Ofwat has published a discussion paper exploring options to introduce further competition for strategic investment in the English water sector, including the removal of regulatory barriers.
Ofwat has published a discussion paper exploring options to introduce further competition for strategic investment in the English water sector, including the removal of regulatory barriers.
Writing in an open letter in January 2022 to the chief executives of Ofcom, Ofgem and Ofwat to set out the Government's strategic priorities for the utilities sectors, Secretary of State for Business, Energy and Industrial Strategy Kwasi Kwarteng asked Ofwat to undertake a high-level stocktake to identify both opportunities and barriers to unlocking more competition in strategic investment.
Introducing the report Competition in strategic investment: a high-level stocktake, Ofwat said:
“We believe that there is an important opportunity for competition to unlock further strategic investment in the water sector, primarily to support the delivery of major infrastructure in water and wastewater.”
The report provides information on ongoing work to unlock further competition in the water sector, identifies barriers which may limit the potential benefits and sets out recommendations for ways in which the barriers might be removed.
Ofwat’s draft methodology for the PR24 price review says that major projects will be classified as projects with whole-life total expenditure (totex) in the region of £200 million upward. The regulator said that putting these major infrastructure projects out to competitive tender, for a third party
to design, build, finance, and/or operate and maintain can deliver better value for customers.
To date Ofwat has introduced two competitive delivery models to the sector :
SIPR - a licensed model under Part 2A of the Water Industry Act 1991 and the Specified Infrastructure Project (English Undertakers) Regulations 2013
DPC - Direct Procurement for Customers contracting model
Via the DPC model, which uses a contractual approach between the incumbent water company and a competitively appointed provider, Ofwat continues to directly regulate the water company for the delivery of the project, rather than licensing and directly regulating the competitively appointed provider as under the SIPR model.
The paper describes the DPCmodel as “still in its nascent stage” with three pathfinder projects:
- United Utilities' Haweswater Aqueduct Resilience Programme: a very large project to replace parts of United Utilities' 100km Haweswater Aqueduct which brings drinking water to Cumbria, Lancashire and Greater Manchester.
- Dŵr Cymru Welsh Water Cwm Taf Water Treatment Works: a new, large water treatment works to serve c. 1.4 million people in Wales. Currently Dŵr Cymru is developing this on a design-build-finance only basis.
- Southern Water's Hampshire Water Transfer and Water Recycling scheme: a new water transfer from the planned Havant Thicket Winter Storage Reservoir and a water recycling scheme to ensure supplies to Southern Water's Hampshire region and enable it to meet 1 in 500-year droughts.
Based on the current pathfinder projects, Ofwat estimates that delivering projects via DPC could deliver benefits for customers of “between 6% and 40% of totex associated with delivery and operation over the lifetime of the asset.”
Ofwat also believes that another way in which competition can lower costs is through the process of price reveal. Under the normal price review process, the regulator sets efficient allowances for companies to deliver services to customers, including the delivery of new assets.
“However, this can be challenging due to information asymmetry between Ofwat and companies. It is particularly difficult for large projects where there are few robust benchmarks as similar projects may not have been delivered in recent memory or in some cases since privatisation” the paper says.
In Ofwat’s view competitive delivery models overcome this issue, as under these models customers benefit upfront from market tested finance and delivery costs through the procurement process, described as price reveal benefits.
According to Ofwat, price reveal can also provide wider benefits for the regulatory regime by providing greater transparency on the costs of delivery and financing that can be used to inform the price review process.
The paper states:
“By growing our evidence base in this way, we will have a better sense of the efficient costs of company spending proposals, allowing us to make sure customers only pay for what's necessary.”
Competition can help deliver major infrastructure more quickly and effectively
As well as delivering solutions at better cost, the paper says competition can also help to deliver major infrastructure more quickly, than might otherwise be the case if delivered in house, and with reduced impact on the incumbent water company which has competing priorities and incentives to manage across its business.
Ofwat says that while incumbent water companies already competitively procure the capital delivery of infrastructure projects, these are traditionally limited to "design and build" competitions where “the incentives on the contractor are more heavily focussed on reducing capital delivery costs through value engineering rather than considering whole-life costs.”
Under a competitive delivery model such as DPC or SIPR, the regulator suggests that this could provide greater opportunity for innovation and may support the increased use of nature-based solutions to meet the water company's requirements.
In addition, Ofwat also foresees that a competitive delivery model may open up opportunities for a broader, more varied investor base and access to new sources of green finance which cannot be accessed through traditional funding models.
Recommendations in the report include:
- a need to consider how water quality regulations could be applied to a competitively appointed provider via an amendment to the Water Industry Act 1991
- the possibility to provide for direct regulation of competitively appointed providers in respect of drinking water quality obligations
Next steps
The regulator sums up by saying that while progress has been made in using competition as a driver for strategic investment in major infrastructure, it sees “untapped potential to make further gains.”
Looking forward, Ofwat plans to monitor the outputs and outcomes associated with increased competition with a view to unlocking further strategic investment across the water sector.
However, while achieving greater levels of competition is an intended deliverable output, Ofwat cautions:
“Our longer-term outcomes and success metrics for these schemes relate to our overall objectives for the sector concerning securing better value for money for customers, improved environmental and social outcomes and ensuring that companies are resilient in the long term.”
“….we recognise the challenges in identifying evidence that demonstrates cause and effect in this context. In addition, there are further challenges such as that some benefits, e.g. environmental benefits, may not be realised until several years in the future.”
Click here to download Competition in strategic investment: a high-level stocktake
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