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The Topic: Totex UTILITY WEEK | 11TH - 17TH DECEMBER 2015 | 15 "AMP6 is going to be a real challenge - particularly delivering outcomes and totex." l Cathryn Ross, Chief executive, Ofwat R IIO introduced sweeping changes in 2011 to how price controls were set. However, a previous change we made, putting operational and capital expenditure into one pot instead of setting separate allowances for each, has also made a difference to how networks approach spending. Before the change, companies bore the full cost of additional operating expenditure, but only around a third of the amounts that were capitalised. This created distortions by encouraging companies to find capital expenditure solutions where operational expendi- ture could have been used. They also recorded some expenditure as capital spending, when technically it was not. So Ofgem had to closely police the companies' cost reporting, which was time-consuming for both sides. The 2010-15 electricity distribution price control was the first to tackle this. Using totex, companies have the same incentive to spend either operating or capital expenditure. This corrects some of the distortions. Ofwat has since followed our lead by adopting it for its 2015-20 price controls, and regulators in other coun- tries are considering similar approaches. Using totex has already made an impact. Compa- nies are now considering innovative solutions such as demand-side response or batteries as alternatives to building more capacity. Changes to how the gas distribution networks deliver the gas mains replacement programme in their 2013-21 price control also show how totex encourages innova- tion. The programme is no longer seen purely as capital expenditure asset replacement. Using new technology, networks are making mains inspections online, carrying out remote repairs and employing advanced leakage management. The aim is to repair some mains where possible instead of replacing them. The benefit to cus- tomers is a reduction in costs of around £2 billion over the price control, without any compromises on safety. Finding innovative solutions is so important as the energy sector adapts to the low carbon economy. Elec- tricity networks still need to invest in new connections but they must also find clever ways to operate grids so they can manage changing usage patterns. The totex approach gives them the right incentives to do this and we will keep challenging them to think creatively. Maxine Frerk, senior partner, Smarter Grids & Governance Distribution, Ofgem Regulator view: Totex is a smarter way for energy companies to invest in and run their networks 43% totex will make no difference to how they innovate 54% think totex will make it easier for them to make the case for investment in new technologies 48% said they think totex will lead to better maintenance of water assets TELLING NUMBERS Part of the rationale behind the switch to totex is that it will lead to better value-for- money decisions over the lifetime of an asset. Rather than build- ing something new, alternative solutions will be considered, and innovation pursued to come up with new, more cost efficient solutions. However, an Arcadis and Utility Week report, Water Sector Innovation and Perceptions of Totex, reveals that many operations leaders in the water sector do not recognise a direct link between totex and innovation – although they do see that innovation generally is required in the sector. Almost half of respondents (43 per cent) said they did not expect the introduc- tion of totex to have any impact on the way in which they approach innovation. This is surprising given that the same group of respond- ents overwhelmingly recognised the need to become more focused on outcomes and customer satis- faction – which the introduction of totex by the regulators was designed to support. In place of totex, respondents identified WATER RELUCTANT TO EMBRACE TOTEX AS A PARTNER TO INNOVATION ture, working with non-governmental organisations and local groups, and doing things like catchment manage- ment and widespread community engage- ment on fats, oils and greases or water efficiency, and in different ways to how they have been done previously." The sentiment expressed by water sector operations per- sonnel in this report also stand in contrast to the experience of the gas networks, where totex has been found to be a crucial innovation ally over the past two-and-a- half years. Northern Gas Networks operations manager Richard Hynes-Cooper says the shift to totex, alongside innovation funding allocated by Ofgem, has allowed the GDNs to develop and use innovative solutions to their major challenges. "We can identify where innovation can take technologies to the next level and make them success- ful," he says. "This will help to deliver a better quality of service and reduce costs." Get the full report in the downloads section of utiltyweek.co.uk cost-cutting initiatives and efficiency drives as the means for meeting outcome delivery incen- tives and innovation requirements. Jacob Tompkins, Waterwise managing director and chair of Ofwat's resilience working group, voiced disappointment with this stance. "I would have thought that moving from a capex/ opex system to a totex system would allow you to rethink your systems thinking to do things in a different way – such as using distributed infrastruc-