Water Act 2014 becomes law

The Water Act 2014 has finally received Royal Assent. It introduces a new era of competition into the English water market from 2017. But this will only apply to business customers and is unlikely to make a major difference.

It does open up the possibility that water companies could split into down stream retailers – those who meter and bill water - from those who prefer to only operate upstream, in abstraction, storage, treatment and distribution. This could bring about unintended consequences in that the interests of a retailer are very different from a wholesaler of water.

Given that water is a commodity the only real way to differentiate is to compete on price – why else would a business customer change supplier? This means that retailers will constantly seek to reduce costs and find lower cost wholesalers. But the interests of wholesalers are very different. Investing in water treatment is inevitably a long term decision given that the life of the assets created is measured in 10’s of years. They are looking for steady returns and need to take long term investment decisions. But with retailers looking to reduce costs it will make it very difficult for wholesalers to take a long term view. This could lead to essential maintenance being put off and investment in replacing worn out water mains delayed increasing the risk of an unexpected breakdown. Is this really in the best interest of customers? 

Is the water industry really sustainable?

The Government has made very clear it is committed to sustainable development. One could argue that the water industry given that it is driven by the natural water cycle must be sustainable. But the recent floods have again called into question whether this is actually the case.

New guidance on sustainable development and resilience in the Water Bill currently being debated has recently been published. In it the Government sets out its view that sustainable development is already a duty and no further powers are needed but it does think new resilience measures are required. These will commit Ofwat to ensure the water companies take a long term view and ensure factors like population growth, climate change and social changes to water demand are taken into account.

This blog would argue that this is already in place in that the water companies already produce 25 year plans. For a water company like Anglian Water adapting to population growth and climate change is already their top two priorities. So it is not clear what difference, if any, the proposed resilience measures will make.

On building on flood plains – again the guidance note says this is already adequately covered by existing planning guidance. But as the floods have made clear – building on flood plains is still continuing at an alarming rate.  200 000 houses over thelast 10 years were built on flood plains. In the last year 87 planning applications to build on high flood risk areas opposed by the Environment Agency still got the go ahead.

There is a real tension between the desire to build more houses and the need to ensure sustainable development. At the moment it is clear the economic case is winning and the other two pillars of sustainability, the environment and social costs are being ignored. This does not bode well for the long term resilience of the water industry.

UK water plc faces a lower cost of capital

The water industry regulator has published new guidance on the cost of capital it sees as acceptable for the water companies. Its report gives guidance on a number of financial parameters and sets out what it believes is reasonable to ensure the water companies make a ‘fair’ return that rewards their investors but also protects customers.

Ofwat are saying that the weighted average cost of capital (WACC) should be in the range 3.5% to 4% rather than about 1% on average in the water companies business plans. The highly leveraged water companies (Thames, Anglian, Southern and Yorkshire) may as a consequence struggle to protect their credit ratings. Fitch the credit ratings agency said last week that this move could lead to a down grading of their ratings.  

It is a double whammy in that Ofwat is also questioning the high gearing of some companies suggesting that gearing should be around 62% - its currently in the range 60-70%.

It is part of the on going battle between those who feel that water bills are too high and still rising at an unacceptable rate. The Ofwat Chairman Jonson Cox has been quoted as saying: “the last few years have been very kind to the owners of water companies, at a time when life is very challenging for customers”.

This signals that the water industry is likely to be entering a new era of much harsher financial constraints which will inhibit there room for manoeuvre. It also comes at a time when some of those in the water sector need to strengthen their balance sheets to support future growth in their asset base.

The outlook is likely to get more challenging. Its clear that the current problems with flooding are spreading too other parts of the country and are likely to get worse given the weather outlook. Contamination of flood water with raw sewage is one of the major problems and a significant risk to those exposed to flooding. Concerns over the state of the sewerage network are bound to significantly increase as the lessons start to be drawn from the current flooding problems. 

Flooding on the Somerset levels

Photo: King's Sedgmore Drain

The Somerset levels are a totally man made environment. They were first extensively drained by the Church back in the early 17^th century with the help of a Dutch drainage engineer. The clue is in the name of the water course’s like the King’s Sedgmoor Drain. Most of the levels are below sea level (although with a tidal range of 11m defining sea level is interesting). All year round water is pumped from the levels into the man made rivers (or drains) that are designed to store water and allow it out at low tide.

It’s a surprisingly complex drainage system that was managed successfully by local drainage boards comprised of local farmers and land owners. Now responsibility has been transferred to The Environment Agency who promptly decided to save money and for the last 10 years halted the year round work of dredging the rivers. As the head of the local drainage authority said this week, “it was a totally avoidable flood”. Just look at Holland, there has been no severe flooding there this winter.

With the drains being higher than the surrounding land, having allowed the water to spill onto the farm land there is no way to get it back except by pumping. But with 12% of Somerset under water the volumes involved are colossal.

Local knowledge is vital but this is being lost. The blog’s author lives on the levels. The local farm was in the same family for three generations. Unfortunately the next generation did not want to continue farming so it has been sold. The farm has now been split up and has about 20 owners. Some of the land was bought by home owners looking to extend their gardens, another part is now a horse stud, while other fields are let to tenant farmers. Many of the home owners don’t understand that their ditch is actually called a Rhyme and a vital component of the complex drainage system. The problem is who now takes responsibility for ensuring dredging of the ditches happens? It needs every one of the 20 plus land owners to dredge their ditch or else the water can’t flow. This situation is a microcosm of the challenges being faced across the country.

Routine maintenance is not ‘sexey’. It is an on going cost rather like painting the Forth Road bridge. It is too easy for dredging to be the first victim of cuts especially where the local management and ownership has been lost. Initially stopping dredging may have no impact but eventually the inevitable will happen. Until this issue is recognised and a holistic approach taken – flooding is inevitable.    

Investment in the UK water industry

Photo courtesy of Thames Water - mains replacement in London

Drivers for investment in AMP6 (2015-2020) is the theme of the blog this week. 

The Water Framework Directive is driving massive investment as a better understanding of each water basin develops. Nutrient input especially from phosphates is proving a bigger problem than anticipated. Already many sewage discharges have a 1mg/l consent especially in slow moving rivers. This can be achieved relatively easily by using a tertiary treatment process usually involving chemical dosing (typically ferric chloride) to precipitate out the phosphate. However in some water courses the Environment Agency is suggesting discharge consents may need to be an order of magnitude lower 0.1mg/l. This poses a significant technical challenge – several processes are currently being trialled usually involving a combination of enhanced tertiary filtration and chemical dosing but as yet no clear winner has emerged.

Despite the recent extremely wet weather concerns over water leakage has not eased. The issue is the rising population and changes in lifestyle that is increasing water demand. This is despite the moves by water companies in the particularly water stressed South East regions to install water metering for everyone. Several water companies are proposing huge new reservoirs (Bristol Water for example at Cheddar). The Environment Agency recognises that winning public support is difficult when water losses are still averaging over 24% across the network. Virtually unchanged over the last 10 years.

Some new technologies are emerging to detect or manage water losses especially some sophisticated software systems to improve the monitoring of the distribution network. A few countries have got leakage down to about 5%. This has been achieved through a combination of investment in new distribution mains, extensive metering through the distribution system and tight control of water pressure to minimise the stress on pipes and leakage if a pipe does break.