Wessex Water success

Wessex Water is continuing it’s remarkably good performance. They continues to be the best performing water company. Wessex Water have  topped Ofwat’s new Service Incentive Mechanism (SIM) for all areas of customer service as well as the provision of water and sewerage services. On customer satisfaction 98% of customers who contacted them rated their service as good or very good.

Wessex Water have just released their interim financial results and have continued to perform very strongly out performing their capital and operational allowances by more than any other water company. Wessex Water have also won two environmental performance awards for their work on catchment management and work by GENco on waste reduction and recycling. Wessex Water were the best performing water company in the recently published Carbon Reduction Commitment league tables.

Wessex Water have for most of the time since privatisation been at the top of the league tables. They are very unusual in having had the same Chief Executive, Colin Skellett,  since 1988 and several other of their Directors are  almost as long serving. It’s the view of this blog that this can not be a coincidence and perhaps something other companies should consider emulating. 

Water White Paper

Today sees the release of the long awaited Water White Paper. It starts to address what needs to be done to increase the resilience of our water system and tackle the combined effects of climate change and a rising population.

Its main proposal is to move towards catchment management to tackle the issue of diffuse pollution and abstraction licensing. It recognises that only a quarter of our rivers and lakes are fully functioning ecosystems.

While the general tenor is to be welcomed its disappointing that the White Paper is more about talk than action. The legislation needed to tackle abstraction licensing is not planned to be introduced until the next Parliament. Given the current issues with water supply can we really wait that long?

Does showering really save water?

An interesting study by Unilever that monitored Brit’s showering habits has found that having a shower uses almost as much water as a bath – with power showers using more. It seems that on average we spend 8 minutes at a time in a shower. This would cost the average family of four £416 a year (90% is the energy cost) and 90 000 litres of water.

This may not seem revolutionary but behind the figures are two important learning points. Firstly and surprisingly it seems the Unilver work is the first significant scientific study of showering. The scientists used a shower sensor devise to monitor 2600 showers taken by 100 families. All too often people assume they know what is best, this report challenges the assumption that showering will save significant amounts of water. 

Secondly it highlights the importance of thinking holistically. The saving does not come from reducing water consumption – it makes very little financial difference - but from the huge cost of heating the hot water. Perhaps if people want to save money the advice should be to have a bracing cold shower!

Unilever has also published its research into how to bring about behaviour change. The ‘Five Levers for Change’ Unilver identified are:

             

    Make it understood. Sometimes people don’t know about a behaviour and why they   should do it. This Lever raises awareness and encourages acceptance.

              

        Make it easy. People are likely to take action if it’s easy, but not if it requires extra effort.  This Lever establishes convenience and confidence.

              

        Make it desirable. The new behaviour needs to fit with how people like to think of themselves, and how they like others to think of them.  This Lever is about self and society. 

              

        Make it rewarding. New behaviours need to articulate the tangible benefits that people care about.  This Lever demonstrates the proof and payoff. 

Make it a habit.  Once consumers have changed, it is important to create a strategy to help hold the behaviour in place over time. This Lever is about reinforcing and reminding.  

Water low priority in corporate board rooms

Water management trials behind climate change on the board room agenda, despite significant near term risk and opportunities. The Carbon Disclosure Project (CDP) Water global report has found that 57% of the publically listed organisations that took part in the survey report board level oversight of water issues compared with 94% of global 500 companies that address climate change. 

Over half (59%) of companies surveyed report exposure to water-related risks such as flooding, scarcity, and reputational damage. The majority of these risks are near term: 64% of risks in direct operations and 66% of risks in the supply chain are identified as occurring between now and 2016. Illustrating the urgency of water risk, more than one-third of responding companies (38%) have already experienced water-related business impacts, such as disruption to operations from severe weather events (e.g., flooding) and water shortages.

Underscoring the opportunities associated with effective water management, 63% of respondents say that water presents commercial opportunities, most of which (79%) are near term. The most commonly identified opportunities are associated with cost reductions from increased water efficiency, revenue from new water-related products or services, and improved brand value.

While its encouraging to see that so many companies recognize that water is both an opportunity as well as a risk, we need to see a lot more companies really taking water issues seriously. 

Changing owners in UK water sector

It has been all change in the ownership of Northumbrian Water with UK Water acquiring the company for £2.41 billion. UK Water is a consortium of Hong Kong companies ultimately owned by Li Ka-shing, supposedly Hong Kong’s richest man. Cambridge Water has been sold to South Staffordshire Water and a Canadian Infrastructure fund Capstone Infrastructure has bought a 70% stake in Bristol Water with Agbar, the Suez Environment subsidiary retaining 30%.

It is not hard to see why the water sector is proving so attractive. It offers secure long term investment that is almost risk free and an attractive rate of return of somewhere between 6 and 13%. With the 5 year regulatory cycle investors can be certain of the return until the next periodic review and even then with so much investment linked to the existing asset base and of course with zero risk of demand for water reducing investors can be confident that similar returns will continue. There is not many investments in the current climate that are so safe.

The water industry does need investors given the need to finance the massive capital programmes. But the question has to be asked that if investors continue to be willing to value companies at well above the regulated asset value is the returns set by Ofwat too generous and are customers getting a poor deal?

Valuing water

Water is a precious resource. Its importance is universally recognised. Over recent decades, it has become an increasingly prominent issue. We face a number of new challenges, including a changing and unpredictable climate, population growth in water scarce areas and affordability issues.

“These challenges mean that we have to look carefully at how we use water. We need to value it and manage it responsibly. The problem is that we do not actually have a value for water. The price that customers pay reflects what has been done to get the water to the tap, but not the value of the resource itself. So, we must start valuing water, using a range of tools to reveal that value, including regulation and water trading” This quote from the Ofwat Valuing Water report misses the point. Water only has a value when it is available at the point of use. The water in Lake Windermere has no value. Its only because there is an water main running all the way down to Manchester that it is then valuable to the people of Manchester. It is of precisely no value to people in London as it would be prohibitively expensive to transport it to London from the Lake District. Ofwat need to recognize that the value is not in the water but in the assets used to store, treat and purify the water. The real question is how can these assets be used more effectively? 

The other implicit assumption behind the Ofwat report is that competition is a good thing. Ofwat  show the electricity and gas markets as ones to aspire to. Yet only today the Energy Secretary has called in the big six energy companies as its clear to everyone that the energy market is not working.

Ofwat should forget about competition and focus instead on ensuring there is a regulatory system that is not biased towards capital solutions and one that encourages and rewards innovation. 

Capex bias in the water and sewage sector

Ofwat’s report on Capex bias is an important contribution to the debate. This is a vital issue for three main reasons.

•  The water industry will continue to need massive investment £22bn over AMP5; the financial structure must ensure that this investment can be funded.
•  Water bills are continuing to rise and with the squeeze on household incomes it is even more important that everything is done to minimise costs.
•  Everyone agrees the water sector needs a lot more innovation. It faces some huge challenges from climate change and rising population and if these are to be solved at a cost customers can afford then new innovative solutions will be needed.  Capex bias limits the options open and is a major constraint on innovation.

Ofwat’s paper makes clear there is a capex bias as this quote illustrates: “When we consulted on SuDS, a number of (water) companies considered that the existing regulatory framework incentivises capex rather than opex solutions. So, they thought that they have incentives to build sewers, rather than investigate alternative approaches”.

The bias is even more starkly illustrated by the Abington reservoir inquiry. The Inspector concluded that Thames Water had not adequately investigated the alternative solutions such as demand management. Instead it had favored the highest capital cost solution. The current debate over the Thames Tideway Tunnel is raising this issue up the political agenda.

The water companies can not be criticized for working to ensure the best return for their shareholders. It is the regulatory framework that must change. This is an issue that has been around since privatization 25 years ago. It is time to stop talking and take action. The responsibility clearly lies with the Government and Ofwat. Decisive action is needed from the Ofwat “future price limits project” supported by the water white paper when it is published at the end of this year.    

Private sewer transfer is completed

October 1^st marked the transfer of responsibility for private sewers from householders to water companies. It’s a huge shift that may have unforeseen consequences. For the water companies the increase in responsibility is massive, it adds over 200 000 kilometres of sewers to their network and worse the condition and maintenance history of most of these sewers is not known.

It will certainly increase water bills, initial estimate suggest that costs for the water companies could increase by £200 million and it is likely some will apply for an interim determination. It is certain that household insurance bills will not decrease even though insurance companies will no longer be liable for the cost.

There will be a huge increase in the number of calls to water companies. This could have a significant impact on their SIM ranking. The arrangements for handling the increased workload vary with each water company, some are using their tier 1 contractors to mange the process. Certainly the transfer is to be welcomed and once the new arrangements have settled down it should lead to proactive approach to sewer management rather than the wasteful just fix it mentality that previously existed.  

ITT spins off water business Xylem

It is ironic when all the concern is over high levels of debt that ITT is to split out its water business into a new company called Xylem. It then plans to raise $1.2 billion in debt to pay off the parent company. Xylem’s 2010 revenue was $3.2 billion but most of its income comes from pumps (87%),  brands like Flygt and Lowara.

This financial engineering may make sense to the money markets but the concern has to be whether it diverts attention from its customers and its core business. The water sector is in for a turbulent few years as it can not escape the ramifications of the Euro crisis and drive by Europe and America to reduce debt. This potentially has a big impact on future water investment as funding from the state for water infrastructure projects is bound to get reduced.

Xylem may be insulated to an extent as much of the market for pumps is of course replacement of worn out assets. The concern has to be whether its really healthy for companies like Xylem to have so much debt or will they suffer the same fate as Southern Cross?  

Capex bias in the water sector

Ofwat’s discussion paper on Capex bias clearly outlines the drivers for Capex bias but is silent on what it intends to do. Water companies in their evidence to Ofwat indicated that earning a return on capital is a key driver of Capex bias. This is compounded by the financial ownership structure with many water company boards having performance targets to increase their Regulated Capital Value and hence return to its shareholders.

This was starkly highlighted by BBC Panorama this week (report on water abstraction). The example quoted was Thames Water’s focus on a new £1bn reservoir at Abington. The Public Enquiry early this year comprehensively rejected Thames Water’s proposals and said it had not adequately examined the alternatives.

This is important as innovation is vital to the water industry if it is to meet the challenges ahead. A financial system that rules out operating cost solutions is not in the best interests of the industry or its customers. Lets hope the forthcoming Water Bill and Ofwat in their “future regulation’ review take ‘decisive action’.

Shrinking rivers

Photo: Hobson's Conduit

This year has been unusual yet again. While Scotland may have been deluged many parts of England have had some of the driest weather in 100 years. In Cambridge they have had the driest spring in 98 years. A 400 year old historic watercourse – Hobson’s Conduit – is drying up. Is this just normal variation in weather patterns or are rising population, increasing demand for water and concreting over of countryside equally important causes?

About a quarter of rivers are classified by the Environment Agency as being in danger or “over-abstracted”. The Kennet in Wiltshire is among the worst affected yet over 9.6 bn gallons a year of water are being abstracted. It is perhaps not surprising that the forthcoming water bill is likely to propose increasing the cost of abstraction licences and perhaps make them tradable.

The new planning framework so hotly debated at the moment talks about the need for all new development to be sustainable. Does this mean that it will not be possible for there to be any development in Wiltshire given the perilous state of the Kennet which is clearly not sustainable? Unfortunately the new planning framework does not define sustainable leaving the way open for a lawyer’s paradise.

What is clear is that a holistic approach that really values water and the environment is essential. It is no good just reducing extraction – instead its vital to look at the demand side as well, is 20% leakage really the economic level? Will Metering help? Should building regulations be tightened further to reduce water demand from new properties, should development be restricted in water scarce areas? 

These are not easy questions but the trend is clear low river water flows are an increasing problem and the current position is not sustainable. 

Water bill still on track

Water Minister Richard Benyon confirmed last week that publication of the Governments’ water bill is still on track for December 2011. MPs debated water legislation and flood management in Parliament last week.

The elephant in the room is the rising levels of bad debt in the water industry and increasing concerns over affordability. With the current economic gloom and rising water bills and now the additional cost of transferring private sewers it’s a problem that will only get worse. It is particularly acute in the South West with SWW water having some of the highest water bills but in a relatively poor area.

Changing the structure of the industry and introducing further competition is unlikely to make a significant difference, in deed in the view of this blog restructuring would only make matters worse. Ofwat has just published a report on ‘vertical integration or seperating the companies by discrete function e.g. sales or supply. The conclusion will not come as a surprise to those with long experience in the industry – there is no evidence that either is better.

The water industry needs to focus even more on ensuring it prioritises investment where it will make the biggest difference and delivering schemes as cost effectively as possible. Huge strides have been made on this since privatisation but its clear there is still scope to do better.  Just look at the cost penalty British Water has identified that comes from the 5 year regulatory cycle and loss of experienced people at the end of each AMP period. The forthcoming water white paper is the opportunity to take action and address the elephant in the room.

Adapting to climate change in the water sector

Ofwat’s “adapting to climate change report” is another step forward to ensuring the water industry changes to cope with climate change. It’s a huge challenge for the industry against a backdrop of uncertainty in the science and difficulty in predicting what the impact will be. Will summers really get hotter and dryer as some forecasts suggest – hard to believe given the wet August?

What does seem certain is that there will be more extreme events. The cost implications for the water sector are huge. Just look at the vulnerability of many sewage treatment and water treatment sites to flooding. The big stumbling block is gaining political acceptance for increasing bills to pay for the investment. Certainly in PR09 that was a step too far and now with the more challenging economic climate it is even more difficult.

Ofwat rightly aims to encourage more innovation. Anglian Water’s success so far in meeting its target to half its embodied carbon in the building of new assets shows what can be done when there is a real commitment to act. They are on track to meet the goal and do it within the tight price limits. The passion inherent in the Anglian Water Love Every Drop campaign needs to spread across the industry.

With the dark evenings approaching the books to read are Taleb’s Black Swan (The impact of the highly improbable) and Fooled by Randomness. 

Water sector - August a bad month for investors

August has not been a good month for investors in the water sector. It started with the news that Veolia’s first half results were much worse than expected. Veolia shares are down to about $13.4 from their 2007 peak of $65.65. The London-listed Aqua Resources Fund had to announce its net asset value per share had dropped 8.27% in 6 months.

While no one doubts that demand for water is increasing with the rapid urbanisation of the world, increasing population and threats from climate change. This combined with the rise in environmental regulations and increasing scarcity of water resources will require massive investment. The problem is who pays for the investment?

The current debt crisis means that Western Countries cannot take on ever more debt to fund investment, raising prices is an option for those that charge for water but politically very difficult.  But in many of the countries were the need for investment is highest, there is no history of charging for water.

Introducing water charging is extremely difficult as the Government has found in Northern Ireland. Many countries just don’t have the systems to collect tax let alone establishing water charging when the infrastructure is in a state of disrepair or non-existent. Politically its extremely difficult, not only is it highly unpopular but also it tends to hit the poorest in society hardest, the very people who need clean water and wastewater the most.

Until there is confidence that the funding mechanisms for investment are realistic the water sector is likely to remain an sector with great promise and need but with significant risk for investors. The key is to look at the specifics of each country and to understand the regulatory and political environment in that country. 

Stopping customers using water - a daft idea

Photo source: Thames Water

The article by Thames Water suggesting that ladies should not shave their legs in the shower due to the water in wastes is already starting to backfire if the press comment is anything to go by. Typical reactions are “water companies should sort out their leaks before telling ladies how to shave” or “Thames Water wastes more water in 10 weeks that ladies across the whole of the UK use in shaving their legs in the shower”  

It is inconceivable that Tesco would suggest to its customers they should stop using its supermarket as it was making the shop too busy. Why do water companies think it is acceptable to suggest to their customers they should stop using their product? Customers want water at an affordable price and in the quantities they need. 

When we have just had a very wet August and when water leakage is still running at about 25%, the argument to stop using water will not wash.  Water companies keep stressing they are businesses that need to make a return to reward their shareholders, they also need to recognise that businesses are only successful if they satisfy customer needs.

Commission to investigate Thames Tunnel

Photo source: Hammersmith and Fulham Borough Council Lord Selbourne and Councillors at Commission launch

 An independent commission is to study the case for the massive Thames Tunnel. The tunnel is Thames Water’s preferred solution to reduce sewer discharges into the Thames and avoid EU fines. But it is hitting increasing opposition from local residents, councils and MPs.

The commission will be led by Lord Selbourne. He said: ”The key question is whether this multi – billion pound scheme is the best solution for making the Thames cleaner or whether there are sensible alternatives that are cheaper, greener and less disruptive”. Thames Water’s Chief Executive, Martin Baggs, recently revealed that the sewer’s initial £3.6 billion price tag  - initially costing customers £65 per year for life – was based on 2008 figures and ‘will inevitably increase’. 

The concern has to be that the Water Companies have a strong incentive to favour capital intensive rather than operating cost schemes. One of the reasons for this is that any new capital expenditure increases the Regulated Capital Value of the business and therefore increases returns to shareholders. This is one of the main reasons why investors like Mcquarie bank are able to achieve returns of nearly 12% for their shareholders. Ofwat is looking at the capital cost, operating cost balance and in the view of this blog needs to take action to redress the balance. 

Ofwat review backs slimmer regulation

Photo source: Thames Water - Beckton, Europe's largest treatment works

Defra has published David Gray’s review of Ofwat. The main conclusion is that the regulatory review process has worked well and that there is no need for major change. It does suggest that a lighter, less prescriptive approach is needed back by much clearer guidance from Government on the objectives.

The review has recognised the highly negative impact on the industry of the current 5 year roller coaster of investment and all the unnecessary costs this imposes on the supply chain.  The reviews recommendation to reduce the burden of reporting is to be welcomed.   

The concern is that the current regulatory process encourages capital intensive, end of pipe solutions and does not adequately address the need for the industry to become more sustainable and adapt to the challenges of climate change and population growth. Gray does recognize that currently there is an incentive for water companies to increase their regulatory capital valve and hence return to shareholders and suggests that there needs to be a review by Ofwat of the current rewards and penalties and framework of incentives. There is increasing concern in the industry that some current shareholders are only there for the short term gains – as evidenced by the bid for Northumbrian Water and that some water companies are selling key assets like buildings and then leasing them back – the model that ultimately led to the downfall of Southern Cross.

The industry has some massive challenges – especially the unprecedented growth in population and the uncertainty of climate change. Innovation and sustainable solutions like reuse of water and management of catchments must become the norm – it is disappointing that Gray has not taken this on board. Lets hope that Richard Benyon in the forthcoming water white paper rises to the challenge.    

Private sewer transfer goes ahead

Changes being introduced today (1^st July) by Defra mean that from October responsibility for private sewers will transfer to the water companies. This change has been a long time happening and will remove the uncertainty and risk from householders. For water companies it means a doubling in the length of sewers for which they are responsible and also a massive increase in workload.

The change may have unexpected consequences for the water companies. The condition and repair history of the sewers being transferred is not known. Currently repair work has been done on a short term fix basis with no incentive to solve the underlying long term issues. This is where the real benefit to society lies. Hopefully wasteful repeat visits to repair reoccurring blockages will become a thing of the past. Finding and justifying long term solutions wont be easy given the complete lack of knowledge of the private sewer system and the lack of historic records. There may be significant opportunity for the water companies to reduce repair costs but until a repair history is established this may be hard to justify.

There will certainly be a huge increase the number of calls with customers. Managing this well will be crucial if water companies are not to see their Service Incentive ratings plummet. As yet no one knows what the cost of all this will be. it is likely that some water companies will push for an interim determination and that may bring fresh problems. 

Failed Italian water privatisation

Picture source: Thames Water - long term investment in 1920's

The news that Italians had rejected in a referendum a new law that would have required cost recovery pricing across the Italian water sector and allow privatisation of water operating companies was not a surprise. Turkeys don’t wont for Christmas! But it only puts off a problem that wont go away. Greece is already suffering from a lack of investment in its water infrastructure. Water shortages are becoming more common. They may get a temporary reprieve if as seems likely their economy collapses and demand for water falls. But this only postpones the inevitable need for investment.

This political stalemate over water pricing is common across the world. Close to home it’s the key issue facing Northern Ireland Water as the winter water supply failure starkly highlighted. It means that if long term solutions are so unpalatable to the politicians then crisis management will become the order of the day.  Water tankers, and bowsers will become a regular feature. It will create market opportunities for quick fixes like portable desal plants and may drive up the cost of water. But it will only lead to a more unstable world. Putting off important decisions on water investment will mean that the options open to solve the problem will be more limited and expensive and make the economic situation for Governments worse.   

UK water sector drought - opportunity or threat?

The news this week that parts of the UK were suffering from drought came as no surprise to those living in the south west or east and it was closely followed by the wettest day for months! But one wet day does not change the seriousness of the long run of exceptionally dry weather.

One strand of Thames Water’s strategy to answer water shortages was to construct its  £270m desalination at Beckton. In its first year the controversial Thames Water desalination plant ran for only three days – proving trials only - as there was insufficient demand to justify running this very expensive way of producing water. This must make the water produced some of the most expensive in the world!

It does sharply question whether having highly capital intensive and expensive desalination plant on standby is really the best way to tackle the growing water shortages. Water leakage in London is still around 25% and in some areas much higher still. Investment in replacing the 100 plus year old water network has increased but still the rate of replacement assumes much of the existing old pipework will last another 100 years. Other European countries have shown that achieving leakage rates of 5% is feasible albeit it would require massive investment. Would it not be better to increase investment in pipe replacement if we are to have a sustainable solution? 

Water White paper delayed further

It is disappointing to report that Defra have announced the water white paper has been delayed further. As this blog reported it was delayed to the autumn and has now gone back to December. Having raised expectations for water customers in the South West that their bills would be reduced it is not surprisingly proving difficult to find a resolution to how to have a more equitable charging system.

Black Swans in the water sector

Ever since Nassim Taleb wrote his book, “The Black Swan” the world has been aware of the need to consider low probability but high impact events. This has proved true yet again in the nuclear industry with the Fukushima disaster – a supposedly extremely low probability event and as is now becoming clear with very serious consequences.

The water industry also needs to think carefully about low probability, high impact events. The lessons from Fukushima and the Gulf of Mexico BP oil disaster are clear – it is vital to prepare for the worst. In both cases much could have been done to alleviate the impact if thought had been given in advance about what to do if these low probability events occur. Now belatedly BP and the oil industry are investing in emergency devices to cap a blow out.

With events like cryptosporidium contamination the water industry has already given much though to its emergency plans. But as a report by UKWIR has made clear much more needs to be done. Not only will this make the water industry safer it will also reduce costs as investment and effort is targeted where it makes a difference.  

Innovation priorities in the water sector

Photo: Rainwater harvesting in Botswanna

The innovation working group set up by Defra has published its views on the key areas where innovation is needed in the water sector. The top three are:

• Reducing leakage
•  Adapting infrastructure to climate change
•  Economic regulatory reform to incentivise markets and innovation

It will not come as any surprise that leakage is still one of the biggest challenges the industry faces, especially as more plastic pipework is used in the network. In the view of the blog the biggest issue is actually changing the culture so that innovation is accepted and welcomed.

Tesco, market leaders in a totally different field have a traffic light system for assessing innovation. Within three weeks of an idea being first mooted, it is tried out at the store level, reviewed at area level and if promising it is escalated straight up the line see if it should be rolled out nationally. Contrast this with the one month needed in the water industry just for an idea to be submitted and typically at least 6 months to be assessed.

The water industry needs to learn from other sectors. Rapid assessment and feedback on new ideas is vital and just as importantly suppliers need to have confidence they will be properly rewarded – otherwise they will turn to more attractive business sectors like oil and gas.  

Adapting to climate change in the water industry

Photograph source: Thames Water

The government has today published the water company’s plans to adapt to climate change. These set out how water companies are approaching the climate change issue and what impact they expect it to have on their business.

The biggest issue is the uncertainty. Trying to predict the impact of climate change is inherently uncertain and this poses huge dilemmas’ for everyone and creates several barriers hindering progress. Customers are not sure what impact climate change will have and consequently and in many cases unwilling to accept yet higher bills. Support from Ofwat for the cost of adaptation was sadly lacking from PR09 – again they did not want to see step increases in customer’s bills when the likely impact of climate change is so uncertain. The other big issue is the lack of any national design standards again because no one is willing to say for certain what impact climate change will have.

But this uncertainty must not be an excuse for doing nothing. There is no doubt that we are getting greater extremes in our weather – what ever the cause. This combined with population growth particularly in the water stressed South East means that our industry is being seriously affected. Add in the possible impact of climate change and its clear that its absolutely essential that action is taken.

Just look at the current concerns over water shortages in the south of England. Government needs to provide clearer guidance and It is vital that work continues to mitigate the impact. While at the same time more research is needed into the likely effects of climate change.