Smoothing investment cycles in the water sector 13 July 2012 Mark Worsfold, Chief Engineer, Ofwat 7 Water today, water tomorrow
Agenda Prime Ministers views of infrastructure Future Price Limits Framework update Smoothing investment cycles in the water sector 8 Water today, water tomorrow
Prime Minister on infrastructure Investment in infrastructure produces real, tangible assets that can earn a return, and yet no government has really solved the problem of how to finance the infrastructure we need within the public spending constraints that we obviously have…. …Now, Britain already has a long and successful track-record of regulating infrastructure providers such as the water industry, and now we need to go much further and faster in opening up the financing of our infrastructure. So, we’re encouraging the appetite of investors, both at home and abroad, for investment in British infrastructure; taking advantage of our stability and our open markets…. …But we now need to be more ambitious. We should be asking ourselves, ‘Why is it that other infrastructure’ — for example, water — ‘is funded by private sector capital through privately owned, independently regulated utilities, but roads in Britain still call on the public finances for funding? David Cameron, 19 March 2012 9 Water today, water tomorrow
Future Price Limits statement and next steps Published 15 May Documents published: Statement From principles to price setting - next steps Appendix 1 - Impact assessment; and Appendix 2 – Summary of responses Publication preceded by: Consultation Workshops Published papers 10 Water today, water tomorrow
Framework statement – statement of principles We will target our price We will use our risk-based control regulation approach to focus regulation where appropriately it matters and reduce any unnecessary burdens We will develop clear, simple and effective incentives that drive allocative, dynamic and productive efficiency We will set price controls in a way that gives companies ownership and accountability for delivery of what customers want and need We will continue to regulate in a way that is transparent and predictable We will design and use our regulatory tools in a way that is future proof and capable of adapting to support the sectors 11 Water today, water tomorrow
Future price limits Wholesale control Retail control Other wholesale Network plus sub-limit Contestable market activities Treatment and transport Customer of water and wastewater challenge groups Non- Companies deliver contestable market and customers influence outcomes Changes to cost assessment 12 Water today, water tomorrow
How the framework meets the external agenda Gray, OFT, supply chain, innovation – Cave and others Challenge Increase Reduce the Smooth the Sustainable Address capex Cross – innovation burden investment cycle long-term focus bias / behaviour regulator working Cave, OFT Gray, Govt Supply chain, Gray OFT, EA Gray, Govt Approach Govt � � � � � � Outcomes Incentives � � � support outcomes � � � � Customer engagement � � � Water trading and AIM � � � � Totex approach Simplifying the � � business plan process 13 Water today, water tomorrow
The FPL framework statement – Long lasting principles The framework statement sets out a direction of travel We will: create binding retail and wholesale controls begin to create a new framework for access prices hold companies to account for delivering the outcomes customers and society want expect companies to involve their customers fully in their plans develop tools such as totex and menus that can support outcomes and sharpen incentives adopt measures to support water trading and resource efficiency The ‘next steps’ document shows how we will continue to engage with stakeholders before the consultation on the next price review in autumn 2012. 14 Water today, water tomorrow
Timeline to the 2014 price determination Government Water White Welsh Govt Draft Water Possible Act Paper strategy Bill 2011 2012 2013 2014 2015 2016 Water trading contract Market codes, architecture Market Market reform and guidance and contracts in place systems projects testing Bridging Price review methodology Determinations New bills Ofwat price work – Consult autumn 2012 – Draft April 2015 review FPL to – Final spring 2013 – Final method- ology Ofwat Customer Advisory Panel input Customer engagement Business plans Customer Companies – Direct Customer challenge engagement – post- – Customer challenge groups groups report to Ofwat draft determination 15 Water today, water tomorrow
David Gray review The impacts of cyclicality are a recognised issue in the water sector “ The extraordinary degree of cyclicality in business flows from the water companies to the sector supply chain, which appears to be largely a response to the price review process, is obviously undesirable. It is hoped that the proposals to make regulation less intrusive and give companies more ownership of their business plans will improve the position, but it may also be necessary to consider some more proactive approaches in the shorter-term.” David Gray � s review of Ofwat in 2011 16 Water today, water tomorrow
Improving infrastructure delivery Government’s commitment to infrastructure Updated the National Infrastructure Plan 2011 Infrastructure a key feature of the Growth Review and Autumn Statement Established the new Infrastructure Cabinet Committee Exploring new approaches to funding infrastructure investment Implementing the Infrastructure Cost Review Published the infrastructure pipeline alongside the public sector construction pipeline 17 Water today, water tomorrow
Improving infrastructure delivery Infrastructure Cost Review UK civils costs consistently in upper quartile Potential savings of 15% to 20% identified (£2 billion to £3 billion annually) Key implementation objectives: Pipeline visibility and certainty Supply chain engagement Competition/procurement models Focus on cost and risk (not budgets) Engineering standards Infrastructure data/benchmarking ...need to change client and industry behaviours 18 Water today, water tomorrow
Mitigating against cyclical investment Infrastructure Cost Review, IUK (December 2010) “…even in the regulated sectors, the five yearly reviews are creating a line of uncertainty in investment around the review point which means that potential efficiency savings continue to be lost” Review of Ofwat and consumer representation in the water sector (July 2011) “The extraordinary degree of cyclicality in business flows from the water companies to the sector supply chain, which appears to be largely a response to the price review process, is obviously undesirable” 19 Water today, water tomorrow
Mitigating against cyclical investment Joint IUK/OFWAT study To understand and expose the causes and drivers of peaks and troughs in the investment cycle in the water sector and to consider the changes all players in the sector can make to reduce its impact 20 Water today, water tomorrow
What is the regulatory cycle of expenditure? Key considerations What actually is it? What impact is it having? How did the study work ? What did it find ? What are the challenges that we need to look at ? 21 Water today, water tomorrow
Cyclical investment since privatisation 22 Water today, water tomorrow
Setting the scene – What is the cycle 23 Water today, water tomorrow
A perfect storm During the last price review period (AMP4, 2005-10), a combination of factors made the situation worse… The regulatory capping of capital expenditure during the period The fall in the Construction Output Price Index (COPI) The alignment of Scottish Water’s price review control period with England and Wales companies The increase of capital maintenance in years 2 and 3 to get to a stable serviceability position 24 Water today, water tomorrow
So why does this matter ? 3-5% costs due to redundancies and staff costs alone Equates to £660m to £1.1bn over the five years Costs customers £5 to £6.50 on an average bill at the end of the five year period Estimated jobs impacted are 40,000 with loss of skills, training and impact on health and safety. We all recognise the need to take action in this area. 25 Water today, water tomorrow
In an ideal world Companies’ expenditure profiles would have been smooth across each of the five-year periods We have carried out some simple analysis to measure ‘Amplitude’ based on a scoring system in which a company receives the highest score for having spent 20% of its five- year total in each year This analysis has allowed us to: Identify companies with least and most smooth expenditure profiles by way of a amplitude score (over three AMPs) Consider those companies with the greatest/smallest share of the current AMP5 programme The results are quite interesting… 26 Water today, water tomorrow
The most efficient companies have smoother profiles 27 Water today, water tomorrow
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