In the wake of Ofwat’s tough price determinations, water companies are deciding priorities and finalising investment plans. Jo Stimpson looks at how the industry’s money will be spent.
Two weeks ago the deadline passed for water companies to accept or reject Ofwat’s final price determinations for the period from 2010 to 2015 (AMP5). Every company except one accepted the prices that were set.
By declining to challenge the regulator’s decisions, most of the companies accepted that they could not do as much as they wanted, or that there was scope for more cost efficiency. The water industry is steeling itself for a challenging − but productive − five years when AMP5 begins on 1 April.
Ofwat’s final price determinations, published in November, earmarked £22bn for capital expenditure by water companies. The final figure was £1.3bn higher than the draft figure published in July and 7% higher than the amount set for the previous AMP period. In fact the final sum was higher than the capital expenditure programme of any of the previous five year regulatory periods.
But it was significantly lower than the £27bn companies asked for in their business plan proposals, meaning the water industry now faces the problem of curbing its ambitions. The investment programmes that firms settle on will show which issues the industry is prioritising, which projects are considered the best investments,and where the opportunities are for the supply chain.
“Water companies are focusing on consumers. It’s all about maintaining supply to customers.”
Ian Kirkaldy, Black & Veatch
Spending plans show major projects and new assets playing only a minor part. Much more prevalent are schemes to upgrade and improve assets and networks, improving the consistency, quality, sustainability and resilience of water services.
This type of project will dominate in the next five years, says cost Terry Povall, who is utilities director at cost consultant EC Harris.
“What we’re seeing is a shift from major projects into capital maintenance schemes,” he says.
This, he says, is part of a much wider trend that has seen the average cost of projects fall from £5M around the time of privatisation 20 years ago to just £100,000.
“It’s a trend that’s been going on and will continue to go on,” he says. Through smaller maintenance projects, water companies are seeking to add to the value of their assets rather than just remedy flaws.
The trend is symptomatic of a shifting ethos from ambitious growth towards quality of service, says Black & Veatch managing director Ian Kirkaldy
“Water companies are focusing on consumers. It’s all about maintaining supply to customers,” he says.
Accordingly, while some new assets are due to be built in the next five years they will be small projects, Povall says. “Other than the [London] Tideway Tunnels the others are all relatively small. Generally speaking the scale of projects is much smaller.”
Figures published by Ofwat show that only £900M will be spent on delivering major projects, while £12.9bn will fund maintenance and renewal of assets. What the water companies have to say about their own spending plans reflects these priorities: extensive pipeline replacements and treatment works upgrades crop up again and again.
The second largest area for investment is in water quality and environmental improvements, on which £4.6bn will be spent. Particularly notable is Cambridge Water’s £7.8M programme to build five nitrate removal plants.
Due to pollution from agricultural fertilisers, nitrate levels in the area’s ground water have been steadily rising for decades, and the company says its ability to comply with government water quality standards is likely to be compromised during the next five years without treatment.
Renewable energy is also big news in investment programmes, with a number of companies planning to incorporate or increase spending on new technology.
South West Water has allocated £10M to increasing hydropower and other generating activities. But most interesting is investment in sludge to energy technology. Southern Water is investing in energy from waste, while Welsh Dŵr Cymru plan
And Wessex Water, which currently generates nearly 10% of its electricity from biogas emitted from sludge digesters, says it will increase the amount of energy generated in this way.
Flood resilience of critical assets is another major concern for water companies, and many will be investing accordingly. Severn Trent, South West, Wessex and Dee Valley are among those looking to protect their sites with flood defences. These projects aim to prevent damage from floodwater and to enable assets such as treatment works to carry on operating during floods, or to come back into operation as soon as possible afterwards.
s to install full advanced sludge digestion at three sites in Wales with a view to adding a
“There is a big efficiency challenge − can they deliver the efficiencies that are needed”
Terry Povall, EC Harris
Several companies are also undertaking measures to ensure customers can be supplied from at least two different sources, so that problems at one source need not mean a complete loss of supply.
Other issues that are prominent in water companies’ spending programmes include reducing the risk of sewer flooding, controlling leakage and water main bursts, renewing treatment works and reducing environmental impacts.
What this amounts to is a large number of small capital maintenance projects spread widely across large areas of the country − and this could mean changes to the way in which water projects are delivered.
“They’ll need to rethink the supply chain,” says Povall.
He anticipates that having lots of small, geographically diverse projects will lead water companies to favour small local contractors over large national ones. The next five years are likely to bring more opportunities for small companies, he says.
Furthermore, as water companies seek efficiencies to meet Ofwat’s stringent budgets, the middle man will be cut out, says Povall, and small contractors may be contracted directly rather than as sub-contractors to larger firms. There may also be a rise in the popularity of insourcing as water companies seek cost savings.
Water companies will also have to rethink the way their projects are managed, says Povall. With one project management team dealing with large numbers of projects spread over wide areas, the financial reins could become slackened.
Maintaining and replacing assets, from pipes to water treatment works
Improving drinking water and the environment
Making sure there is enough water, and capacity to treat sewage
“The risk of overspend is probably greater because your control is too diverse,” he says. Project management systems should be restructured to reflect the diversity of work over the next five years, if water companies are to deliver their projects as cost efficiently as possible.
Of course, costs will be squeezed all over, says Povall. The supply chain will feel the effects as water companies chase the value for money that Ofwat demands. “Everyone out there is seeking increased efficiencies,” says Kirkaldy.
Povall agrees. “There is a big efficiency challenge − can they actually deliver the efficiencies that are needed?” he asks.
Perhaps not. Bristol Water took the decision to appeal against its Ofwat determination to the Competition Commission.
The company claims Ofwat’s price determinations will not allow it to carry out critical works − including mains replacement, a 10% reduction in leakage and four major schemes around the Bristol area to improve resilience − to be delivered.
The decision could be a risky one, as the appeal may suspend progress, divert management focus and damage confidence in the company. More worryingly, it is not possible for a water company to challenge a specific part of a determination.
This means the whole of Ofwat’s determinations for Bristol Water is now up for review, and there are no guarantees that the outcome will allow the company greater capital expenditure. It could even demand even more efficiencies.
“Historically the number of challenges [to Ofwat’s determinations] have been few and far between,” says Povall. Bristol’s difficult decision therefore says a great deal about how tight budgets must be over the next five years, and how carefully considered investment will have to be.
“It’s about being smart, it’s about being clever − things that engineers are quite good at.”
Still, Povall says some of the water companies should be pushed towards getting more for their money. There are opportunities for greater efficiency in the industry, he says.
He also cites EC Harris’ estimate that there could be a 30% difference between upper quartile and lower quartile performance on capital delivery in the water sector.
Kirkaldy says the key is determining “where real value lies”. While the recession may have made the challenge tougher, he says, the supply chain should always expect to be challenged on its cost efficiency. “I expect that every time,” he says.
After a year of building up to the final determinations, Kirkaldy says he is looking forward to getting his teeth into AMP5, despite the financial pinch ahead.
“It’ll be nice to return to doing things and building things again,” he says. “It’s a challenge that we as engineers can rise to.
“It’s about being smart, it’s about being clever − things that engineers are quite good at.”