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Letters to Regulatory Directors
RD 21/07 12 December 2007 Dear Regulatory DirectorRelative efficiency assessment 2006-07 As we set out in our letter of 2 October 2007, we are reporting this year's relative efficiency assessments in a different way. The results of the assessment for 2006-07 are summarised in this letter. The supporting information, which includes our methodology and the data needed to re-create the results, can be found on our website. This year, we have used the same methodology for calculating relative operating expenditure efficiency as in previous years. For capital maintenance expenditure efficiency we have used broadly the same methodology, but have used a seven-year average period. Our econometric models have been recalibrated with average expenditure data over the period 2000-01 to 2006-07. Water relative efficiency assessment Table 1 shows the results of the water relative efficiency analysis. For water operating expenditure, the most efficient company, also known as the frontier, is Portsmouth. Wessex is ranked second, and Yorkshire is ranked third. We have used Yorkshire as the benchmark company for our operating efficiency assessment. Yorkshire was also the benchmark for water operating expenditure in our 2005-06 assessment. Portsmouth is assessed as more efficient than Yorkshire, but it is too small to be used as a benchmark company on its own. Wessex is ranked second; however, this year the company has made an adjustment to its water operating costs to take account of the additional costs of its customer supply pipe repair policy. Although the accounting treatment is consistent with our accounting guidelines, we are not convinced that all companies are making similar adjustments. Because of this, we have decided not to use Wessex as the benchmark company this year. We will review the treatment of these costs and will clarify the 2008 June return guidance, if necessary, to make sure that any analysis carried out for the 2009 price review will be based on consistent data. For water capital maintenance, we have also assessed the most efficient company to be Portsmouth. However we have not used Portsmouth as our benchmark company as it is too small. We have also not been able to use the next most efficient companies Cambridge, Thames and Folkestone & Dover, and instead have used Yorkshire which is ranked fifth. For a company to be a benchmark on capital maintenance, we must be satisfied that it has been investing enough money to maintain its assets. We measure this using serviceability assessments, which we publish in our annual 'Financial performance and expenditure' report. Thames and Cambridge appear to be more efficient than Yorkshire in our assessment, but both have less than stable serviceability and therefore do not meet our benchmark criteria. Folkestone & Dover is also ahead of Yorkshire in the rankings, but is too small to be our benchmark. In 2005-06, Northumbrian, which was ranked thirteenth, was the benchmark company for capital maintenance. Yorkshire was ahead of Northumbrian in last year's assessment. However, in previous years we have been reluctant to use a company with a leakage adjustment as the benchmark company. We have reviewed our benchmark criteria this year and are satisfied that the adjustments made for the re-allocation of leakage costs are appropriate. We are therefore content to use a company with a leakage adjustment as a benchmark. This is in line with the approach we take on operating expenditure. Figure 1 contains the same information as table 1, but presented in the form of a matrix that compares operating and capital maintenance efficiency bands. The matrix shows that there are a number of companies that perform well on both water operating expenditure and water capital maintenance expenditure. Anglian, Yorkshire, Bournemouth & West Hampshire, Portsmouth and South Staffordshire all achieve band A for both operating and capital maintenance water efficiency. Table 1 Relative efficiency bands and ranks water service 2006-07  Figure 1 Relative efficiency bands water service 2006-07  Sewerage relative efficiency assessment Table 2 shows the results of the sewerage service relative efficiency analysis. For sewerage operating expenditure, Thames is the frontier company and Wessex is ranked second. In line with our approach in previous years, we have not used Thames as the benchmark since it has a significant special factor adjustment. We have therefore used our second ranked company, Wessex, as the benchmark. Last year, Yorkshire was the benchmark company. This year it is ranked third, although the difference between our assessment of relative efficiency for Yorkshire, Wessex and Thames is small. This year Wessex is the frontier company for our sewerage capital maintenance assessment. However we have not used Wessex as the benchmark company due to its serviceability assessment. This year, we only have two companies eligible to be the sewerage service capital maintenance benchmark, South West, ranked eight, and United Utilities, ranked ninth. This is because, as for the water service assessment, we do not allow a company with deteriorating or marginal serviceability to be a benchmark. In 2006-07, we assessed the serviceability of all companies except South West and United Utilities to be less than stable for infrastructure, non-infrastructure, or both types of assets. A poor serviceability assessment may suggest that a company has not been investing enough money to improve and maintain its assets. This could result in a company appearing efficient when its low costs may be due to a lack of investment in maintaining its assets. We are concerned about the small number of eligible benchmark companies we have had for our 2006-07 sewerage capital maintenance assessment. However, we have asked a number of companies to produce action plans to restore stable serviceability, and we are monitoring them. We expect companies to continue to sustain improvements in performance over time and to regain lost ground in achieving stable serviceability. We believe that this will lead to a larger number of eligible benchmark companies for the sewerage capital maintenance assessment in the future. In 2005-06, we used Wessex, ranked first, as our sewerage service benchmark. This year, its serviceability assessment for sewerage infrastructure has dropped to marginal. We have therefore used South West, ranked eighth, as the sewerage service capital maintenance benchmark. There are seven companies ahead of the benchmark to which we have also given band A status. The only company not to receive a band A for capital maintenance sewerage expenditure is Southern, which is a band C. The company has significantly increased investment to recover from deteriorating serviceability for sewerage non-infrastructure. When Southern's serviceability becomes stable, it will have more opportunity to improve its efficiency ranking. Figure 2 contains the same information as table 2 below, but presented in the form of a matrix comparing operating and capital maintenance efficiency bands. There are a higher number of companies which achieve band A status for both operating and capital maintenance sewerage expenditure than in previous years. These are Anglian, Thames, Wessex and Yorkshire. However, this is in part because of the high number of band A companies for sewerage capital maintenance as a result of our chosen benchmark. Table 2 Relative efficiency bands and ranks － sewerage service 2006-07  Figure 2 Relative efficiency bands － sewerage service 2006-07  Yours sincerely Jonathan Hodgkin Director of Network Regulation Phone: 0121 625 1313  |
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