Ofwat has advised the water sector its 2019 price review, PR19 is a “prime opportunity” for companies to “drive up efficiency and productivity”.
The regulator said by doing so, water firms will be able to deliver the “kind of services” customers will expect in the future.
David Black, senior director at Ofwat told water companies at a recent workshop that innovation and productivity growth is “at the heart” of the current debate on the legitimacy of the sector.
He said: “When we started on the Water 2020 journey, we talked about value creation (or how we grow the pie) and value allocation (how the pie is sliced between customers, investors and other stakeholders) – and that we saw the 2019 price review having a major role in both value creation and allocation.”
Black explained the scrutiny the sector has been under in recent months has often focused on value allocation, in particular around whether “equity investors are benefiting at the expense of customers”.
“There will always be a debate about sharing benefits in the sector – it is entirely reasonable for stakeholders to raise these issues,” he said.
Describing the move to a “totex and outcomes” framework in PR14 as a “fundamental shift” in the regulatory regime, Black said it provides companies “with significantly more flexibility” to make sure they are delivering the right schemes to meet customer needs and to innovate.
“The combination of focus on customers, outcomes and totex means huge scope for productivity gains in the sector,” he said.
Black also told companies: “It is clear that the totex and outcomes framework can deliver even more in the next control period than the current period.”
He added: “Water companies have a strong interest in demonstrating that they can stretch to deliver and that business plans reflect company aspirations to deliver more, deliver better and deliver more efficiently.”
The workshop was also presented with the results of an analysis conducted by KPMG and Aqua Consultants on behalf of Ofwat, to look at how totex and outcomes are helping companies become more efficient.
The analysis reveals where companies use totex and outcomes to take alternative approaches, they typically save a third on costs compared to more traditional methods.
Looking to the next price review, evidence suggests water companies could cut costs by between 5 per cent and 17 per cent by the end of the next control period, Ofwat said.
Black also referred to the Frontier Economics report produced for Water UK in November last year, which showed productivity in the water sector saw a 64 per cent improvement between 1994 and 2017.
While it highlighted “strong productivity gains” in the sector since privatisation, it also suggested there had been a slow-down in productivity growth over the last decade.
Black said some water companies have already been demonstrating “great examples” of using the flexibility “to innovate, do things differently and improve efficiency and outcomes.”
Water companies have until 29 March to comment on the results of the KPMG and Aqua Consultants analysis.