Water companies are re-examining their spending options after regulator Ofwat set their budgets for the five years between 2005 and 2010 earlier this month. The 22 water and sewage companies in England and Wales had asked to carry out a combined spend of £21bn. But Ofwat told them to think more in terms of £15.7bn, equating to an average water bill increase of £33 a year. Between all the water companies, a total capital maintenance investment programme of £9.5bn was proposed. Ofwat has approved just £8.1bn. The increase is expected to be finalised in December, pending government approval.
'Around £1bn of capital maintenance schemes were challenged on efficiency grounds, ' says water regulator Philip Fletcher. In many cases Ofwat has ruled that schemes could be done for less than the water company estimates - perhaps by changing the pace at which the projects are carried out or by making them cheaper through better procurement.
Ofwat maintains that the tighter £8.1bn capital programme will enable companies to maintain water supplies and keep sewerage operating over the next five years.
Thames Water managing director John Sexton is not so sure. His company has proposed a £4.1bn investment programme, but has only been allowed £2.7bn by Ofwat: 'We are still digesting the full implications of Ofwat's draft determination, but are very concerned that it will not enable us to deliver the improvements we know are necessary to maintain our service to customers in the years ahead, ' he says.
The squeeze on budgets applies to a range of areas. The water companies were looking to spend over £1bn on tackling sewer flooding, but Ofwat has limited their demands to just £360M. 'We have scrutinised sewer flooding and have not approved the very expensive schemes that cost in excess of £120,000 per home, ' says Fletcher.
And the reduced figure will still enable water companies to tackle sewer flooding on private property at 8,200 of the 10,540 properties at risk, says Fletcher. But Ofwat says it is ready to consider some schemes if they have wider benefits than the initial estimates suggest.
The Ofwat figures have some areas where final budgets are still to be decided. Most significant of these is environmental quality improvements. For £2bn worth of these schemes, Ofwat is awaiting further ministerial, guidance on the interpretation of European legislation.
'The best example of this is the Freshwater Fish Directive, which is designed to give better protection to rivers from the effects of intermittent discharges, ' says Ofwat chief engineer Dr Bill Emery.
This could involve construction of large tanks to store storm water so it can be released slowly, after heavy rain.
'Yorkshire Water said to build huge stormwater tanks would cost in the region of £200M. We need to ask [ministers] if delivery of this scheme is worthwhile. Is there a way to do this where companies could maybe get 80% of the benefit for 20% of the cost?' says Emery.
As it stands the environmental quality programme will cost £5.1bn to carry out. This could swell to £7.1bn by the time spending figures are confirmed in December, if new projects materialise as a result of European legislation like the Water Framework Directive and the Habitats Directive.
But it is highly unlikely that projects arising from new legislation will appear before the final determinations in December.
As a result, water companies will have to find the cash to do the work outside what will be recouped from water prices, before clawing the money back in the next review, in 2009.
Ofwat believes meeting the supply and demand balance, which includes connecting in new properties and developments, should cost £2.1bn. Water companies think it should cost £3.3bn.
'We have challenged companies to demonstrate that their plans represent the optimal way to maintain the balance between supply and demand for their customers. We have also scrutinised companies' work on individual elements of the supply-demand balance, ' says Ofwat's draft determinations report.
Operating efficiently has become a prerequisite for water companies and the industry has repeatedly stated that in this respect all the obvious improvements have been made since privatisation in the 1990s.
As businesses, the water companies are more efficient than ever but between 2005 and 2010 the regulator sees scope for further annual improvements of 3% across the industry.
'There is still some way to go to optimise productivity, ' says Emery.
He says he has not had a consistent message from the water companies that they are at the frontiers of efficiency and that there is still some way to go before they have all optimised productivity.
Contractors, consultants and materials producers will no doubt feel the pinch if more money is shaved off project costs.
'Contractors and suppliers will move into other utilities if the water companies squeeze them too hard, ' says Paul Mullord , director of industry body British Water.
Water companies must respond to Ofwat's draft determinations by 13 September. This will be their last opportunity to try and justify billions of pounds of spending before Ofwat takes it away from them.