dixon Regulatory accounts consultation: water Peter Hetherington 9 15.00 (30m) resources boundary Simon Harrow 10 Actions and agenda for next meeting 15.30 (15m) Colin Green Trust in water 2
Project management Project management Actions from July meeting By Whom Minutes : Ofwat to circulate the minutes to group members for comment. Comments Ofwat, Group members should be sent to Hanif Jetha. Ofwat to share calculations presented during the form of control item. This has been sent round to group members alongside the draft minutes. If you have any comments or Ofwat want to discuss please contact Peter Hetherington. Canal and River Trust to update group on status of paper on raw water transfers Darren Leftley Access pricing sub group to prepare materials to update the next water resources Access pricing sub working group meeting on progress group Presentations for future working groups : Ofwat is looking for volunteers to present and facilitate discussions at future working groups. Among others topics available include: Resilience (in September); Cost assessment for water resources (in September) Form of control; Group members RCV allocation for water resources; Bid assessment framework; and Incentives for trading/interconnection. If you are interested in this or other topics please contact Peter Hetherington. We have set up a Water 2020 working groups website where all papers, plus minutes of the meetings are available for download: http://www.ofwat.gov.uk/regulated- companies/improving-regulation/future-price-setting-for-2020/water-2020-working-groups/ Trust in water 3
Cost Assessment for Water Resources David Young September 2016 Trust in water 4
Water Resources Cost Assessment – Format of the session 1. Why we need cost assessment for water resources 2. What is Cost Assessment 3. Options for PR19 4. Issues 5. Breakout Sessions 6. Next Steps Trust in water 5
We introduced separate binding controls for water resources and sludge On 25 May we published our decision document “Water 2020: our regulatory approach for water and wastewater services in England and Wales ” We decided to introduce separate binding controls for water resources and for sludge in PR19 The separate controls will support the development of markets and help ensure a level playing field between incumbents and third party entrants. It will also limit cross subsidy risks Separate binding controls means we will have to set allowed expenditure in these areas for the first time! This, in turn, means we will need to develop an approach for cost assessment in these areas • Trust in water 6
What is cost assessment? In every price review Ofwat sets an efficient expenditure allowance for the water companies for a period of five years. Cost assessment is an extremely important and material component of price reviews In PR14 our approach to cost assessment was based on top-down benchmarking of historical costs and special cost factors adjustments Specifically, we developed benchmarking (econometric) models on the basis statistical relationships between historically incurred costs and ‘cost drivers’, as reported annually by companies. The models provided an initial cost baseline The initial cost baseline were then subjected to “special cost factor” adjustments, which are factors that impact company costs but are not captured in the model (e.g. a very large capital scheme such as building a new reservoir) But there are other approaches to cost assessment, such as bottom up assessment Trust in water 7
Let’s think about cost activities and their drivers… Operational costs Maintenance costs Enhancement costs New source identification and Abstraction charges development Catchment management Abstraction rights Power costs (of pumping) Operation of pumping stations Maintenance of pumping stations Building pumping stations Operation of boreholes Maintenance of boreholes Building boreholes Operation of dams and Maintenance of dams and Building dams and impounding impounding reservoirs impounding reservoirs reservoirs Procuring bulk raw water? Note: The allocation of What are the drivers of each cost? costs in the table is for illustration only and may Is the driver under management control? not strictly coincide with RAG rules. Is the cost fixed or variable in the short run? Is the cost fixed or variable in the longer run? Is the cost material? Trust in water 8
Potential approaches for setting efficient water resources expenditure* Top-down water Top-down water Top-down wholesale Bottom-up resources resources + treatment Benchmarking of Wholesale totex (as Water resources Water resources + Unit cost per asset what? in PR14) costs treatment costs type? An engineering assessment of (capital) Estimate an efficient The benchmarking Estimate an efficient costs per unit of wholesale totex first, model will directly level of WR+treatment capacity for different How will we set and carve out a estimate an efficient expenditure first, and water resource asset efficient allowance? portion for water level of water split out a portion for combined with a resources resources water resources separate assessment subsequently expenditure subsequently of overhead and other operational costs * Other options may be considered Trust in water 9
Further issues to consider RCV protection – we said will protect RCV as of 31 March 2020. Investment to enhance water resources beyond 2020 will be incurred at risk. What are the implications for Cost Assessment? How do we assess maintenance going forward? Are their implications for special cost factors ? Boundary do we have a clear and consistent boundary between water resources and Network Plus activities? Cost allocation of overheads – are there any issues with the assessment of overhead costs allocated to water resources business units? Separation of treatment and water resources Heterogeneity in water resources – companies use very different water resource assets. This makes benchmarking of costs across companies more challenging Trust in water 10
Heterogeneity in water resources Water Resources Assets in 2016 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% ANH NES UU SRN SVT SWT TMS WSH WSX YKY AFW BRL DVW PRT SBW SES SEW SSC Impounding reservoirs Storage reservoirs River abstractions Boreholes (excl. MAR schemes) To what extent is the mix of assets under management control? Trust in water 11
Break Out Session Group 1 Group 2 Group 3 Group 4 Top-down water Top-down water Top-down wholesale Bottom-up resources resources + treatment Benchmarking of Wholesale totex (as Water resources Water resources + Unit cost per asset what? in PR14) costs treatment costs type? An engineering assessment of (capital) Estimate an efficient The benchmarking Estimate an efficient costs per unit of wholesale totex first, model will directly level of WR+treatment capacity for different How will we set and carve out a estimate an efficient expenditure first, and water resource asset efficient allowance? portion for water level of water split out a portion for combined with a resources resources water resources separate assessment subsequently expenditure subsequently of overhead and other operational costs ‒ pros and cons ‒ how the option deals with issues set out on slide 10 Trust in water 12
Next Steps We thank you for your input and thoughts today We will continue to work with the Cost Assessment Working Group to develop our approach to water resources We will consider establishing a cost assessment sub-group dedicated to Water Resources. We will extend invitations to this if taken forward. Trust in water 13
Access prices for bilateral water resources providers in England Update to Water Resources Working Group September 2016 Trust in water 14
The issues we said we needed to resolve Deriving access prices from cost information Link with How to use AICs? WACC Redundancy? controls? Form of pricing Volumetric? Capacity? Mixed? Treatment Account for DWI Raw water or treated Who treats water? requirements and water price? double treatment? Distribution and transport costs Average or specific How to deal with Price for transporting transport costs within leakage? out of area? an area? Trust in water 15
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