Ofwat cuts £16bn from water sector plans and introduces new funding model for major projects

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Meanwhile the new environment secretary Steve Reed has commenced reforming the sector to “end the crisis” of pollution.

Draft determinations

Ofwat’s moves come as the regulator publishes its draft determinations on England and Wales’ water companies’ investment plans for the eighth asset management period (AMP8), between 2025 and 2030, as part of its 2024 price review (PR24).

The 16 water companies revealed their draft investment plans for the next regulatory period last October, which were worth a combined £96bn. This rose to £104bn when companies were asked to accommodate climate impacts.

Ofwat has now cut this down to £88bn through “analysis of those plans, removing or reducing costs where expenditure is insufficiently justified, inefficient or for activity for which companies have already been funded; customers will not pay twice”.

Some companies can provide additional evidence to support their proposals to convince Ofwat to allow them back into their investment plans before final determinations are made in December.

Water UK, which counts all of the water and wastewater companies in England and Wales among its members, highlighted that the £16bn reduction is “is the biggest ever cut in investment by Ofwat” and added that “if it doesn’t put this right Ofwat will be repeating the mistakes of the past”.

Ofwat says its interventions have been made for the benefit of the customer, with the average bill for water and wastewater companies increasing by £19 a year over the next five years, whereas it had been £28.80 a year under the proposed plans.

The level of investment required by the water companies is a response to environmental requirements that have been set out through statutory planning processes led by the Environment Agency, Natural Resources Wales and the UK and Welsh governments.

This has led to a £29bn increase in total expenditure required compared to the previous five year period. Ofwat says this is split between a £5bn increase in the core business running costs and £24bn to meet the requirements set by governments and for environmental improvements.

Among the £88bn to be spent between 2025 and 2030 is £35bn investment in new infrastructure and resources – more than triple the £11bn that was invested during AMP7 (2020-2025).

Ofwat acknowledges that the scale of investment will “challenge companies’ capacity to deliver”. The regulator says it is therefore “encouraging that over the past 18 months many companies have strengthened their relationships with key suppliers to enable the step-up in activity that will be needed”. This is something that NCE heard about from numerous companies in its overview of the challenges of stepping up for AMP8.

Ofwat has highlighted that the plans set out in the draft determinations will protect the environment by:

• Reducing the number of spills from storm overflows by 44% (compared with 2021 levels) by spending £10bn and upgrading 2,500 storm overflows; this includes the 21% reduction which Ofwat has required companies to deliver by 2025 at their own expense
• Delivering £1.4bn of investment on storm overflows to be delivered through catchment- and nature-based solutions
• Improving river water quality by investing £6bn including improvements at over 1,500 wastewater treatment works – with around 880 removing more phosphorus
• Introducing eight new performance targets for companies including reducing spills from storm overflows, reducing operational greenhouse gas emissions and improving biodiversity
• Introducing rules so that failure to meet these performance commitment results in an automatic penalty for companies

New delivery model for large and major projects

At PR19 Ofwat introduced a direct procurement for customers (DPC) model which was to be considered for the delivery of infrastructure projects valued at over £100M, considered “large” projects.

The DPC requires companies to put these projects to competitive tender where the infrastructure is discrete and separate from the company’s network, because it is considered that delivery by a third party is likely to offer better value for money for customers. The third-party competitively appointed provider (CAP) is appointed to design, build, finance and in some circumstances operate and/or maintain the infrastructure. The water company enters into the agreement with the CAP to deliver the asset and relevant services. The CAP then recoups its investment through a surcharge on water bills.

In addition to DPC, there is also the specified infrastructure projects regulation (SIPR) model, which is very similar to DPC but allows Ofwat to licence and directly regulate the infrastructure provider. SIPR was used to fund the £4.5bn Thames Tideway Tunnel and Tideway chair Sir Neville Simms recently said that this model was crucial to the project’s success.

Using the DPC or SIPR model has now become mandatory for “major” projects, valued at over £200M. This will ensure best value for money for customers, according to Ofwat.

The full list of major projects to be delivered by either DPC or SIPR is at the bottom of the story.

Thames Water turnaround plan

Thames Water’s precarious financial situation has been well publicised. The UK’s largest water company, which is responsible for £147bn worth of assets, had proposed £19.8bn worth of investment in its AMP8 business plan, but Ofwat has limited this to £16.9bn.

Additionally, around 20% (over £3bn) of this is conditional on the company “demonstrating it is ready and able to effectively deploy investment or that the investment will be effectively and efficiently targeted” according to Ofwat.

The regulator is also imposing a Turnaround Oversight Regime on the company. This includes:

• A requirement to create a delivery action plan to set out the actions Thames Water will take to expand its delivery capacity. The company will have to provide regular progress reports
• A requirement for the company to fully re-evaluate its plans for transformation in order to demonstrate how it will deliver the necessary step change in operational performance
• A requirement for the company to provide a financial resilience plan in response to the draft determinations

Ofwat is also considering the appointment of an independent monitor to report on the company’s progress, including against its transportation plan.

Thames Water said: “Although Ofwat currently categorises our business plan as ‘inadequate,’ this judgment rests on over 20 very specific tests around the scope of information to be provided, and evidence required to depart from Ofwat’s own assumptions.

“Ofwat has made clear it will revisit its view if we provide further evidence to reach a final determination that is, in the round, affordable for customers, deliverable, financeable, as well as investable.  We welcome the opportunity to provide Ofwat with further evidence about the need for the investment we plan to make, our costs and how we will deliver it.”

Mixed reaction – ‘repeating past mistakes’

Reaction to Ofwat’s decisions in its draft determinations has been mixed.

On top of its warning that “Ofwat will be repeating the mistakes of the past”, Water UK said: “As a direct result, more housing will be blocked, the recovery of our rivers will be slower and we will fail to deal with the water shortages we know are coming. Water companies proposed to invest £105 billion because it is the minimum needed to meet the legitimate concerns we’ve heard from the public about our environment and our economy.

“Ofwat is right to want to ensure customers receive value for money and that is why protections are in place to ensure customers only pay for projects that are new, necessary and value for money. But for far too long, Ofwat has failed to be realistic about the levels of investment needed and what it will take to deliver and maintain necessary infrastructure. We cannot allow this pattern to repeat itself. Water companies are ready to invest in an unprecedented overhaul of the country’s water and sewage infrastructure. Ofwat now needs to let them get on with it.”

Future Water Association, which supports businesses in the sector, said the draft determinations “set out the case for a tougher Ofwat” and that “there is clearly a political dimension”.

Future Water Association CEO Paul Horton said it will be discussing the determinations with its members and asking questions such as “is the proposed plan ambitious enough to drive significant improvements in the water sector? Will the allowed spending encourage merely minimum compliance, or will it foster innovation and higher standards? Does the complexity of the water sector necessitate a systems thinking approach and should this be driven by the determinations? In what ways are nature-based solutions integrated into the current plans and strategies?”

Horton also suggested that Ofwat’s usage of spills reduction target as a driver could result in the “wrong solutions in the short term”.

Arcadis, on the other hand, focused on the tripling of infrastructure investment, which it “embraces” according to its director – digital advisory, resilience Suresh Nar.

Nar continued: “AMP8 heralds a new era of capital innovation, environmental resilience, and customer engagement, reinforcing our dedication to the water sector’s progress and future. At Arcadis we have a long standing global heritage in the water sector, and whilst we understand there has been greater scrutiny of the sector, our commitment is steadfast in continuing to support the water sector to deliver to approved AMP8 plans and beyond.”

Sector reform

Meanwhile, the new secretary of state for environment, food and rural affairs Steve Reed has announced initial steps to reforming and “ending the crisis” in the water sector. Reed has met with chief executive of the water companies to impress upon them that they will be answerable for their performance for customers and the environment.

Reed said:

• He has written to Ofwat to ask them to make sure funding for vital infrastructure investment is ringfenced and can only be spent on upgrades benefiting customers and the environment. He also wants Ofwat to ensure that when money for investment is not spent, companies refund customers, with money never allowed to be diverted for bonuses, dividends or salary increases
• Water companies will place customers and the environment at the heart of their objectives. The Secretary of State is clear that he expects companies to change their ‘Articles of Association’ – the rules governing each company – to make the interests of customers and the environment a primary objective
• Consumers will gain new powers to hold water company bosses to account through powerful new customer panels. For the first time in history, customers will have the power to summon board members and hold water executives to account
• Strengthened protection and compensation for households and businesses when their basic water services are affected. Subject to consultation, the amount of compensation customers are legally entitled to when key standards are not met will more than double. The payments will also be triggered by a wider set of circumstances including Boil Water Notices

“We will never look the other way while water companies pump sewage into our rivers, lakes and seas,” Reed said. “This unacceptable destruction of our waterways should never have been allowed, but change has now begun so it can never happen again.

“Today I have announced significant steps to clean up the water industry to cut sewage pollution, protect customers and attract investment to upgrade its crumbling infrastructure.

“That change will take time. Over the coming weeks and months, this Government will outline further steps to reform the water sector and restore our rivers, lakes and seas to good health.”

Water UK chief executive David Henderson said: “We welcome today’s swift action by the Secretary of State. Companies have agreed to his direction that, in addition to turbocharging investment, they put customers and the environment at the core of how they operate.

“We will work with Government to implement these reforms as quickly as possible and deliver our largest-ever investment plan to secure our water supplies, end sewage in rivers and enable economic growth.”

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