Utility Week

UTILITY WEEK | 21ST - 27TH JUNE 2019 | 23 Operations & Assets ity issues with farmers and other local stakeholders at source, before they get to the treatment works. The focus on outcomes has been supported by regulatory incen- tives – outcome delivery incentives (ODIs) have been par- ticularly effective in the water sector. But this is just the start. Delegates suggested that although totex thinking has been applied to the current asset base, the real challenge will come in the next regu- latory cycles. What impact will AMP7 and RIIO2 have on utilities' approach to totex? The new regulatory regimes for water companies and energy networks are putting unprecedented pressure on utilities to deliver more for less. "Totex thinking is going to have to come more to frui- tion [under AMP7]," noted one water company delegate. He added that under the current regime, companies have "driven efficiency a‰er efficiency" and there isn't the headroom to continue making savings in this way. Thus, a true step change, embracing the potential of disruptive technology to really do things differently, will be required. "Totex thinking has got to go to the next level," he said. "As you get disruptive technologies that actually work, that will give us a mechanism for not building unsustain- able chemical treatment plants, or whatever it might be." However, totex may not be as embedded in the new regulatory regimes as it might be. Delegates cited a spe- cific issue with PR19, where enhancement schemes have been assessed on the basis of capital expenditure only, without allowances being given for operational costs – an issue that has been raised with Ofwat and is expected to be addressed in the forthcoming dra‰ determinations. What challenges do utilities face in embracing totex? While the economic regulators Ofgem and Ofwat have led the drive for totex thinking, utilities businesses are still operating in a framework that is not entirely sympathetic. Accounting rules in particular remain a challenge. For example, in the energy networks industry, the shi‰ towards smart grids and the distribution system operator (DSO) model, whereby energy generation and demand is balanced at a local level, is driving the introduction of much more monitoring and control on the system. This drives up the operational cost of running the grid – as does the extra staff needed to manage and act on the data generated. Under current accounting rules, capital expenditure such as that on a new asset is depreciated – discounted from the balance sheet over a number of years – whereas operational expenditure comes straight off the annual profit. Moreover, even where costs such as new technol- ogy systems or refreshes are classified as capital expend- iture, they are depreciated over much shorter periods of time than traditional long-life assets, making them less attractive from an accounting point of view. As one delegate said: "While we're in a totex environ- ment, in terms of your profit and loss you've still got to keep your overheads down." Water companies face a further, unique, challenge S even years ago, totex was the big- gest buzzword in the business – this was before "innovation" was on everyone's lips, and long before most people had even heard of today's Labour leader, Jeremy Corbyn, with his headline- grabbing policy to renationalise the nation's energy and water companies. As the water and network industries pre- pared for PR14 and RIIO1, the introduc- tion – or extension – of totex in the regu- latory system was big news, with utilities keen to explore the approach but o‰en worried about their ability to deliver. Fast forward to today, and we don't hear so much about totex. There could be two reasons for this change. Could it be that utilities have fully embraced totex, realised its benefits, and embedded it so deeply in their culture that they no longer need to talk about it? Or could it be that the "totex" box has, on the surface, been ticked, and utilities have moved on to newer buzzwords? This was the question I put to dele- gates at Utility Week and Costain's recent roundtable on "totex and transforma- tion". The answer was unexpected – and in fact, challenged the grounds of the question itself. Rather than a binary approach – totex or not totex – it seems that the indus- try has moved on to a point where the question of totex has been absorbed in the much bigger issue of whole-systems planning. That is to say, it's no longer just about whether to build a new asset or come up with another solution; rather, it's a question of looking holistically at the infrastructure system, cross-vector, and determining the best solution. It's a complicated picture, throwing up questions about who will govern a multi-vector system, and whose role it is to drive it forward. While government is struggling with the current Brexit- induced leadership vacuum, delegates name-checked the increasingly influen- tial National Infrastructure Commission, chaired by Sir John Armitt, as having both the nous and the political clout to come up with the right solution. With the commission currently investigating regu- lation in utilities, watch this space. EB View from the chair: Totex, or not totex? continued overleaf "As you get disruptive technologies that actually work, that will give us a mechanism for not building unsustainable chemical treatment plants, or whatever it might be." "While we're in a totex environment, in terms of your profit and loss you've still got to keep your overheads down." Brought to you in association with

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