In their Draft Determinations for Price Review 2024 (PR24), Ofwat has proposed allowing a spending package of £88bn by water companies.
£35bn of the expenditure reflects the investment needed to reduce pollution, improve customer service, river and bathing water quality, and deliver greater resilience to the impact of climate change. This is more than a trebling of the level of investment in the 2020 to 2025 period.
The total expenditure proposed is £16bn lower than in companies’ business plans. This reflects Ofwat’s analysis of those plans, removing or reducing costs where expenditure is insufficiently justified, inefficient or for activity for which companies have already been funded; customers will not pay twice.
The average bill increase for water and wastewater companies will be £19 a year over five years (£94 in total), excluding inflation. Companies’ business plans proposed increases averaging £144 over five years. Ofwat’s interventions have reduced the level of bill increases proposed by companies. For example, Thames Water’s proposed increase of £191 by 2030 has been reduced to £99; Severn Trent’s proposed increase of £144 has been reduced to £93.
Companies have been required to prepare for the future by setting their plans in the context of a 25-year delivery strategy. These proposals include the work of the regulators’ joint team RAPID, which is helping to accelerate the delivery of £17bn of new water assets including 6 reservoirs, some of which are part of the wider programme of major projects; in total 9 new reservoirs are proposed.
The overall investment programme will deliver improvements in the environment, strengthen the resilience of water supplies and improve day-to-day customer service.
Protecting the environment
- Reducing the number of spills from storm overflows by 44% (compared with 2021 levels) by spending £10bn and upgrading 2,500 storm overflows; this includes the 21% reduction which Ofwat has required companies to deliver by 2025 at their own expense
- The announcement builds on Ofwat’s approval in 2023 of £2.2bn of accelerated investment to make an early start on delivering improvements and drive down spills from storm overflows.
- £1.4bn of investment on storm overflows to be delivered through catchment- and nature-based solutions
- Improving river water quality by investing £6bn including improvements at over 1500 wastewater treatment works – with around 880 removing more phosphorus
- 8 new performance targets for companies including reducing spills from storm overflows, reducing operational greenhouse gas emissions and improving biodiversity
- Failure to meet these performance commitment results in an automatic penalty for companies
Securing supplies
- £6bn for securing water supplies including progressing 9 new reservoirs and 7 large-scale water transfer schemes
- Requiring companies to replace around 8,000 km of water mains pipes – a 400% increase compared with the current 5-year period
- Targeting companies to reduce leakage by a further 13%
- Launching a £100m Water Efficiency Fund
Day-to-day delivery for customers
- Tougher targets on internal and external sewer flooding, reducing sewer flooding in homes by 13%
- Higher standards set for assessing companies’ customer service through comparing water companies with other sectors
The cost of this investment will initially be funded by shareholders or through borrowing, with these costs then recovered through customers’ bills in this 5-year period and beyond. Ofwat has proposed a rate of return of 3.72%. This is above the level set for 2020 to 2025, reflecting increases in the cost of finance and the need to ensure the sector can raise the finance necessary to fund such a significant programme of investment.
David Black, Chief Executive, Ofwat said:
“Customers want to see radical change in the way water companies care for the environment.
“Our draft decisions on company plans approve a tripling of investment to make sustained improvement to customer service and the environment at a fair price for customers.
“These proposals aim to deliver a 44% reduction in spills from storm overflows compared to levels in 2021. We expect all companies to embrace innovation and go further and faster to reduce spills wherever possible.
“Today’s announcement also increases the resilience of our water supplies to the impact of climate change and will reduce how much water is taken from rivers by enabling a range of long-term water supply projects, which includes plans for 9 reservoirs.
“Let me be very clear to water companies. We will be closely scrutinising the delivery of their plans and will hold them to account to deliver real improvements to the environment and for customers and on their investment programmes.”
PR24 at a glance
Overview
Every five years Ofwat is required to set the price, investment and service package for water companies in England and Wales. Today’s proposals are part of the 2024 Price Review (PR24) and cover the period from 1 April 2025 to 31 March 2030.
Investment
As with previous price reviews the level of the investment programme is principally driven by environmental requirements, set out through the statutory planning processes led by the Environment Agency, Natural Resources Wales, and the UK and Welsh Governments.
This has led to companies’ proposed total expenditure increasing by £29bn – this is split between a £5bn increase in the core costs for running their business and a £24bn increase in expenditure to meet requirements set by Governments and for other environmental improvements.
Part of Ofwat’s role as the economic regulator is to scrutinise companies’ cost proposals, to ensure they deliver efficiently; this has led to a £16bn reduction. The reductions have applied to proposals where additional expenditure allowances have not been justified, including where customers are being asked to pay twice, or where proposed costs do not reflect efficient delivery. Where companies can provide additional evidence to justify their proposals it will be considered by Ofwat ahead of final decisions.
The increase in the scale of investment will challenge companies’ capacity to deliver. It is encouraging that over the past 18 months many companies have strengthened their relationships with key suppliers to enable the step-up in activity that will be needed. Ofwat is putting in place additional processes for Thames Water and Southern Water which face some of the greatest delivery challenges; approval for parts of their funding will be phased over time, linking it to progress on delivering their investment plans.
Ofwat has established new approaches for large schemes to ensure that investments of over £100m are delivered as efficiently as possible, improving value for customers and outcomes for the environment. 21 large schemes in today’s proposals will be delivered by these new approaches, enabling capital and operational cost savings as well as a reduction in financing costs, while maintaining quality.
In addition to these large schemes Ofwat has a programme of 18 major projects ranging from reservoirs to water transfers and treatment works. These projects will attract around £26 billion pounds of new investment to the sector over the next 5 – 15 years through innovative competitive delivery models. Third parties will compete to design, build and in some cases operate and maintain this essential infrastructure, driving best value for money for customers. To qualify for these models major projects are over £200 million and distinct from the rest of the company networks.
This builds on the experience from the £4.5bn Thames Tideway super sewer, which is currently being commissioned. This is showing how the use of competitive models for delivery and innovation in finance arrangements helps deliver better outcomes for customers and the environment.
The increased allowance for companies’ base expenditure reflects measures including: increased expenditure in maintaining long term asset health by increasing the rate of mains replacement; accommodating population growth including by increasing capacity at sewage treatment works; and the effect of higher energy costs.
Bills
The increase in investment will lead to an increase in customer bills. Ofwat is committed to fair bills for current and future customers:
- Bill increases will not cover work for which companies have already been funded – customers will not pay twice.
- Costs have been challenged to reflect efficient delivery of investment, while continuing to ensure that companies can deliver their statutory requirements and the sector can attract the investment it needs.
- Investment funding will be ring fenced with a claw back guarantee which will ensure money not spent on investment is returned to customers.
The average bill increase for water and wastewater companies for the five years from 1 April 2025 is £94 (21%), around £19 per year.
Ofwat welcomes commitments from a number of companies to increase substantially the level of support given to customers who need a helping hand. Overall, nearly £500 million is going to be made available for the five-year period.
A breakdown of bill changes by company is provided at the end of this statement.
Delivering improved performance
PR24 also sets performance targets which companies are expected to achieve, with rewards or penalties for outperformance or underperformance. There are 8 new environmental targets including:
- Reducing spills from storm overflows for companies in England to an average of 16 spills per year by 2029.
- Cutting the number of serious pollution incidents to zero.
- Reducing operational greenhouse gas emissions by 13.8%.
A fair return for investors
Investment in the water sector is financed up front by investors and repaid by customers over time. Companies will therefore need to access additional debt and equity to support the investment programme. Since 2021 over £4.6bn of equity has been raised by the sector; business plans identified a further new equity funding requirement of £7bn by 2030. Some water companies will need to take further steps to strengthen their financial resilience and Ofwat has required further assurance about their financial resilience in 2025-30 and beyond
Ofwat has set the allowed rate of return for companies at 3.72%, reflecting a cost of equity of 4.8% and debt at 2.84% and underpinned by a gearing ratio of 55%. At these levels, and taking account of the overall balance of risk and return in these proposals, Ofwat is satisfied that an efficient company can finance its functions.
Thames Water
Ofwat has allowed Thames Water £16.9bn to invest on improving services for customers and the environment. Around 20% of the £16.9bn funding (worth more than £3bn) is conditional on the company demonstrating it is ready and able to effectively deploy investment or that the investment will be effectively and efficiently targeted. This is in addition to the price review process that will see customers’ money clawed back if investment is not delivered.
Given concerns about the performance of the company, Ofwat is imposing a Turnaround Oversight Regime on the company. This will include:
- a requirement to provide a ‘delivery action plan’ which sets out the actions the company proposes to take to expand its delivery capacity. The company must report on its progress regularly, subject to review and additional scrutiny by an independent third-party assurance provider;
- a requirement for the company to fully re-evaluate its plans for transformation in order to demonstrate how it will deliver the necessary step change in operational performance
- a requirement for the company to provide a financial resilience plan in response to the draft determinations. We will continue to monitor and engage with the company on its financial resilience.
In addition, we are considering appointing an Independent Monitor to monitor and report on the company’s progress, including against its transformation plan. The Independent Monitor would report back to us and be entitled to full access to company information.
Next steps
Today’s announcement sets out Ofwat’s draft decisions based on its review of company business plans.
These draft decisions are open for consultation and responses are welcome from customers, stakeholders and water companies. The deadline for consultation responses is 12 noon on 28 August 2024.
Ofwat expects to publish its final decisions on 19 December 2024. If companies do not agree with the final decisions, they have two months from the date of publication to ask for an appeal to the Competition and Markets Authority.
A consultation has also been published today on a proposed modification to companies’ licences. This would allow Ofwat to delay final determinations until January 2025 if necessary due to unforeseen circumstances.
