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Monitoring water spending plans: Q&A with Ofwat regulation director George Day

Ofwat regulation director George Day is starting his sift through the water company draft investment plans for - AMP5. What is he thinking?

How well have the companies done with the draft submissions they put in last month?

It’s early days and it wouldn’t be fair to comment in detail but we can sense that the companies have put a lot of effort into them. And they have come up with some big numbers in terms of expenditure, especially on maintenance. This may reflect their growing asset bases, of course, but we’ll need to review, and of course challenge, the submissions.

What we are trying to do is encourage the companies in their final business plans [due in April 2009] to really challenge themselves and submit their best estimates rather than first bids for a protracted negotiation.

We are building this into the financial incentives - so that the leading companies who set themselves a real challenge in their business plans will stand to gain more from outperforming in future. This places a real incentive on companies to be realistic and challenging at the business planning stage as well as in delivering capital programmes once price limits are set.

Many of the companies admit they did not make a great job of the early start programme in AMP4 [whereby some capital plans and the funding for them were agreed early so work could start in advance ironing out peaks and troughs in workload]. They’d like to try again though, but you’ve dropped early start for AMP5. Will you reinstate it?

I think companies could be managing the investment cycle and flow of work more smoothly. A lot of forward investment is broadly predictable, especially capital maintenance and supply and demand issues. These are investments companies can predict and plan for. They don’t know precisely the efficiency assumptions that we will make, that’s true, but innovative companies could and should manage this a lot better. When companies ask for a big uplift in expenditure in year one and then fail abysmally to make that investment, it’s poor form. We’ll be challenging the companies when we look at their business plans this time to check that they do have the delivery capability in place if they want bills to go up.

I believe the companies are too boxed in to the regulatory mechanism - Ofwat is simply determining how much money can be raised from customers; actually running the business is up to them. The great claim is that the five year cycle is bad for efficiency. If that is so, there must be opportunities for better planning.
However, we are going to help the companies by giving them an early clue as to what Ofwat is thinking by setting out our initial view of the likely capital expenditures in December this year, well ahead of the final determination in November 2009, though we can’t guarantee there won’t be some changes.

Several water companies have expressed concern that Ofwat appears not minded to allow explicit funding of renewables such as wind turbines in AMP5. Why is this?

We don’t want to extend the regulatory framework into an area that is competitive and renewable energy generation is a competitive market. We are not standing in the way of companies getting involved but where the renewable energy in question is not created as a function of being a water and sewerage company, we are saying that it doesn’t need to be part of the regulated business and customers shouldn’t pay for its development.

Anyone can build a wind turbine on their land for instance, you don’t need to be a water company to do it. But some renewable energy is closely allied with the way sewage and sludge treatment in carried out, for example, and using the by-products of the regulatory business does make sense - such as using methane gas for combined heat and power plants. There will be grey areas, but generally where the renewable energy is for the company’s own use and is created using its business assets that’s fine.

The companies have set themselves voluntary targets for 20% of their energy to come from renewable sources by 2020. Don’t you want to encourage them?

This is very commendable but we don’t want the companies to burnish their green credentials at everyone else’s expense.

The government is committed to sustainability. How does Ofwat define sustainability?

There is a lot of association of sustainability with greenery. That’s part of it but it is also about financial sustainability and sustainability of the assets themselves which is why we are very keen on the long term asset management approach. And then there is social sustainability - how you tackle charging of vulnerable groups?

Can increasing quality drivers be made compatible with the drive to reduce carbon emissions?

The first thing to do is to get a handle on the numbers and see what the trade offs are so we are getting carbon accounting built into the business plan. The companies have to set out the carbon implications of their proposals in terms of annual C02 emissions and embedded carbon in the capital programme. We are trying to expose the issues regarding water quality and the atmosphere. There are a number of statutory quality drivers to be met in the next AMP - Urban Waste Water Directive, Habitats Directive etcetera - and we will look precisely at what is being delivered and assess whether the solutions are rigorous. We are talking with the Environment Agency all the time and we are working better with them than for a number of years.

Do you need to take into account the likely cost to the water companies of the carbon reduction commitments that start in 2010? (Companies annual emissions will be capped and then targeted to reduce; if they are too high they will have to buy carbon credits - predicted to be expensive)

We have a duty to ensure that companies can manage their funding but we don’t want to insulate them from their Carbon Reduction Commitments. This will strengthen the incentives on them to manage their carbon footprint down, especially via things that have previously been at the margin. If the CRC does have a material impact on costs I am not sure the efficiency barrel is empty for energy efficiency for instance.

Following recent flood events, asset resilience is now receiving a large amount of attention, with some companies including significant investments in their draft plans. Should there be nationally agreed levels of risk that the industry should be working to, to determine this?

There is real danger to a standard approach. Government is looking again at basic requirements for security and emergency measures. I think it is important that we focus on the really critical assets - the single sources of drinking water supply. I don’t think we have to do it all in five years. We need to look at the risks, have a good sense of what they are and then maybe put in place investment with multiple benefits. I don’t think building bigger sewers is the answer to the flood problem. Predict and provide is a fairly well discredited model. Rather we need to manage the demand placed on overground drainage and that requires upstream solutions, catchment management and sustainable planning controls.

How does Ofwat take into account willingness to pay surveys?

They are an important part of the price determination process and feed through into cost benefit analysis.

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