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Letters to Managing Directors
MD190 18 March 2004 Dear Managing Directors FURTHER GUIDANCE TO COMPANIES FOR FINAL BUSINESS PLANS INTRODUCTION I set out in March 2003 the methodology(1) I intended to follow for the coming price review. In October 2003 I published a summary of the companies' draft business plans(2) and the issues arising from them. The purpose of this letter is to set out our revised timetable following publication of the principal guidance and to provide some further guidance to companies before they complete their final business plans in April. This further guidance covers the cost of capital and financeability, infrastructure renewals charges, taxation, uncertainties, tariff differentials and the overall performance assessment. I will write to you next week with my final conclusions on incentive mechanisms. For completeness I also attach as an annex to this letter a complete list of all our periodic review related publications since the issue of our last substantive review publication in October 2003. TIMETABLE FOR THE REVIEW The principal guidance from Ministers was finally published on 11 March. We realise this has made it difficult for some companies to comply with our timetable for submission of final business plans on 7 April. We have now agreed revised submission dates with companies and we can confirm that all final business plans should be with us by the end of April and public summaries issued early in May. This has had a knock on effect on our timetable but because companies need to know their final price limits for 2005-06 before seeking approval of tariffs we have tried to minimise changes to the dates for draft and final determinations. Our revised timetable is set out in the table below.
THE COST OF CAPITAL AND FINANCEABILITY Our approach and methodology for the cost of capital and financeability have been established for some time and we do not propose to make any changes of principle. This letter explains our current thinking on the issue, which we shall take into account in reaching provisional conclusions in draft price limits. Our approach to setting price limits should create conditions under which additional investment could come from debt or equity. Shareholders must be able to earn a return on both existing and new investment, which takes account of the risks of the business as a whole. Returns should provide shareholders with sufficient incentives to provide additional funds, either in the form of retained earnings or new equity injections, to enable companies to make additional investment where this is appropriate. Efficient companies should also be able to retain stable credit quality going forward. Assessing the cost of capital It is apparent that applying the capital asset pricing model (CAPM) framework on its own could produce a very wide range of estimates for the cost of capital. This arises principally because of an extended period of volatility in the capital markets and the impact of it on some of the components underlying CAPM, particularly the risk free rate and beta factors. For example, currently observed beta factors for the listed water companies are around 0.3 – a significant decline since the last review. This decline is likely to reflect wider market influences rather than a fundamental change in the business risk faced by the water companies. Another component of CAPM, the equity risk premium, has always been difficult to measure with any precision. These uncertainties mean that direct market data might not give a reliable view on the forward cost of capital and reinforces the point that we have made in previous publications that we cannot rely in isolation on the output of CAPM. We will need to assess a wide range of evidence in order to make a judgement on the cost of capital, including that from other models, from market valuations and from talking to investors. As we noted in our paper in October 2003, this evidence is suggesting that the return required by equity investors may have risen since 1999. On the cost of debt both the current risk free rate and debt spreads for the water companies remain at historically very low levels. This might point to the possibility of assuming a very low cost of debt within the cost of capital going forward. However, it is vital that companies can continue to access the markets through the whole of the next price limit period and probably beyond in order that they can deliver the continuing investment programmes required of them. We continue to believe that there is more risk that the cost of debt will rise over the period 2005-10 than of it remaining unchanged or falling. We will therefore adopt a cautious view towards current market data on the cost of debt in our cost of capital assumption. By taking this approach, we will also avoid the need to make any allowance for embedded debt other than in exceptional circumstances. Taking all of the above into account, we continue to believe that there is no strong case for setting the basic cost of capital at a level lower than at the last review. We have said that this would mean a cost of capital of 5.0% on a post tax basis before any small company premium. But this level should not be interpreted as the starting point for a higher final position. Our final view will depend on a clear understanding of the financing requirements faced by the companies, including the implications of the principal guidance that has now been published by Ministers. We will set out our assessment of the cost of capital in our draft and final determinations. Small company premium There is very little evidence that investors differentiate between the water and sewerage companies in terms of required returns. Therefore, we would require further convincing before allowing a size premium for the smaller water and sewerage companies. However, we believe there remains a case for allowing a small premium to the cost of capital for most or all of the water only companies. The 'small company effect' can be analysed in terms of three broad components:
Quantification of the effect is difficult. At the 1999 review we allowed a premium to the post tax cost of capital of 0.75% for most water only companies (the three largest had a lower premium of 0.4%). There is little evidence to suggest that the required small company premium has increased since the last review. Indeed there is evidence that the debt component (both the interest rate premium and transaction costs) has decreased. This is in part due to developments in the sector enabling the smaller companies to gain greater access to a variety of debt sources including the European Investment Bank and the bond markets. With regard to the latter there is no clear evidence that the cost of debt incurred by the water only companies is significantly higher than that incurred by the water and sewerage companies. In contrast a premium on the cost of equity remains valid, principally to address the fact that there is a less liquid market in the water only companies' shares. We have raised the possibility that given the diversity in the size of water only companies (there is a factor of more than ten between the largest and smallest water only companies) there may be a case for greater differentiation between companies in the size of the premium than at the 1999 review. In progressing this issue we have found evidence that the premium varies with size, but it is difficult to quantify the precise relationship of costs to company size. We are keen to avoid incidence effects in making such differentiation. Logically on the basis of the regulatory capital values forecast in the companies' preferred strategies, the water only companies fall into four size bands. We propose to move forward on this basis. These bandings are set out below.
In addition to the size-dependant financing costs identified above, some of the water only companies have argued that they are subject to a greater risk profile because of a relatively low regulatory capital value compared to the scale of their operations. We will continue to set an industry wide cost of capital that is sufficient to allow companies to finance their functions given the risk of the sector as a whole. We do not think that any move toward company specific costs of capital is appropriate. Financial ratios The price limits will be set with a view to enabling the companies to continue to be able to raise the finance in the capital markets necessary to undertake their investment programmes. We set out a package of indicators to be used in the review in our March 2003 methodology paper. The scope of ratios considered by individual companies in the draft business plans submitted in August 2003 tended to be narrower than this package, with different ratios being important to different companies. Historic cost interest cover remains the focus for some companies because of existing covenant arrangements. However, looking forward the focus of credit rating agencies is on the cash based financial ratios and the net debt: regulatory capital value measure of gearing. For example FitchRatings(3) points to the importance of the post maintenance expenditure cash interest cover, the net debt to regulatory capital value ratio and a dividend payout ratio as being important in rating the water companies. In a recently published research note, Moody's(4) Investor Services explains that its analysis uses an array of cashflow coverage and dynamic leverage ratios but that the two important indicators are adjusted cash interest cover and the debt to regulatory capital value ratio. The Moody's paper also sets out the level of these ratios that would be consistent, in its view, with a credit rating in the "A" range. In assessing the financeability of the price limit package, we will focus on cashflow based measures, in particular cash interest cover, adjusted cash interest cover, the retained cashflow to debt ratio and gearing (net debt: regulatory capital value). In addition we will model dividends consistent with our cost of capital assumptions in respect to gearing and the cost of equity. If shareholders are assumed to provide additional funds for required investment, either in the form of retained earnings or equity injections, we will take account of the need for a reasonable level of dividends on these additional funds. This approach could also mitigate the impact of investment on the cashflow financial indicators. We do not have a prescriptive view of the credit ratings that companies should maintain. That is for the markets and companies' management to determine. But it is important that water companies are seen as good credit quality. In assessing financeability we will look at the level and trend of these ratios to ensure that a company's overall financial profile remains robust so that efficient companies can continue to finance their functions and retain stable credit quality going forward. We still have some work to do with the rating agencies, investors and other commentators before reaching conclusions on the levels for these ratios consistent with a credit rating comfortably within the investment grade category. At the 1999 review we assumed higher levels for the water only companies on the critical financial indicators. To support this, the water only companies have argued that some of the business and financial risks assessed when determining credit quality may be more accentuated for smaller water companies than for the larger companies. There is evidence from recent transactions that the tests for water only companies may be slightly higher than for the water and sewerage companies for an equivalent rating. However, some of the arguments presented in the case for the small company premium on the cost of capital for water only companies, in particular higher credit risk, appear to overlap with the arguments for higher ratio tests. We will need to be sure that we are not double counting credit risk factors before concluding on the small company premium and on the level of ratios for the water only companies. PROFILE OF PRICE LIMITS The profile of price limits (and hence the profile of bills) is an important issue for customers. In economic terms, price limits and the changes in bills should respond to the changes in costs faced by the companies. Consequently if changes in costs occur in the first year (or are first recognised in price limits in that year) then this would point to a larger rise in the first year. If costs build up more evenly, then this would point to consistent rises in price limits each year. The draft business plans proposed by the companies presented three general profiles
Most companies adopted the first profile. A smoothed or phased change in price limits and bills would mean that bills would be higher at the end of the five year period compared with a more front ended loaded profile. For example, the overall industry average from the draft business plans showed an increase in the first year of 13% followed by increases of 4% in the remaining years. This would result in an overall increase in average household bills of around 30% over the five years. If this profile was fully smoothed, the overall increase in bills by 2009-10 would be more like 37% - an increase of 7% due to smoothing. In the recent joint survey of customers, a majority of customers expressed a preference for any price rises to be smoothed over the five year period. However, those surveyed were not told that this would mean higher bills at the end of the period. From the companies' perspective, a profile for which price limits (and bills) followed the changes in costs would achieve a stable level of returns in each of the five years. Everything else being equal, a smoothed profile of price limits would give lower than average returns in the earlier years but higher than average returns in the later years. One important issue is the view which providers of finance and the credit rating agencies would take on the certainty of returns implicit in the five year price limits. They need to assess whether this provides adequate reassurance in relation to divergences in returns between years within the five year period. We wait to see what companies propose in their final business plans. METHODOLOGY FOR CALCULATING INFRASTRUCTURE RENEWALS CHARGES In the March 2003 methodology paper, we confirmed that we would continue to use a 15 year average of infrastructure renewals expenditure (IRE) for the period 2000 to 2015 to calculate the infrastructure renewals charge (IRC). Under renewals accounting the IRC should reflect the assessment of the long term capital maintenance requirements for a company's underground assets. In setting price limits we use a 15 year average of IRE as a proxy for this. Only one company commented on our proposed use of a 15 year average in response to our consultation on the methodology for the 2004 review(5). However, in their draft business plans, around half of the companies used a different basis of calculation. They said this was because, where there is a stepped change in IRE in 2005-06, our 15 year methodology does not fund all of the IRE for the period 2005-10 on a pound for pound basis but instead creates a prepayment which is carried forward. A number of companies also raised this with us in their strategic meetings in January and February this year. For the 2004 review we intend to retain our 15 year basis of calculation. We accept that where there is a stepped change in IRE in the 2005-10 period this may create a prepayment. However, the size of this prepayment will depend upon the size of any change in IRE. Any differences between the IRC we allow and our projection of IRE (i.e. any prepayment) are remunerated through the regulatory capital value at the cost of capital. Companies do not therefore remain 'unfunded' for this element of their expenditure. To the extent that any prepayment we project in our forecasts crystallises during the period to 2010, we will take account of this at the next review in 2009 either through an increase in the IRC or through the regulatory capital value. TAXATION In the October 2003 paper we highlighted two changes to corporation tax, which could impact upon customers' bills. The first change is related to changes in the way in which the Inland Revenue treats certain types of expenditure for tax purposes. This would bring the treatment of water companies into line with that of other companies. This change is due to take effect from April 2005, resulting in a stepped increase in tax payable in 2005-06. We have therefore asked companies to reflect the impact of this change in the projections of price limits in their final business plans. The second change relates to a possible change in accounting standards (FRED 29) which could change the way in which water companies will have to account for their expenditure to replace and renew their underground networks of assets. Because of the move by the Inland Revenue to align the tax treatment of certain types of expenditure with their accounting treatment, this change could have a knock-on effect on the timing of the deductions for tax purposes for infrastructure renewals expenditure. We have asked companies to reflect this change in their final business plans if they think it will have a material impact on customers' bills. However, we believe there is considerable lack of clarity around whether the change will happen, what exactly that change will be and the consequential impact on the behaviour of companies and the implications this would have for companies' tax bills. An alternative approach would be to allow a notified item for this issue. However, we believe that there are practical difficulties around drafting a workable notified item to deal effectively with the consequences of this particular change. These two factors mean that, at present, there would need to be a very strong case to reflect anything in price limits either directly or through a notified item. However, if companies want us to consider further the use of a notified item, they should signal this in their final plans, quantify the likely impact and provide a robust justification of their assumptions. This should include proposals for a workable draft of the notified item itself for us to consider. PRICE INDICES We will continue to set price limits using the Retail Price Index (RPI) as set out in the Licence. We will also monitor charge increases over the 2005-10 period using the RPI + K constraint. We will need to consider whether to change from the RPI to the Consumer Price Index (the new measure recently adopted by Government) for subsequent reviews. We will consult on this following the 2004 review. We had assumed that the projection of the average trend for capital maintenance would be indexed using the RPI. Following discussion with companies we accept that when assessing the typical level of current capital maintenance expenditure it may be appropriate to use the construction price index (COPI). Each company should explain its assumptions in its final business plan. ODOUR To date we have considered management of odour to be an integral element of a company's functions and carried out as a matter of course consistent with its established policy. As a minimum we expect companies' established policies to provide for the operation and maintenance of routine odour control measures and good housekeeping. Odour control measures should take site-specific circumstances into account. We have written to companies setting out how they should treat odour issues in their final business plans. I attach as annex 2 to this letter the guidance sent to companies. TARIFF DIFFERENTIAL Companies will be aware of the changes to our approach on the measured / unmeasured household tariff differential, which were set out in RD02/04. We expect all companies to achieve their tariff differential targets under the revised method by 2006-07. This will have a significant impact on tariff action plans and therefore on forecasts of revenue required for the final business plans. RD02/04 contained detailed guidance (and a spreadsheet template) on how to calculate tariff differential targets for the purpose of final business plans. Where tariff action plans do not follow this guidance, we will make appropriate adjustments which could have a material impact on price limits. UNCERTAINITY We confirm that our general approach to uncertainty remains unchanged from the March 2003 methodology paper. Our consultation on Licence modifications(6) proposes a change to the calculation of materiality for standard interim determinations and substantial effect clause claims. We have considered companies' and Water UK proposals for notified items at the review. For the purpose of compiling final business plans, companies should assume that there will be two notified items relating to:
We are aware of the current consultation by the Environment Agency on future abstraction charges. At this point it is difficult to predict how abstraction charges will change. We are considering the possibility of a notified item in this area to allow for a subsequent change relating to compensation payments. In your final business plans we expect you to set out clearly the assumptions you make about future movements in abstraction charges. Following discussions at our strategic meetings in January / February companies may also wish to propose notified items in respect of power costs. Our approach to the uncertainty relating to changes in taxation is set out elsewhere in this letter. Where companies believe further notified items are required they should make a case for these. CHANGE PROTOCOL We are developing the change protocol, which sets out how we deal with changes to requirements placed on companies between reviews. We intend to consult with companies and others on this in May and to include a draft of the protocol with our draft determinations. OVERALL PERFORMANCE ADJUSTMENT In previous publications we have said that we will make graduated price adjustments, depending on the range of performance. We wish to avoid making artificial distinctions between companies. In recent meetings and in their responses to our recent consultation on the overall performance assessment (OPA) companies have sought clarification. We are confirming that we do expect to make some OPA adjustments to price limits at this review. We are still considering the fairest way to do this. However, in the light of comments made in the consultation on the OPA, we will not be making separate adjustments to water and sewerage turnovers as we proposed in our consultation. A summary of the responses to the recent consultation and our conclusions will be published in the next few weeks. PHILIP FLETCHER (1) 'Setting water and sewerage price limits for 2005-10: Framework and approach' 27 March 2003 (2) 'Setting water and sewerage price limits for 2005-10: Overview of companies' draft business plans' 16 October 2003 (3) UK Water Sector – FAQ: FitchRatings – January 2004 (4) UK Water Industry Sector Update: Encouraging signs for Regulatory Review but outcome remains uncertain: Moody's Investors Service – December 2003 (5) Setting price limits for 2005-10: Framework and Approach' 15 October 2002 (6) See MD189 'Proposed licence modifications consultations' 3 March 2004. Annex 1 2004 periodic review publications – since 16 October 2003 Efficiency and incentives RD 41/03: Further work on the potential scope for future efficiency – 18 December 2003 A letter to regulatory directors of water and sewerage companies asking for their views on the two scope for efficiency studies commissioned by Ofwat. PR04: Scope for efficiency improvement - uncertainties and measurement issues Report commissioned by Ofwat from Europe Economics – 18 December 2003 A study by Europe Economics considering measurement issues that are common to all studies of efficiency. PR04: Scope for efficiency improvement - final report to Ofwat Report commissioned by Ofwat from London Economics, Black & Veatch Consulting and Professor Maurice F Shutler – 18 December 2003 A comprehensive study on the possible scope for future efficiency, taking both a top down and component based analysis of future prospects. This study takes account of arguments made by companies' in their draft business plans. Environment programme MD 188: Water price 2005-10 - advice to inform the principal guidance on scale and timing of further quality enhancements - 19 December 2003 Letter sent to companies along with a copy of the public advice sent to Ministers. Advice to inform the principal guidance on scale and timing of further quality enhancements: open letter to Ministers – 19 December 2003 Letter from the Director General of Ofwat setting out his views of the potential improvements and their costs and benefits listed in the initial guidance from the Secretary of State and his views on the way forward. Cyngor I hysbysur prif ganllawiau ar raddfa ac amseru gwelliannau ansawdd pellach (Advice to inform the principal guidance on scale and timing of further quality enhancements) – 6 February 2004 Letter from the Director General of Ofwat setting out his views of the potential improvements and their costs and benefits listed in the initial guidance from the Minister for environment, planning and countryside and his views on the way forward. Early start programme RD 42/03: PR04 – Early start initiative: capital works to be completed by March 2007 – 23 December 2003 Summary of decisions made by Ofwat on companies' applications for capital works projects to include in our early start initiative. Licence modifications MD189/04: Proposed PR04 licence modification consultation – 3 March 2004 Customer Research Customer research 2003: periodic review - national report. Final report Research study conducted for Defra, Welsh Assembly Government, Ofwat, WaterVoice, Water UK, Environment Agency, Drinking Water Inspectorate, English Nature, Wildlife and Countryside Link by MVA in association with WRc – 16 December 2003 Customer research 2003: periodic review - company results. Final report Research study conducted for Defra, Welsh Assembly Government, Ofwat, WaterVoice, Water UK, Environment Agency, Drinking Water Inspectorate, English Nature, Wildlife and Countryside Link by MVA in association with WRc – 16 December 2003 Joint statement Responses to – setting water and sewerage price limits – a joint statement – 4 February 2004 Summary of responses to the joint statement showing individual and organisational views on environmental improvements and increases in bills. Business plans External review of the reporters' audit of water company draft business plans – summer 2003. Report commissioned by Ofwat from Babtie – 9 January 2004 Babties' conclusions on the review of reporters' work for the draft business plan. Information requirements PR04 business plan reporting requirements - working draft – 28 November 2003 PR04 business plan reporting requirements - 16 January 2004 A working draft of the business plan reporting requirements enabling companies to view changes made to the draft business plan reporting requirements for the final business plan. RD 40/03: Consultation – AMP4 monitoring plan information requirements – 18 December 2003 AMP4 monitoring plan for 2005-10: company strategy for 2005-2010 - its commitments on drinking water quality, environmental improvements, services to customers, maintaining serviceability to customers and prices – 18 December 2003 Consultation seeking the views on the proposed format, data requirements and the range and scope of the information for the AMP 4 monitoring plan. Aquarius 3 – Ofwat's financial model Aquarius 3 and the information capture system for final business plans: letters to RDs – 12 November 2003 Letter outlining the changes we intend to make to Aquarius 3 and why. It also sets out the timetable for issuing the revised model, the information capture system and the business plan reporting requirements. Aquarius 3: input guide instructions – 17 December 2003 Input guide to assist with the inputting of data into the input sheet of the Aquarius 3 financial model. Aquarius 3: pre-audit version 5.1 – 17 December 2003 Aquarius 3: pre-audit version – letter to RDs – 17 December 2003 Aquarius 3: pre-audit version – letter to RDs – 22 December 2003 Aquarius 3: financial model rule book appendix B: Financial model inputs – January 2004 version – 16 January 2004 Aquarius 3: financial model rule book, January 2004 version – A technical paper – 16 January 2004 Aquarius 3: input guide version 5.2 – 16 January 2004 Aquarius 3: financial model – final business plan version – letter to RD's 16 January 2004 Aquarius 3: input guide version 5.2 – Issue 2 – 23 January 2004 Aquarius 3 user manual: January 2004 version – 29 January 2004 User manual to provide guidance on the use of the Aquarius 3 financial model Aquarius 3: input guide version 5.3 – issue 1 – 25 February 2004 Aquarius 3: input guide version 5.3 – issue 2 – 3 March 2004 Aquarius 3: input guide version 5.4 – 9 March 2004 Aquarius 3: financial model rule book appendix C: Definitions manual February 2004 version, 5.3 – 26 February 2004 Aquarius 3: financial model rule book appendix B: Definitions manual – March 2004 version, issue 5.4 – 9 March 2004 Aquarius 3: user manual: March 2004 version, 12 March 2004 Other publications Investigation into the costs of sewer flooding alleviation schemes. Report commissioned by Ofwat from Babtie – 18 November 2003 Updating the overall performance assessment (OPA) – a consultation – 10 December 2003 Consultation paper looking at longer term OPA issues. The paper sets out possible updates to the OPA and the way in which OPA might be used during 2004-09. Structure of the water industry in England: does it remain fit for purpose? Joint Defra and Ofwat study – 8 December 2003 This study looked into the reasons for and the implications of recent trends in the pattern of ownership and financing of water and sewerage operators and their ability to meet the Governments' objectives for this sector. RD 01/04: 2004 Periodic review – External review of reporter's – 9 January 2004 A summary of Babties' conclusions on the review of the reporters' work for the draft business plan. Investigation into evidence for economies of scale in the water and sewerage industry in England and Wales. Report commissioned by Ofwat from Stone and Webster consultants – 15 January 2004 RD 02/04: Measured/unmeasured tariff differential: conclusions – 21 January 2004 Conclusions from the consultation on some proposed changes to the measured/unmeasured household tariff differential, explaining how the changes will affect measured/unmeasured bills. It sets out the assumptions we will expect companies' to make about the differential when they complete their final business plans. RD 03/04: Progress on completing the national environment programme 2000-05 – 23 January 2004 Delivering the national environment programme 2000-05- prospects for completion in 2005 – 23 January 2004 Related publications Security of supply, leakage and the efficient use of water: 2002-03 report – 30 October 2003 Water and sewerage unit cost and relative efficiency: 2002-03 report – 22 January 2004 Annex 2 Periodic Review 2004 Guidance to companies on odour control measures for final business plans Later this year Ofwat expects there to be a non-statutory code of practice for managing odour at sewage treatment works. We will expect each sewerage company to develop its policy and strategy for odour management to reflect the practices, processes and technologies recommended in the code. Plans to meet and maintain compliance with the code will form part of the output expectations for each company for AMP4. We require each company to demonstrate why and how its policy for odour management has or will change from AMP3, the consequences of changes in policy and how the company has developed, appraised and adopted the strategy upon which its AMP4 and onward investment proposals are based. To date we have considered management of odour to be an integral element of a company's functions and carried out as a matter of course consistent with its established policy. Companies' established policies should provide for maintaining good operational practice to minimise odour risk (good housekeeping) and the provision, operation and maintenance of routine odour control measures. Odour control measures should take site-specific circumstances into account, both odour generation, control and impact on the surrounding environment. We recognise that companies may be under increasing public pressure to mitigate the impact of odour, and that the forthcoming code may, in some circumstances, require some companies to implement measures that go beyond their established policies and practices. In the absence of the code, we expect each company's business plan to be based on policies, practices and actions to reflect the following generally accepted principles:
Each company should explain its past strategy for the management of odour at sewage treatment works in its business plan. The company should then set down its assumptions as to the new practices and measures that it intends to follow setting out the extent to which this would result in a change in the level of expenditure relative to that implied by the established strategy. For example, if the attainment of a specific odour unit target at the site boundary or nearest receptor forms part of a company's strategy, then it should state what the target is and what it used to be. The company should justify its assumptions, for example by demonstrating their consistency with principles and practices set down in recognised reference documents such as:
Justification at scheme level should also be provided including information on abatement orders and other legal action, histories of justified complaints (numbers, frequency, seasonal patterns, etc), involvement of environmental health authorities, encroachment of development and planning requirements. The company should also indicate the relative priority of odour control schemes included in its plans and set down the criteria on which priority has been assessed. In addition it should provide detail on how the individual schemes score on each criterion. We expect each company to discuss its approach to prioritisation with its WaterVoice committee and Reporter noting their respective views in its plan. Each company should allocate forecast capital and operating expenditure on odour control to one of four categories: i. capital expenditure for maintaining existing odour control measures at existing sewage treatment assets and replacing them at the end of their working life is to be allocated to maintenance non-infrastructure. Use cost driver code CM01 when populating the sewerage quality and other projects (C5-2) database. No new, first time odour control facilities on existing treatment facilities are to be included in this category. ii. capital expenditure for maintaining existing odour control measures at existing sewage treatment assets and replacing them at the end of their working life where upgrading is considered necessary to align with the future code and/or new company odour control objectives is to be allocated to maintenance non-infrastructure. Use cost driver code CM01 when populating the sewerage quality and other projects (C5-2) database. This category includes all new odour control facilities on existing treatment facilities. iii. capital and operating expenditure on the provision of odour control measures in line with companies' established policies on new or enhanced sewage treatment assets required under the NEP is to be allocated to quality enhancements. Use the 'parent' cost driver code of the obligation necessitating the enhancement when populating the sewerage quality and other projects (C5-2) database. iv. capital and operating expenditure on the provision of odour control measures on new or enhanced sewage treatment assets and which is in excess of that implied by companies' established policies is to be allocated to quality enhancements. Use cost driver code A20 when populating the sewerage quality and other projects (C5-2) database. In their business plans companies should provide separate commentaries explaining the proposed expenditure in each of the categories above. Ofwat recognises the difficulties surrounding the selection of a reliable output measure to monitor the effectiveness of company investment, for example numbers of complaints can be very misleading. We therefore propose that for capital works exceeding £250k on an individual site a company is monitored against an activity, eg the installation of specified measures, rather than an 'effect' based measure such as a reduction in the number of complaints. A number of sites with capital works less than £250k may be combined into general odour control schemes. This would overcome the difficulties of objectively and directly measuring odour management improvements and establishing with certainty whether a target has been met. Accordingly the company should set out in its business plan details of the physical outputs and other activities included in its plans. These should be project based and allocated to the appropriate driver code in the sewerage quality and other projects (C5-2) database, as indicated above. The prioritisation and justification for the individual projects should be included in the commentary to the relevant section of the final business plan and Reporters should comment on the appropriateness of the case.  |
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