Ofwat and the water industry face something of a perfect storm at a time when trust in the water industry, and to a lesser extent the regulator, has been eroded. At the same time, the industry is facing its 2024 price review, potentially the most important intervention by Ofwat for a generation.

The demands, and indeed the justified need, for a significant increase in investment in the water environment feature in the media most days. Of special concern is the antiquated system of storm sewer overflows. 

The drought this summer is only the latest sign of the deficit in water resources which must be tackled as climate changes impacts on the south and east of the country.  

The case for investing in the long term is set out clearly in Defra’s strategic policy statement and Ofwat have published their new requirements to understand how industry will deliver their long-term strategies. 

The cost of living crisis will mean water bills will rise next April, and pressure is mounting for further help for customers in vulnerable situations. The Ukraine war, Covid-19 and Brexit have led to major issues around supply chains, with very large inflation in steel and concrete costs. And the Covid pandemic, coupled with demography and long NHS waiting lists has increased the extent of non-financial vulnerability: including through deteriorating mental and physical health. 

Inauspicious backdrop

For the previous four price reviews, over 20 years, the falling cost of capital (and until 2019 increased gearing) has effectively given water firms a ‘get our of jail free card’. But that is all changing and as borrowing costs go up, investment becomes more expensive.

All these factors amount to an inauspicious backdrop to the 2024 price review and Ofwat has in its draft methodology statement acknowledged a number of the above factors, which is welcome. 

As an organisation it is definitely among the more competent regulators we deal with. But in our view it is rather too evolutionary: there are things which need a more radical approach and where this is needed requires some serious strategic thinking. Thinking is not as joined up as it could be: particularly between the new long term strategies and the detail of economic regulation such as ‘baseline total expenditure’.

Our views on the statement were set out in our recent response to Ofwat’s consultation. Our key points are: 

• We welcome the improved joint working with Defra and the Environment Agency and hope that this will be extended to cross-sectoral regulators, going beyond the current activity of the UK Regulators Network, where there are interdependencies between water and other sectors and shared challenges. 
• The relative paucity of information on how Ofwat will approach trade-offs reflects, at least in part Defra’s Strategic Policy Statement. However, how any trade-offs - in particular inter-temporal trade-offs - are drawn will be critical. We would strongly urge Ofwat not to push decisions back to PR29 and beyond, unless fully justified. And to establish a fuller methodology for making these trade-offs. In our view it is Ofwat’s role to ensure that outcomes on resilience, environment etc. are delivered in practice as stated in the best-value fashion, not to set outcomes/funding in line with a desired freeze in headline bills despite the current economic climate. 
• The draft methodology statement and the long-term delivery strategies are not fully consistent. Effective adaptive planning requires a step change in funding for monitoring/telemetry/data interrogation; we can’t see how this fits with the draft methodology. It also requires a more nuanced approach to capital maintenance than Ofwat allows. 
• We can see two possible approaches to the aquatic environment and wastewater more widely: one is to concentrate on spending that directly benefits water consumers; the other is to ensure that water company spending can take into account multiple benefits and thereby leverage and work with other funding streams on water resources, catchment management, flood defence and land management. While tempting, we feel that a simple adherence to the first approach would continue the current ‘less that the sum of the parts’ (while this is not by any means Ofwat’s sole responsibility, the messages and incentives given by Ofwat will be critical). 
• None of the escalating cost of living, the legacy of Covid (direct and through the NHS crisis) including a sharp increase in non-financial vulnerability, and supply chain dislocation are properly covered in the methodology. Nor has the regulator considered the perfect storm of non-financial vulnerability approaching, which an increasingly aging and disabled population, a growth in single person households coupled with more extreme climate scenarios, and technological change which will create opportunities and challenges for many. 
• The (techy but important!) approach to direct procurement is overly simplistic. More thought is needed about what if any flexibilities may be needed as global supply chains continue to change rapidly to avoid unintended increases in unit costs.
• It would be a mistake to imagine that we have seen the last ‘disruptive shocks’. The past three years have seen: a major pandemic; a big shock to cost of living; the worst drought for many years; a number of issues related to Brexit; the war in Ukraine, and disruption to global supply chains. We need to build in flexibility and resilience to adjust to further shocks (including climate-related shocks, which we expect to accelerate).
• We are encouraged to see Ofwat’s evolving approach to operational and financial resilience including its ambition to get a more complete view of asset health. And we support its continued focus on performance related pay and dividends, though Ofwat could do more to understand customers views on fairness in this area. A greater focus is needed on community and customer resilience, and resilience generally.
• The draft methodology statement shows Ofwat is in danger of not walking the talk on its minimum high-quality engagement standards. In particular there is an absence of civil society voices on the selection and development of the common performance commitments. Ofwat needs to (and needs to be seen to) proactively reach out to these groups, in particular environmental groups and activists and locally-focused delivery bodies who have been so successful in bringing environmental issues on water to the fore, and engage them in the development of the methodology.