Totex incentives a must
Industry jargon always sends a shiver down my spine and this summer it will be the words 'Totex', 'Capex' and 'Opex' getting a full airing, as Ofwat consults widely on its plans to reform the way it sets prices and regulates the expenditure of the UK water companies.
Notwithstanding the ugliness of the terminology, Ofwat's intentions set out in its Future Price Limits consultation, and embodied in the recently-published Statement of Principles, are a thing of beauty to those of us in the industry supply chain. They signal real hope that we can contribute to greater engineering innovation and develop solutions that are based on achieving the best through-life costs for our customers. Now that has to be good news for sustainability, as well as for consumers.
Ofwat has signalled its determination to tackle what it calls the 'unintended bias' of the current regulatory system towards capital expenditure amongst the water companies. As part of its far-reaching reforms for PR14, it wants to combine the assessment and incentivisation of Opex (operating costs) and Capex (capital expenditure) into a more holistic Totex (total expenditure) approach.
At the same time, Ofwat wants to move towards a system which rewards the best outcomes, rather than the outputs that can be achieved if companies play the regulatory game well.
Whilst widely welcomed by the supply chain, the Totex proposals received a lukewarm reception from water companies themselves and Ofwat has indicated it will conduct consultations, workshops and working groups over the summer before launching a Methodology Consultation in the autumn.
Working out robust mechanisms is essential, but once they are in place the same thinking will need to be applied to the way water companies let contracts to their suppliers.
Speaking from the supply chain perspective, I think this looks like another major challenge: it will mean water companies potentially letting contracts on the basis of cheaper operating and through-life costs, even when initial set-up costs appear uncompetitive.
It will simply go against the grain to let a contract to the supplier that is not the cheapest. Water companies will need to be open-minded and creative in developing the necessary scrutiny and assessment criteria for bids, as well as providing robust incentives for suppliers to deliver operating efficiencies long after they have left site.
I don't believe these challenges are insurmountable, but as debates continue this summer over the regulatory framework itself, they should not be overlooked. We should begin to get the best contracting minds to work developing ideas for the exciting future ahead.
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