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Letters to Managing Directors
MD 212 2 February 2006 ASSET MANAGEMENT PLANNING TO MAINTAIN SERVICEABILITY Following the 1999 periodic review we challenged companies to produce economic appraisals of the options for maintaining serviceability to customers. We set down our thinking in MD161 in April 2000, and we continue to endorse the principles set out in that letter. Subsequently the capital maintenance planning common framework was developed through United Kingdom Water Industry Research (UKWIR), with the participation of regulators and the industry. This provided an agreed framework, and set of approaches, for long-term asset management planning. Significant progress was made by the industry in applying these principles during the 2004 periodic review. The common framework also informed our process for assessing and challenging companies' asset management plans. Following our final determination in 2004, a review of the application of the common framework by the industry, and its use in assessment by the regulator was initiated, again through UKWIR with broad support and participation. This review has now been completed, and with UKWIR's permission, a summary is appended to this letter. We see this as an influential piece of work in developing the industry's long-term asset management. This letter sets out our initial thinking in the light of this review. It is clearly for the Water Services Regulation Authority (WSRA) to develop and consult on policy for the next periodic review. At this stage, however, we think it is appropriate to set out our current thinking on some issues raised by the UKWIR review. We believe that this will assist you in developing your business planning processes, including those for the 2009 periodic review. Further development of the common framework The UKWIR review indicates broad support for the use of the common framework, and for its further development. For our part we expect companies to continue to develop their application of economic, forward looking, risk-based analysis in their asset management planning, through application of the principles and methodologies such as those set out in the common framework. We expect that companies will progress initiatives to improve the quality of the data on which their planning is based, and the analytical approaches adopted. The review recommends that companies apply common framework principles in their business decision making, as well as for forecasting expenditure for regulatory purposes. It also suggests greater integration with wider corporate objectives. We believe that companies will be best placed to deliver value for customers by ensuring that their ongoing asset management systems are informed by economic, risk-based analysis. The common framework should not be seen purely or mainly as a tool to inform regulatory submissions, rather a set of principles and techniques to inform business decisions and planning. This idea of integration with 'business as usual' was reflected in the assessment criteria we used in the 2004 periodic review. Companies who were able to demonstrate that their corporate systems and business planning were informed by economic principles, such as those set out in the common framework, achieved higher assessments. The consultants have identified a number of 'additional success factors'. In particular we note those relating to integrating the analysis and selection of interventions across asset types; across enhancement and maintenance; and between operational and capital interventions. Companies should be able to demonstrate that economic and risk based principles, such as those reflected in the common framework, inform all asset management planning whether for investments to enhance service or to maintain serviceability. Serviceability outputs The UKWIR review also contains recommendations for the development of our approach to assessing capital maintenance requirements. The review suggests that we should consider discontinuing the standard adjustments to past levels of expenditure, to allow for the restoration of stable serviceability (as part of 'stage A' of the 4 stage process we used in 2004). In particular, the consultants point to the potential for a perverse incentive on companies against the efficient targeting of capital maintenance expenditure, by rewarding poor performers with extra revenue. This is in line with our own concerns, and we believe that the common framework should provide a clearer basis for serviceability judgements to inform future capital maintenance planning. Achieving stable serviceability is a required regulatory output for all companies by the due dates set out in their determinations, prior to the 2009 periodic review. The 2004 final determination provided financing for a 22% real increase in the level of capital maintenance, compared with the 1999 review. We have established financial mechanisms at periodic reviews to take account of any failures to deliver regulatory outputs. Where companies are unable to demonstrate that they have delivered stable serviceability according to the timetable set out in their determinations, our starting presumption will be a shortfall in service delivery. The shortfall process ensures that customers are not required to pay for outputs that have not been delivered by companies. To date this has most commonly been applied for quality enhancement outputs, but it can be applied equally where companies fail to deliver stable serviceability. It will be for the WSRA to develop the methodology for the 2009 periodic review. However, we are clear that our processes should not offer financial advantage to companies that fail to deliver regulatory outputs. Assessing capital maintenance requirements The UKWIR review suggested that we consider placing more emphasis on the quality of the company's forward-looking analysis (or 'stage B' in our 4 stage process as applied in 2004). This would reduce the relative importance of a company's 'typical' or historic level of expenditure in determining the outcome. We concur with this recommendation, which was also highlighted by our consultants (Mott Macdonald) in their review of our capital maintenance assessment process, published in September 2004. This will guide our developing thinking, and the options we consult on this year, prior to the WSRA's formal consultation on the framework and methodology for the 2009 periodic review. We intend that typical levels of past expenditure will be subject to a more searching challenge. Ofwat's capital maintenance team concluded a series of meetings with companies last year to provide in-depth feedback on our assessment and scoring of their 2004 capital maintenance plans. This has provided each company with detailed guidance on the improvements we think they need to progress. We have been encouraged by much of what we have heard from companies, and the priority that this work appears to be receiving. Capital and operating expenditure The UKWIR review also suggests that some companies are concerned that Ofwat's methods do not favour balanced consideration of capital and operating expenditure. On this point MD161 is clear that companies should appraise how to maintain stable serviceability at least cost in terms of both capital maintenance and operating expenditure. Similar issues were also raised at the November 2005 stakeholder workshop on our sustainable development duty. We wish to understand your views on these issues. You could progress this most usefully by providing specific and material examples describing where and how you believe our processes may inhibit the balanced appraisal sought in MD161. You should send these detailed examples to George Day, Head of Capital Maintenance, (george.day@ofwat.gsi.gov.uk) and we will review how to take this forward. Future consultation We intend to develop our thinking on the staged process that we use to assess economic levels of capital maintenance necessary to deliver serviceability to customers, in the light of the UKWIR review's full set of recommendations. We intend to seek views on some initial thinking this spring, to help inform the WSRA as it takes the agenda forward thereafter. In the meantime, I urge you not to delay action to meet the challenges raised in our feedback to you, and in the UKWIR review of the common framework. Much further work is needed to develop the quality of your data and analysis so that you are able to demonstrate a clear understanding of the economic level of capital maintenance expenditure in your business plans for 2009. PHILIP FLETCHER (1) Independent Assessment of Ofwat PR04 Process to Draft Determination, Mott Macdonald, September 2004. Available at http://www.ofwat.gov.uk/aptrix/ofwat/publish.nsf/AttachmentsByTitle/mott_dd_report060904.pdf/$FILE/mott_dd_report060904.pdf MD 212: Asset management planning to maintain serviceability - Annex (Word - 40Kb)  |
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