Utility Week

Uberflip 17 01 14

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Finance & Investment Analysis PR14: the verdict so far At a roundtable organised by Utility Week and EC Harris, senior water sector stakeholders talked about how Ofwat's radical new price review process was shaping up. D ays after the 2 December deadline for the submission of water company business plans, a group of industry leaders joined Utility Week and EC Harris for a roundtable discussion of PR14. With a strong track record in the sector, EC Harris was able to give an independent point of view from a third party non-stakeholder perspective. Relief was palpable in the room as the heads of regulation of five leading water companies reflected on the price review process, and made the most of the opportunity to discuss it with the new Ofwat chief executive Cathryn Ross; Consumer Council for Water chief executive Tony Smith; and the head of policy at Water UK, Rob Wesley. It was a lively and engaging discussion, chaired by Utility Week editor Ellen Bennett, in which the participants acknowledged the scale of change the 2014 price review (PR14) had brought so far. There was consensus that the price review was a "game of two halves", with the full consequences yet to be fully understood. However, participants were generally optimistic about the process, with the introduction of far greater customer engagement seen as one of the main wins. to date "a good start" – but said there was still work to be done. He highlighted the segmentation of customer groups; a sophistication of approach that has yet to reach the water sector. He also mentioned the cost of capital and value for money, saying further work would need to be done – a prescient comment in light of Ofwat's changes to the price review process around risk and reward, announced a week later. The rest of the discussion was held under Chatham House Rule, with comments nonattributable to individuals. First up was the degree of change that PR14 represented. One water company director who had been through two previous price review cycles said this one was "fundamentally different". Another agreed that this was "the biggest culture change since privatisation". One delegate said: "Operations and asset management are now talking to each other, saying if we did this, what would it deliver to customers?" They also spoke about the focus on outcomes rather than inputs, saying this too represented a major cultural shift. One said: "Investment programmes that do not lead to an outcome for customers have been refused." Revolution, not evolution In her opening comments, Ross observed that the nature of the debate had changed since she left the water sector in 2011. She praised the sector's "constructive mindset" when it came to competition, and observed a change in what society and customers wanted from water companies. She questioned what this means for the nature of water companies and the services they offer in the longer term. Water UK's Wesley agreed that the change in methodology for the price review had been followed by a "change in culture". He observed that greater customer engagement had led to greater commitment to the business plans throughout organisations, and gave legitimacy to the sector at a crucial time. CCWater's Smith agreed – he called PR14 Chain reaction Not everyone has yet fully bought into PR14. There were warnings that unless the supply chain was engaged in the new way of working, it could fall down. One delegate said: "The supply chain has to deliver in totex and opex [total expenditure and operating expenditure] – and there is still a misunderstanding of what they really mean." Many suppliers are still driven by a capital expenditure view and are slow to adopt a low cost, no-build solutions approach. Similar resistance to totex exists within some of the companies themselves. As one delegate said: "We're a big company and it will take a while for the culture change to come through." Totex also entails greater business risk for the companies because they will be judged on outcomes and, unlike capital programmes, catchment manage- 18 | 17th - 23rd January 2014 | UTILITY WEEK ment and other such approaches do not have defined outcomes. "If you do a capex solution then the risk is less and the problem has gone away." Delegates agreed that Ofwat could help organisations take risks by making it clear that, under the right circumstances, failure would not be penalised. "People will revert back to a low risk solution if failure is not allowed," warned one. There was widespread agreement that totex is a far more fundamental change than just a new accounting rule. It encourages companies to look beyond cost to the whole life of the asset: "Totex liberates you to look at the best solution." Bills, bills, bills No part of the utilities sector can ignore the affordability agenda, and throughout the PR14 process Ofwat has been clear that it expects companies to keep bills as low as possible. Did Labour leader Ed Miliband's high-profile intervention in the energy market send any water companies back to the drawing board? One company confessed that its plan was changed very late in the day to reflect the affordability focus. Others said that the message had been coming though from customer challenge groups (CCGs) since the beginning. One commented: "We were a good way there already before the political intervention." The focus on keeping costs down necessarily involves squeezing expenditure, and there was some discussion of how lower bills would affect investment in infrastructure. As one delegate pointed out, delaying necessary work to the next regulatory cycle would simply mean that customers would pay higher bills further down the line: "Are savings now genuine, or just a put-back? It's a balancing act." Customer legitimacy is not just about keeping bills down. It was pointed out that customer engagement and corporate governance arrangements can help customers accept less palatable messages on cost. Lower bills mean lower investor returns, and delegates were aware there were some

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