Utility Week

UTILITY Week 13th May 2016

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18 | 13TH - 19TH MAY 2016 | UTILITY WEEK Operations & Assets Market view I t is just over a year ago that the water industry followed a path blazed by the energy sector when the regulator-man- dated shi to totex came into play. AMP6 has seen the removal of the capi- tal expenditure (capex) and operational expenditure (opex) pots of money, with one single cash allocation taking its place. It is hoped this shi – alongside the move to outcomes based regulation – will help to encourage innovation, which will in turn help to lower costs to the companies, and ultimately consumers. The leap from AMP5 and the capex-opex regime to AMP6 and the totex regime has not however led to an instant rise in innovation in the sector – as we discovered in research last year, this is in part because many middle managers in the sector do not acknowledge a link between the two and, more broadly there is considerable uncertainty about how to embrace the new framework for better, more innovative investment planning. Help may be found by looking to the energy sector – which first saw totex come into play in 2010 in the electricity distribution network' price control DPCR5, and once again in the RIIO ED1 and RIIO GD1 price controls in April 2013 and April 2014 respectively. Because this sector has been working with totex for longer, some of what Hydro International UK sales and marketing manager Keith Hayward calls the "considerable inertia among middle manag- ers" in water companies has disappeared and there is shared understanding at both senior and middle management about the role totex can play supporting long term and innovative thinking. Back in the water sector and Tim Cooper, partner, advisory at Arcadis, says this is not, so far, the case and adds that "it will be clearly beneficial for Ofwat to look at clear incentives" for innovation, above and beyond relying on the totex regime to act as a spur to investment in non-conventional solutions to infrastructure and operational challenges. Ofgem has already gone down this path – initially with the Low Carbon Networks Fund (LCNF) and then following this up with the Network Innovation Competition (NIC) and Network Innova- tion Allowance (NIA), which pro- vide funding for the research, devel- opment and dem- onstration of new technologies, oper- ating and commer- cial arrangements. These schemes have led to a number of innovation pro- jects and trials going ahead oen with totex related benefits – i.e. the ability to avoid grid reinforcement (capital expenditure) while achieving better total operational and finan- cial efficiency through the implementation of smart techniques – such as active network management. The NIC awarded a total of £62.8 million to innovation projects in November last year, with £22.8 million going to National Grid. Ofgem has said the projects which ben- efit from its innovation funding will help to deliver "long term value for money" for consumers – also a clear intention behind the introduction of the totex model which, according to Northern Gas Networks' opera- tions manager for construction services Richard Hynes-Cooper goes "hand in hand with the 'I' in RIIO (Revenue=Incentives+ Innovation+Outputs). This said, there's no doubt that it's the availability of funding that has been the main driver for a recent uptick in innova- tion activity in the energy sector, rather that the move towards totex. Should there come a time when this funding is withdrawn – it was originally introduced as a time-limited measure – it would be interesting to see the extent to which totex-thinking continued to drive smart, long term solutions to network challenges. For the meantime however, the two are increasingly seen by energy companies as logical companions in an overall environ- ment of significant change for utilities. Is totex working? The move to totex was intended to herald a new dawn of innovation in the utilities sector – but has it? Utility Week assesses the impact of totex on energy and water companies. "A status quo mindset in the face of new challenges could lead to missed opportunities for efficiency and outperformance and is not in the spirit of the PR14." Arcadis view on business as usual "Innovation within any industry is critical for growth." Liam Naidoo, counsel, Hogan Lovells

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