RD19/02

TO ALL REGULATORY DIRECTORS OF
WATER AND SEWERAGE COMPANIES
AND WATER ONLY COMPANIES                                                           28 June 2002

Dear Regulatory Directors

RESPONSES TO 'RD05/02 – THE APPROACH TO DEPRECIATION FOR THE PERIODIC REVIEW IN 2004'

In March 2002 we issued a consultation paper 'RD05/02 – The approach to depreciation for the periodic review in 2004'. In the paper we considered the main issues raised about depreciation following the periodic review in 1999 and consulted on possible approaches for the 2004 review.

We sought views on the following issues:

• What is your preferred approach to the assessment of depreciation that should be allowed in price limits?
• Do we need a check and challenge on the overall level of depreciation allowed in price limits?
• Is the comparison of depreciation charges with long term maintenance expenditure a valid basis for the check?
• What are the valid reasons for differences in depreciation charges and maintenance expenditure projections?
• What is your view on our depreciation calculations at the periodic review in 1999?
• Should we continue to use standard lives and standard apportionment of capital expenditure to achieve consistency between companies in our determinations?

In general, the workshop did not raise any additional issues to those raised in the consultation paper. The views expressed at the workshop largely reflected those submitted in the subsequent written responses to the paper.

At the workshop, we agreed to consider whether companies will be required to carry out a revaluation of their assets for the next periodic review. We will set out our conclusions and any further guidance on this particular issue in a separate letter to all regulatory directors early in August.

We want a continuing dialogue with the industry on the issues raised in the consultation paper. Discussions on the depreciation methodology as an ongoing process will help us understand the reasons for any potential 'gap' between CCD and MNI expenditure. We welcome discussions with companies and other interested parties on the issue of depreciation.

As part of our commitment to a more open and transparent process we have visited five of the companies to discuss their fixed asset systems and their approach to MEA revaluations. This has helped us understand company issues, MEA revaluation methodologies and also the interactions between the historic and current cost asset systems. At the workshop we asked if other companies will allow us to arrange similar visits. Five more companies have invited us to visit. We are happy to extend these visits further.

Our proposed approach to depreciation will be set out in the October 2002 paper 'Ofwat's approach to the periodic review 2004' for further consultation. This will build on the responses to RD05/02.

Keith Mason
Director of Regulatory Finance