Days 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.
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 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 non-attributable 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.”
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 – 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 management 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 difficult conversations with investors ahead. But, as one said: “Investors are pragmatic. They understand the process and recognise the political environment.”
Taking the fast track
Ofwat has introduced the carrot of “enhanced” status for those companies that have fully justified their business plans, meaning they will be fast-tracked through the process. How has this incentive affected companies’ approach? The water company representatives certainly felt it was a prize worth fighting for, if only because it would reduce the massive amount of work entailed by the review, freeing management time to get on with the job of delivery. “With 90 per cent of the plan in place, you can just get on with it and run the business,” said one. There was less clarity about the potential financial benefits of being fast-tracked.
Several delegates believed that the prospect of enhanced status has introduced a greater degree of competitive tension between the companies, which was seen as a good thing.
Above board
One area where Ofwat is seeking significant changes is in the role of water company boards. The regulator believes some boards are too big, or too dominated by investor representatives. It also believes that in some cases they have been too remote from the running of the organisation. It has sought to address this by publishing a new set of guidelines on corporate governance, and insisting that boards sign off on the business plan. This has had a “big impact,” according to delegates. Most companies were fairly positive about the changes, particularly about the higher profile now being taken by non-executive directors within the organisation, and with customers. One said: “This is by far the greatest leadership and engagement with the process the board has ever had.”
Future gazing
There is life after PR14, and water companies and regulator alike need to look forward to the middle years of the cycle, and indeed to the next price review. Delegates thought the most significant change in day-to-day working would be the greater role of customer engagement, and were looking at various ways of continuing this. With the
focus on affordability, there were concerns that research and development budgets, already squeezed, would suffer – and this would have serious consequences going
into PR19.
In summary, delegates were positive about PR14 and optimistic about the new ways of working it has bought to the sector. Questions remain around totex, enhanced status and the continuing role of customer engagement – the next few months will be crucial.