Ofwat has issued draft guidance for water companies conducting competitive tenders for high-value infrastructure projects during the next asset management period.
In line with its draft methodology for PR24, the regulator said direct procurement for customers (DPC) process should be used by water companies as default for all projects worth more than £200 million.
Introduced at PR19, the DPC approach involves companies putting large infrastructure schemes out to competitive tender to find low cost solutions, with a third-party designing, building, financing, operating and maintaining the infrastructure or asset.
The model has been used for the Thames Tideway sewer project, United Utilities’ Haweswater aqueduct resilience project is also designed to follow the same framework.
Ofwat said it favours the model as a way to “promote innovation and resilience by allowing new participants to bring fresh ideas and approaches to the delivery of key schemes”.
Water companies are currently expected to merely consider DPC as an option for discrete projects with a lifetime totex of more than £100 million.
For the next asset management period covering 2025 to 2030, companies will be required to use DPC by default for all projects with a lifetime totex of more than £200 million, although Ofgem will retain the option to allow companies to deliver projects themselves if it is in the best interests of consumers. The DPC process could also be used for lower value schemes at its discretion.
The regulator said the licence conditions for five companies have already been modified to establish the regulation of DPC and it intends to similarly amend licences for other companies expected to deliver DPC schemes during the period.
Changes include introducing a bespoke DPC interim determination to cover unforeseen changes or the termination of the procurement agreements.
According to the draft guidance, Ofwat intends to streamline the DPC process to reduce time and costs for all parties, whilst also expanding the incentives for water companies delivering DPC projects. The regulator said its experience of DPC projects to date suggest the current incentives are “not sufficient”.
Ofwat said the new “focused package” of incentives will seek to provide a balance between incentives and risks, whilst offering “flexibility and simplicity.”
These could include cost-sharing mechanisms to control costs allocated to the water company; allowing the company to keep a share of the incremental value of a scheme after completion; and outcome delivery incentives such as penalties for delays.
When assessing value for money, Ofwat said its decisions must be consistent and based on a fair comparison between DPC and in-house options.
For in-house counterfactuals, financing costs will be based on the weighted average cost of capital (WACC) set by the regulator and informed by the wider price review. For DPC options, companies will be required to justify their debt and equity cost assumptions.
The consultation period for the draft guidance runs to 7 October.