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Water spend threatened by 'flawed' Ofwat cost model

HUNDREDS OF millions of pounds worth of water spending is in danger because of flaws in regulator Ofwat's project evaluation, water companies claimed this week.

Water companies fear they will have to cut their capital programmes because Ofwat's model cannot grasp the cost implications of using different methods to build similar projects.

'It is a cost based econometric model and is unreliable, ' said industry body Water UK, economic adviser, Robert Weedon.

'We believe that there are problems with it.'

Weedon's comments followed the recent draft determination of water prices made by Ofwat (NCE 19/26 August).

As part of the price setting process, conducted every five years, Ofwat asked water companies to price 100 hypothetical capital projects.

These cost estimates are used to value projects that companies want to carry out in future. It can then decide which companies are the most efficient and use their costs as benchmarks for the others to follow. Less efficient companies could be forced to scrap projects if costs fail to match benchmarks.

'Some demanding conclusions are drawn from a fairly coarse model, ' said ICE Water Board chairman Graham Setterfield.

'Some companies go for a technology that has a high capital expenditure and low operating costs, whereas others go for higher operating costs and lower capital cost.

'One company might choose plant with a 20 year life, another chooses one with a 50 year life.

These are variables that can't be accommodated in the model, ' he said.

Ofwat declined to comment on the model but said that it would take the water companies' concerns very seriously.

Water companies are negotiating with the regulator on the draft price limits, which determine how much they can spend over the next five years.

They have until 15 September to convince the regulator that schemes that they have been told to axe from their five year programmes should be included.

'Ofwat has made cuts to unavoidable costs. It has assumed that bad debt won't rise, and not accounted for the increasing cost of landfill, although it has allowed for the increasing cost of energy supply, ' said Weedon.

However Ofwat disputed these claims. 'Bad debt, increasing landfill tax and abstraction charges are all notified items, ' said a spokesman A notified item is an uncertainty that the regulator is aware might affect spending. Water companies can apply for a price increase for changes beyond their control or foresight.

Ministers move

ICE Water Board chairman Graham Setterfield warned this week that government intervention may force cuts in water industry capital maintenance budgets. This could result in more breakdowns and pollution incidents.

'Ministers can have another look at the programme at the end of September and there is a chance that environmental pressure groups will win a bit and capital maintenance lose a bit, ' he said 'There have been arguments between DEFRA (the Department for the Environment, Food and Rural Affairs) and the Treasury and this draft determination seems to satisfy most people.

'If pressure groups say that we need particular schemes but the government says that prices can't rise, then something has to give, ' he said.

Around £1bn of environmental schemes have been shelved pending further guidance from ministers.

In an unprecedented move they have demanded to see the programme a third time before final price limits are set in December.

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