The Water Report’s summary of key points from the PR24 Draft Determinations

Covering: 

1. Expenditure – sector allowances, cost gaps, key expenditure items and points of interest

2. Bills and affordability

3. Outcomes – Performance Commitments and Outcome Delivery Incentives

4. Risk and return, and financeability

5. Deliverability

6. Uncertainty mechanisms

7. Business plan grading

8. Poor performers – Turnaround Oversight Regime and Thames Water

9. Dates

10. Initial reaction from key stakeholders – Water UK, Thames, Steve Reed, British Water, CCW, clean rivers/seas campaigners 

1. Expenditure

Sector allowances

• Draft determinations (DDs) allow £88bn, a 50% increase on PR19, but a 16% (£16bn) cut on company business plan (BP) proposals of £104bn (figures include frontier shift and real price effects). 16% is a bigger cut than imposed at PR19 (11%). Ofwat said it had cut expenditure it considered inefficient, not properly justified, not required, previously funded (10-20% of the enhancement cost challenge – e.g. for storm overflows previously funded to meet existing permit levels), or covered in base allowances (20-30% of the enhancement cost challenge).   

• Base allowances up 13% on PR19 to £56.4bn (7% below BPs), driven by: higher costs including for energy; allowances for increased rates of mains replacement; and accommodating population growth, including by increasing capacity at sewage works. 

• Enhancement allowances tripled from £11bn at PR19 to £35bn (25% below BPs), which Ofwat described as a “step change increase”. 90% of this is statutory (£26bn for Water Industry National Environment Programme (WINEP) / Water Resource Management Plans (WRMPs), £4bn for other legal requirements). 

• Frontier shift (ongoing efficiency gains expected above and beyond current efficient levels, from technology, working practice and other improvements) set at 1% per year, to all base and enhancement allowances. BPs on average used 0.6%, most basing this on an Economic Insight recommended range of 0.3-0.8%. Ofwat based its number on the mid point of a range recommended by CEPA (0.8-1.2%), whose report also argued Economic Insight’s assessment of the scope for productivity growth was “disproportionately negative”. Ofwat further said 1% was consistent with Ofgem’s view at RIIO-ED2 and that this order of frontier shift challenge was used by some companies in their BPs (Portsmouth and South Staffs). 

• Real Price Effects (RPEs – input price increases/decreases in real terms relative to CPIH): RPEs for wholesale labour costs, retail labour costs and energy costs, plus ex-post true-up for materials, plant and equipment enhancement.

• Investment funding to be ring-fenced, with a claw back mechanism so any unspent money is returned to customers (see below, DDCM).

Cost gaps

• Sector wide figures mask wide variety at company level. The average 16% totex gap covers a range, from 3% for South Staffs and 4% for Anglian, to 34% at Wessex and 31% at South East. The gaps, even those towards the lower end of the ranges, will be hugely challenging for firms and in many cases outstrip gaps at the PR19 DD stage. 

• Base allowance gaps are more modest overall than enhancement gaps, but still substantive. Three firms’ base numbers were increased – Portsmouth 7%, SWW 5% and UU 1% – and South Staffs’ remained flat. For those with gaps, these range from -4% at Welsh and Southern, to -24% at Wessex and -15% at SES and Hafren. 

• Enhancement allowance gaps are huge, at 25% on average. Again the spread is wide, from -3% for Anglian and Hafren, to -64% for South East, -40% for Wessex, and -38% for Thames and Bristol. 

Key items of expenditure (sector-wide) include:

• £29bn of totex to be spent on WINEP/environmental improvements, including £10bn on storm overflows – an average 16 spills per year is targeted by 2029-30 – and £6bn on nutrient reduction.

• £4bn on increasing supplies, including nine reservoirs, seven transfer schemes and 12 water recycling plants, to deliver 425m extra litres per day by 2030. £1bn of this is to support RAPID programme schemes.

• £2bn on drinking water quality improvements, including addressing PFAS and replacing lead pipes.

• £1.5bn for 10m smart meters.

• £0.5bn leakage enhancement allowances.

• £225m on other demand reduction activities.

• £297m to increase mains replacement rates.

Other points of interest

• 18 major projects (each worth £200m+) to be delivered outside of price controls, via Direct Procurement for Customers or Specified Infrastructure Projects Regulations.

• £2.2bn on nature-based solutions (NBS), including £1.6bn to reduce storm spills through SUDS and wetlands, and £250m on nutrient removal. Ofwat said its framework was sufficiently flexible and supportive for firms to have put forward NBS. £255m to fund ‘Advanced WINEP’ (innovative approaches) for Anglian Water’s Partnership Centre of Excellence to encourage nature-first solutions, and UU to deliver 58,000m3 equivalent storage via rain gardens, permeable paving and other natural means. 

• Mains replacement – New expectation that all companies will replace at least 0.3% of water mains  a year through base allowances (Ofwat said the actual rate has fallen to 0.1% a year, lower than the level implicit in PR19 base allowances). Through combined base and enhancement allowances, 8,000km of mains (2.2% of total) to be replaced by 2030, at an average rate of 0.46% a year.

• Net zero – £317m of net zero challenge funding for Anglian, HD, Severn Trent and UU for 14 schemes seeking innovation in wastewater treatment process emissions  and one nature-based NZ catchment strategy. £60m in base allowances for low carbon technologies. 

• Competitive funds – £400m Innovation Fund; £100m Water Efficiency Fund. 

2. Bills and affordability 

• The DD put bill rises at £19/yr on average – £94 over the period (before inflation), or 21%. This is a third less than BP proposals (an average rise of £144 over five years), and £44/yr on average less for customers to pay than under the BPs. 

• The rise is driven by increased investment, higher financing and operating costs, and more spend on asset health measures, notably mains replacement. 

• The cut to BPs is driven by Ofwat reducing planned expenditure and pegging returns to a lower level than some companies based their plans on. 

• Price rises have also been mitigated through interventions in BPs to spread the recovery of costs over a longer period. The proportion of annual totex paid in current bills (the Pay As You Go ratios) are lower than at PR19, plus there are lower RCV run-off rates than at PR19, meaning costs will be recovered over a longer period. 

• As with expenditure, the sector bill rise average masks wide variation. Two companies are set to see bill cuts by 2030: SES (15%) and Wessex (2%). The biggest increase is at Southern (44%) followed by Hafren (32%). In cash terms, for a combined bill by 2030, Southern and Welsh customers will pay the most at £603 each, and Northumbrian customers the least at £460. 

• Affordability support will double to over £500m over five years. 8% of customers up from 4% will be on social tariffs, an increase of 1.4m customers. Significant shareholder contributions proposed by companies including UU, Welsh and Wessex.

• Three companies currently trialling innovative tariffs to support affordability and water efficiency; all indicated they will do so in AMP8.

3. Outcomes

Performance Commitments (PCs)

• 24 Common Performance Commitments (CPCs). Eight of these are new environmental PCs. 

• Ofwat has proposed an additional CPC on severe water supply interruptions at or greater than 12 hours (in addition to the existing CPC on interruptions at or greater than three hours).

• The table shows the 18 CPCs with absolute targets (Performance Commitment Levels, PCLs) together with the business customer experience in Wales PC which also has an absolute target. Ofwat called these PCLs “achievable yet stretching”. 

• Full compliance is expected for three CPCs: Compliance Risk Index, serious pollutions (zero) and discharge permit compliance.

• In addition, there are three experience PCs which do not have absolute targets: 

• C-MeX for household customers – Water firms are now to be benchmarked against companies elsewhere in the economy on customer service. Performance will be measured as a single score out of 100, calculated from the average of two surveys: customer service via feedback from customers who have contacted the company (weighted at 66.6%, up from 50% at PR19); and customer experience via all customers (weighted at 33.3%, down from 50% at PR19). Operational incidents and complaints are excluded due to data complexity/reliability concerns. Rewards/penalties to be calculated according to the company’s score distance from a benchmark based on the UKCSI all sector average, and a top and bottom benchmark, based on the UKCSI all-sector upper quartile and the UKCSI minimum, respectively. Ofwat said comparing performance to the UKCSI average, which encompasses 13 sectors “provides an acceptable comparator and an achievable target for the water sector”. C-MeX out and underperformance payments are now symmetric and were boosted to ±0.5% return on regulatory equity (RoRE). 

• D-MeX for developers – Incentive size increased to ±0.25% RoRE. Unlike C-MeX, the within-sector relative approach to benchmarking is retained. The weighting of the survey component of the score increased from 50% at PR19 to 66.6%, with the remaining 33.3% derived from Levels of Service metrics. 

• BR-MeX for business customers and retailers – A new PC. This will benchmark wholesaler performance against the median performer, with rewards for those above the median and penalties for those below, with the size of payments determined by distance from the median score and the top/bottom scores. Scores to be calculated: 50% based on survey results from business customers who have contacted their wholesaler; and 50% based on a twice yearly survey of retailers (R-MeX) – with the latter falling to 25% based on R-MeX and 25% based on the Market Performance Framework metric that measures wholesaler performance against industry codes when this is available. Incentive size set at ±0.2% appointee RoRE. 

• Eight of 17 bespoke PCs accepted: four related to embedded greenhouse gas emissions (Anglian, ST, SWW, UU), plus one each on low pressure (Affinity), lead pipe replacement (Hafren), street works collaboration (Thames) and ‘Wonderful Windermere’ (UU).

ODIs

• Ofwat said a greater use of financial incentives is a key priority for the PR24 regime. All PCs have financial incentives attached (Outcome Delivery Incentives, ODIs) except river water quality which is reputational due to data difficulties. Incentive rates to be consistent for more areas of performance at PR24 than PR19, based on equity return at risk. 

• Greater emphasis also on symmetric incentives – where the amount of underperformance and out performance payments available mirror each other.

• Enhanced financial incentives to be used where the PC is well established and sector data is robust, for companies who go beyond current best levels of performance.

• ODI payments to be made annually through in-period determinations.

• Limits on very large out/under performance payments to protect customers and companies from disproportionate financial risk. 

• PR19’s Aggregate Sharing Mechanism kept but extended to include all PCs, including C-MeX. Payment sharing threshold at ± 3% RoRE.

• Use of caps, collars and deadbands restricted to where performance against the PCL is uncertain or where they are needed to achieve a balanced risk outcome overall. 60% of PCs have caps and collars; there is one deadband – on the Compliance Risk Index PC – and this has been tightened. 

• Ofwat said its overall package “creates balanced risk outcomes on a company and sector basis”.

4. Risk and return, and financeability

• BPs indicate £7bn of new equity needed by 2030, and £45bn of new debt. 

• DD set allowed rate of return at 3.72%, reflecting a cost of equity of 4.8% and debt at 2.84% and underpinned by a gearing ratio of 55%. This is higher than Ofwat’s ‘early view’ of 3.29%, and the return set at PR19 (2.96%) due to higher financing costs and Ofwat opting for a return on equity towards the upper end of its range, to encourage investment. Cost of new debt to be indexed and reconciled at PR29 to protect customers if the cost of debt falls. 

• Interventions in BP cost recovery proposals, to extend the period over which investment is recovered from customers to reduce bill impacts. Average RCV run-off rates set at 4% (range: 3.8%-4.2%), increasing the average period over which the cost of RCV will be recovered to 25 years (up from 24 years in BPs).

• Portsmouth and South Staffs secure 0.35% cost of debt uplift as small companies. Of the two others who applied for an adjustment, SES Water’s request was waived following its acquisition by Pennon, and Ofwat said South East Water “is not a small company” plus the regulator was unconvinced by evidence of customer support for an increase. 

• 1.2% retail margin for household retail controls and the non-contestable segments of business retail in Wales.

• Ofwat has asked four companies (Thames, Southern, Wessex and South East) to provide additional board assurance and to prepare Financial Resilience Plans  (and where relevant, evidence of investor support), to demonstrate financial resilience in the context of the DDs. It has asked a further six firms to provide updated board assurance statements in response to the DDs. 

• Ofwat insisted its DDs will allow efficient companies, under the notional capital structure, to raise the levels of debt and equity necessary to deliver the investment requirement, finance their functions and maintain adequate levels of financial resilience. Moreover, it said the financial ratios assessed in the DDs support credit ratings “that are well within the investment grade” at a target credit rating of at least Baa1/BBB+. 

• Ofwat moots committing to fund the the efficient costs of water companies establishing and raising new equity via an exchange listing where they demonstrate this is in the long-term interests of customers and the environment.

• Expectation of base dividend yield confirmed at 4%, where company performance in the round aligns with DD expectations. Dividend policies expected to demonstrate how performance is taken into account. Some companies expected to adopt lower or zero yields, to strengthen financial resilience. 

5. Deliverability

In addition to existing reporting requirements and £1bn of AMP8 scheme acceleration to AMP7, at PR24 new general measures to support deliverability include: 

• Board assurance on deliverability was a key part of business plan quality assessment.

• 18 large schemes to be delivered outside of price controls via SIPR/DPC.

• Incentives included for on-time delivery.

• Price Control Deliverables (PCDs) introduced to hold companies to account on delivery and return money to customers if outcomes are not delivered in full. 

• All companies will be required to provide independent third party assurance for the delivery of enhancement schemes.

• A Delayed Delivery Cashflow Mechanism (DDCM) will also be introduced for all companies, so Ofwat can claw back a proportion of revenue associated with unspent wholesale expenditure allowances through an adjustment to allowed revenues later in the period. This would be returned to customers so bills reflect actual delivery profiles. The DDCM would be purely a cash-flow mechanism affecting revenue, intended to operate as a customer 'fairness' mechanism not a penalty. Any revenue foregone would automatically be reinstated through reconciliations in PR29 if companies subsequently catch up their enhancement programmes.

For Thames and Southern, Ofwat introduced a Delivery Mechanism, under which some expenditure will only be accessible once firms prove they can deliver the schemes it will fund. This means customers will not fund spending until Ofwat is clear on the timing and profile of elements of the companies’ plans. If triggered, this would increase average 2030 Southern bills by an additional £16, and Thames bills by £5. 

In addition for firms subject to the Delivery Mechanism, Delivery Action Plans will track delivery capacity for enhancement programmes, and Delivery Plans will set out completion milestones for enhancement schemes over the five years. 

6. Uncertainty mechanisms

• Energy price changes to be provided for under the true up for base expenditure. Materials, plant and equipment costs added to enhancement true up.

• Cost sharing rate reduced to 40% of over/under spending on enhancement expenditure to insulate companies more from overspend, and provide customers with a greater share of the benefit of underspend. Cost sharing rate reduced to 25% for uncomplicated schemes of £100m+ and strategic resource schemes – to reflect the higher uncertainty. In all, £2bn of expenditure to be subject to enhanced cost sharing rates. 

• For 21 complex or novel schemes of £100m+, expenditure will be gated; PR24 allowances only provide for development funding and companies will recover additional spend at PR29. Construction funding for strategic resource options to be contingent on schemes proceeding. In all £3.1bn will be contingent.

7. Business plan grading

• Plans were assessed on quality first (against 26 expectations across six areas), then ambition (against affordability, and stretch and efficiency), and a complex array of rewards/penalties applied depending on how companies performed and how much Ofwat had to intervene to reach the DD position. These incentives relate to a financial adjustment to RCV, and cost sharing rates on base expenditure.

• 13 companies (all but Thames, Southern and Wessex) passed the quality test – three post Ofwat’s intervention, making them ineligible for any reward (Welsh, South Staffs, South East; Welsh and South Staffs secured a 0bp adjustment and a 50:50 sharing rate, but South East’s plan was deemed to also lack ambition, resulting in a -15bp penalty and a 55:45 cost sharing rate).  

• Of the remaining 10, Severn Trent and SWW were deemed sector leading on ambition, including on base expenditure as well as on a number of PCs. Their rewards of a 30bp adjustment and 50:50 cost sharing rates (and which include protection from any reductions in the allowed return and base expenditure allowances between now and FD) will be contingent on delivery. 

• The remaining eight of the ten (Anglian, Hafren, Northumbrian, UU, Yorkshire, Affinity, Portsmouth and SES) eligible for rewards on quality were deemed ‘standard’ on ambition, received a 5bp reward and a 50:50 cost sharing rate.  

• Southern, Thames and Wessex did not meet Ofwat’s minimum quality expectations, despite intervention. They each received a -30bp penalty and a 60:40 cost sharing rate. Thames, Wessex and South East did not show sufficient ambition either, in Ofwat’s view. Each had specific reasons, though Ofwat identified “a common feature across each is that the companies have not yet committed to delivering or financing a plan that we consider is consistent with their legal obligations”. For lagging financial and operational performers Thames and Southern, Ofwat is requiring both financial resilience and delivery plans, among other things. The situation is different for Wessex, which is a high performing company on many metrics and not a concern under Ofwat’s Financial Resilience Monitoring assessment. Ofwat said Wessex did not meet minimum quality expectations in six areas that had a material impact on its ability to conduct the price review. Among other things, these relate to compliance with statutory requirements of the WINEP, and Wessex basing its plan on a 4.45% return and questioning financeability under Ofwat’s PR24 early view on return and notional capital structure. Ofwat encouraged these companies to work on “resolutions” and said their categorisation could be changed and they could escape the associated penalties at the FD stage, should they meet its requirements. 

8. Poor performers

Turnaround Oversight Regime (TOR)

Special provisions will give Ofwat closer regulatory oversight while struggling companies deliver a turnaround. Company arrangements will be bespoke but the package includes:

• Enhanced monitoring – for example, a company could be required to create a transformation plan with root cause analysis of the underlying issues and how improvements will be achieved, giving Ofwat enhanced visibility which could be supplemented by deep dives or strategic reviews. 

• Independent monitoring – Ofwat could appoint an Independent Monitor with full access to company information to monitor and report on the company’s progress.

• Additional customer protections – such as a gearing cap defined in the licence, an RCV adjustment in circumstances where dividend distributions are made above a defined gearing level, and mechanisms to ensure expenditure is targeted at areas that will benefit customers.

• Initially the TOR has only been applied to Thames Water, but could be applied to other companies.

Thames Water

• Due to the nature and extent of financial and operational issues at Thames, Ofwat put the company into the TOR. Thames must provide a Financial Resilience Plan, Delivery Action Plan and re-evaluate its turnaround plan. Ofwat is considering appointing an Independent Monitor with full access to company information to scrutinise and report on progress. 

• To get out of TOR, Thames would need to provide evidence of sustained improvident in operational performance, delivery capability and medium term financial resilience. Ofwat mooted on the latter: "That could mean introducing a limit on the amount of debt the company can take on, a separation of the business into two or more water companies, or looking to a public listing to secure additional equity.” 

• There was little forbearance from Ofwat for Thames given its situation. Its BP totex was cut by £5bn to £16.9bn, 20% of which will be conditional (£3.3bn). Bills rises were held to £99, compared to the BP £191, taking the average bill to £535 by 2030, not £627. Outcome expectations are stretching, including a 64% cut in storm spills and a 19% cut in leakage, and Thames is subject to the normal ODI penalty regime. 

9. Dates

• Ofwat’s Your Water Your Say sessions, for customers and stakeholders to comment on its DDs – 23 and 24 July. 

• Consultation closes – 28 August. 

• FD planned for 19 December, but Ofwat is consulting on a licence change that would provide for a January FD as a backstop. 

10. Initial reaction from key stakeholders

Water UK – A spokesperson said: 

“Today’s announcement is the biggest ever cut in investment by Ofwat. If it doesn’t put this right Ofwat will be repeating the mistakes of the past. As a direct result, more housing will be blocked, the recovery of our rivers will be slower and we will fail to deal with the water shortages we know are coming. Water companies proposed to invest £105bn because it is the minimum needed to meet the legitimate concerns we’ve heard from the public about our environment and our economy.

“Ofwat is right to want to ensure customers receive value for money and that is why protections are in place to ensure customers only pay for projects that are new, necessary and value for money. But for far too long, Ofwat has failed to be realistic about the levels of investment needed and what it will take to deliver and maintain necessary infrastructure. We cannot allow this pattern to repeat itself. Water companies are ready to invest in an unprecedented overhaul of the country’s water and sewage infrastructure. Ofwat now needs to let them get on with it." 

Thames Water –  A statement said: 

“…We put forward record investment to improve infrastructure, meet new environmental standards and reduce river pollution.  Our plan will also improve the resilience of our critical infrastructure in the face of challenges such as climate change and population growth. We believe our plan is ambitious, deliverable, financeable and investible. It is also underpinned by a package to support over 500,000 customers with reduced bills.

 “Ofwat’s draft determination understandably challenges us on efficiency and delivery. They have been thoughtful in considering the funding we need for our day to day running costs and the improvements our customers and communities want to see. 

 “Although Ofwat currently categorises our business plan as ‘inadequate,’ this judgment rests on over 20 very specific tests around the scope of information to be provided, and evidence required to depart from Ofwat’s own assumptions. Ofwat has made clear it will revisit its view if we provide further evidence to reach a final determination that is, in the round, affordable for customers, deliverable, financeable, as well as investable.  We welcome the opportunity to provide Ofwat with further evidence about the need for the investment we plan to make, our costs and how we will deliver it.  

“As part of its draft determination, Ofwat has asked us to look again at our turnaround plan, and is seeking enhanced oversight of our delivery against it.  We are in any case taking stock of our turnaround plan under our new leadership and reflecting on our progress to date.  We will consider all of Ofwat’s proposals as we go through this process. This is one stage in a longer process.”

Steve Reed, environment secretary

“Today’s water bill rises are the result of years of failure. 

“The new Government will force water companies to tackle illegal sewage dumping into our rivers, lakes and seas. Firm action should have been taken much earlier to ensure money was spent on fixing the sewage system, not syphoned off for bonuses and dividends.    

“The decisive steps set out today mean this will never be allowed to happen again.” (see news item Industry immediately signs up to light touch reforms from Labour). 

British Water

In light of the £88bn spend, British Water called on the sector to step up to provide:

• An embedded culture of collaboration

• Visibility of programmes

• A balanced work profile over the whole five years

• Sufficient availability of resources 

• Contract terms that do not pass down onerous risks to the supply chain

• Standardisation of solutions across water companies  

• The faster adoption of innovation.

Chief executive Lila Thompson said: “While customers in England and Wales have seen bills remain flat in real terms, for three decades, the needs of our water and wastewater network have grown significantly. Increased investment is essential to meet Ofwat’s ambitions for affordability long term, improvements in customer service and environmental performance. To meet all of these ambitions, we will need an effective ecosystem of key stakeholders where the supply chain can thrive to deliver the diverse range of technologies and solutions for AMP8 and beyond. British Water and its members stand ready to be a vital partner in these discussions and to contribute to positive change across the industry."

CCW – Mike Keil, chief executive: 

“Millions of people will feel upset and anxious at the prospect of these water bill rises and question the fairness of them given some water companies’ track record of failure and poor service. Customers understand investment is urgently needed but they need reassurance that every pound of their money is going to be well spent. Trust in water companies has never been lower and that won’t change until people see and experience a difference – whether that’s having the confidence to swim at their favourite beach or receiving help if they are struggling to pay their bill. We estimate about 2m households in England and Wales currently cannot afford their water bill and while the increase in financial assistance is welcome it falls short of what is needed. Over the summer we’ll be carrying out research with customers of every water company to gauge whether they feel the regulator’s proposals are affordable and deliver what people want. We expect Ofwat to listen and act on what customers tell us.”

Clean rivers/seas campaigners

SAS – “The announcement will come as a major disappointment to the thousands of people who paddled out in fury at the state of our waterways and the 7,000 people who wrote to the Ofwat chair to call on them to ensure water company plans for the next five years deliver an end to sewage pollution affecting their favourite spots…

“Ofwat have championed that water company plans will cut discharges from storm overflows by 44% by 2030. But, this will still allow discharges to occur a massive 200,000 times a year. What really takes this piss is that Ofwat had already told companies to reduce spills by 21% by next year anyway. So when you break it down between 2025-2030 they are only requiring a 23% reduction. This is simply not good enough…

“Ofwat had a chance today to ensure that water companies put the health of water users and the environment. But the announcement was just another disappointment from a failing regulator.”

Feargal Sharkey – accused Ofwat of “treating customers with contempt and charging them twice;” called for street protests to demonstrate the strength of feeling; and called for a boycott of the “sham” PR24 consultation.