During its consultation for PR14, Ofwat proposed that a total expenditure approach to delivering wholesale business plans would address the perceived bias towards capital expenditure, even when operational solutions might be cheaper and better. The regulator’s key motivation is to protect consumer bills and encourage innovation in the delivery of high-value water services.
The perceived capex bias exists because capex benefits companies’ regulated asset value and key financial ratios. In previous AMPs, opex and capex efficiency have been assessed independently, with capex outperformance incentivised through the capital incentive scheme.
Ofwat’s desire is to incentivise companies on a totex menu approach, varying rewards for outperformance against levels of risk appetite.
Working with a number of clients, in preparation for AMP6, has led MWH to identify seven key enablers for a totex-efficient environment:
• Organisational structure – align organisational structures on an end-to-end and geographic basis to enable more effective decision-making and budgetary accountability;
• Business culture – this must be based on a common understanding and sense of purpose. Employees across all directorates and functions must be given a clear vision, understand the imperative and feel empowered to drive totex-efficient operations;
• Supply chain – the supply chain needs to be mutually incentivised to deliver services at lowest totex. Supply chain partners, who traditionally have paid to build assets, need to see how they will be rewarded for optimising existing assets and drive efficiency through long-term investment in innovation;
• Performance data – measuring asset performance and presenting the data in a meaningful way will enable more effective totex decision-making. Moving away from disparate data sets to an enterprise-wide approach will enable a more holistic view, including visualisation of how assets are performing in concert and what needs to be done to minimise risks and service disruption;
• Financial understanding – as with performance data, the ability to measure financial impacts and activity-based costs is essential to balance and trade risk with efficiency. In previous AMPs, companies have established a good understanding of cost base for capex. Companies need to enable a better understanding of opex, at more granular levels, to make totex-effective decisions and establish their ‘cost to serve’;
• Operating philosophy – operating assets will demand a more dynamic mindset. Totex will require a move away from a ‘set-point’ mentality to one that is responsive to changing operating conditions, system demands and sustained asset optimisation. Fundamental to realising totex efficiencies will be improved financial and asset performance data;
• Customer behaviour – encouraging customers to use less water and be mindful of what they flush and dispose of down the sink can lead to lower treatment and asset maintenance costs. Sustained, targeted campaigns to encourage better customer behaviour and awareness of how their actions affect their bills will have a considerable impact on totex efficiency.
One of the greatest challenges of AMP6 will be altering water company mindsets from a focus on asset creation to achieving asset optimisation. The effort required to achieve this change, with companies moving from different maturity points and at different speeds, should not be underestimated.
Ken Gedman, regional lead for the water sector and strategic planning and analysis, MWH Global