Water companies risk ‘significantly underestimating’ PR24 supply chain costs

Water company spending plans for 2025-2030 could rise even further than the current £100 billion estimate because of unrealistic expectations of supply chain costs.

This is the view of leading analyst Colm Gibson, who has questioned how Ofwat will tackle the deliverability of PR24 plans in its draft determinations on 12 June.

Thames Water’s update on cost projections for the next asset management period (AMP) earlier this week took the sector’s total spending ask to just over £100 billion. This is up from just under £96 billion requested across the draft business plans published in October and almost double the £51 billion Ofwat approved in its PR19 final determinations.

However, Gibson, who is managing director of BRG, warned that the bills could rise even higher because of the real-world challenges of delivering the work costed out in the business plans.

He said: “In addition to the material increase in their own demand for supply chain resources, water companies will face significant competition from other industries and the government’s infrastructure programme over the same period.”

He added: “This could have a material inflationary effect, resulting in the historic cost trends underestimating the actual supply chain costs by a significant margin.

“It’s not clear how Ofwat intends to deal with this at PR24.”

In an interview with Utility Week earlier this month, Ofwat’s price control director Chris Walters acknowledged the deliverability challenge facing the sector in PR24, describing the plans as “a step change of investment paradigm by any definition”. He added: “It’s not only the most of any period in Britain, but more than any in Europe, so the idea that it comes without deliverability challenges is, frankly, for the birds.”

While deliverability could push total spending for PR24 even higher, there are already concerns about how affordable the currently projected bill rises will be. Rates are anticipated to be up to 60% higher for consumers in some regions, according to the updates to plans published over recent weeks.

Last week economist Dieter Helm wrote a paper outlining the challenges of pushing through bill increases in such turbulent times.

Helm said the issue is two-fold: what consumers should reasonably be expected to pay after a company has not adequately invested in its infrastructure, and what is a reasonable price to pay for water.

He said a move to smart metering would curb demand and costs to consumers and to make infrastructure costs “socially determined”.

He advocated for capital maintenance to be treated as an operating cost, which would make the investment programme “pay-as-you-go”, or  based upon borrowing for future customers to pay.

“As the capital maintenance takes time to catch up on the serious shortfalls that regulators have allowed to accumulate, there is a time period for adjustment. The so-called capital programme becomes a programme for capital maintenance.”

Taking no action to re-value the price of water and ensure consumers pay accordingly for the product and its delivery, Helm argued, was not sustainable either politically or environmentally.

“Carrying on as at present will see Ofwat do battle with the companies, and the environment will get caught between a rock and a hard place. The rock will be the pressure to hold bills down; the hard place is the expectations of improved water and river quality. It is unsustainable, and therefore it will not be sustained. The status quo means that everyone eventually loses: the companies may gradually collapse further, as their social licence to operate comes under further pressure.

“There will be more demands for nationalisation, which will make it even harder to raise bills to the right levels. Nationalisation will probably make matters considerably worse, as the treasury financial constraints determine the fate of the water industry. The companies will lose. The environment will lose, as it so evidently already is.”

If problems worsen, it will cost billpayers more to clean up the worsening environment relative to dealing with it now, Helm argued.

Although politically unpopular, Helm concluded that it would be “poisonous” to not act.

“Kicking the can down the road can only make matters worse. This is true for the current crisis at Thames Water, and it is also true for the other utilities as well. Don’t waste the crisis which Thames has highlighted.”