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Monday, 27 February 2012 12:32

Should new major water infrastructure projects be left to the water companies?

News that United Utilities is planning to develop a £2.6bn pipeline to pump water from the water-rich North to drought-stricken Southern England raises fundamental questions about whether major infrastructure projects of national significance should be left in the hands of the water companies alone.

Given the importance of the issue, Managing Editor Elaine Coles writes a personal take on the broader implications of the proposal.

The proposal raises some interesting possibilities in terms of the development of future infrastructure projects in the water sector. For example, should all future developments of roads, highways, railway lines and other utility projects be required at least to consider whether other key infrastructure needs could usefully be met by combining other projects – for example, flood defence schemes or water transportation mechanisms?

However, it also raises some fundamental questions about future funding for major UK infrastructure projects. For example, if United Utilities were to jointly share the costs of the project with the developers of HS2, what proportion of the costs would be borne by United Utilities customers and/or investors? Would water company customers in the South be expected to bear a share of the burden?

It also raises the central issue of whether the creation of such large strategically important infrastructure projects should be left to the water companies to implement.

Since privatisation, the great majority of the water industry’s investment projects have been on a relatively small scale; there have been few major long term projects which have spanned price setting periods and no projects with individual funding requirement of a magnitude that no single water company could not adequately fund.

Thames Water’s super-sewer is a case in point. Already identified as a Nationally Significant Infrastructure Project, on 2nd February the Government included a provision in the Water Industry (Financial Assistance) Bill to provide additional financial support for exceptionally large or complex water or sewerage infrastructure such as the proposed Thames Tunnel in London.

Presumably a proposed high-ticket pipeline to shift water from the North to the drought-stricken South may well fall into both categories. At £2.6 billion, the pipeline would appear to be on a par in cost terms with the super-sewer – first costed at £3.6 billion which has now been revised up to £4. 1 billion.

Who should develop large water infrastructure projects?

This is perhaps the most interesting question of all - whether the development of such infrastructure should be left in the hands of the water utilities. A little-known provision of the Flood and Water Management Act 2010 contained a proposal to introduce a new system for dealing with potential large new infrastructure projects needed in the water sector.

This states that the Minister may make regulations about the provision of infrastructure for the use of water undertakers or sewerage undertakers which apply to designing, constructing, owning and operating infrastructure. In this situation, the regulations would also have to prohibit a water undertaker or sewerage undertaker from undertaking this type of infrastructure project when it was put out to tender – although they could permit or require a water or sewerage undertaker to undertake preparatory work.

The regulations must also make provision about the extent to which companies associated with a water undertaker or sewerage undertaker are permitted to bid in a tender process. They can also extend to specifying factors to be taken into account in considering bids and must provide for the water or sewerage undertaker responsible for the tender process to determine which bid to accept (if any).

The regulations would also allow the Minister to designate infrastructure providers and relieve water or sewerage undertakers of their specified duties.

As part of the supporting documentation prior to the introduction of the Act, at the time the Department for Food, Agriculture and Rural Affairs published an Impact Assessment which examined the thinking behind the proposals for large infrastructure projects in the water sector in detail.

This stated that some large projects would raise issues of planning, financing, interface and construction risk that are greater than those normally associated with water-company capital investment programmes and are likely to require construction over two or more asset management periods. They may also straddle companies’ existing areas of appointment, whereby currently water companies have a duty to provide and maintain a system within their licensed geographical area.

Such projects might also have a very different risk profile from the programmes of investment undertaken by the sector to date, both in the construction and operational phases.

The Impact Assessment proposed that the existing water industry regulatory framework should be adapted to accommodate large projects that introduce novel solutions and/or joint ventures between two or more water companies.

The Government at the time took the view that the creation of a specific new large-projects regime (with direct regulation), could offer the most economic and efficient approach for the most complex projects. Potential benefits include:

  • ability to market-test investors’ risk appetite for investing in specific projects;
  • ensures that risk allocation for the project is transparent and occurs up front in the procurement process.
  • exposes costs to competition, including the debt and equity financing costs
  • provides potentially greater discipline and transparency in project delivery;
  • incorporates a longer term framework for large projects; and
  • increases competition and allows new entrants into the delivery of water and sewerage infrastructure and to introduce strategic and innovative approaches to the delivery of improvement schemes in the water industry that are capable of delivering schemes across existing licensed water company boundaries.

A direct regulation value-for-money competitive procurement exercise would establish the costs and  market-test the risk-allocation mechanism for delivery of the project. The winning consortium would enter into a contract with the water company and have responsibility to finance (including equity finance) and deliver the project. The consortium’s revenue stream would be received from the water company/companies that will benefit from the asset. This would be a legitimate operating cost to the water company/companies which would be funded via price limits.

The Defra paper did not define the types of project which might be covered under the proposed system. It refers in general terms to  the identification of projects that represent large-scale novel or radical engineering solutions that have not previously been used to deliver water and sewerage projects on an unprecedentedly larger scale.

However, it did discuss the “Thames Tunnel”.component of the Thames Tideway scheme in this context –budgeted at £1.5bn in 2004-05 prices and estimated to take until 2020 to complete. The paper said:

“This is a significant, complex and risky project when compared with the £3 billion cost of Thames Water’s entire capital programme, or indeed the capital programme of the industry of £17 billion, assumed in price limits for 2005-2010. The project on its own is nearly 50% of the Thames Water's entire programme for 2005-2010”.

Defra said at the time that with no change to the existing funding framework, the water companies could find it difficult to raise the capital to deliver this type of project, even if such projects were mandated by Government.

At the time, Water UK, on behalf of the water companies, said that in view of their expertise and track record they should also be allowed to bid for work. As it stood, the water companies themselves would be unable to bid for major infrastructure projects.

On my reading, this still appears to be the case. So if the legislation is in place, is there an argument to open up the market to all-comers? And could we see the existing Tier 1 delivery alliances cutting out the middleman and tendering directly to design, build and operate such national assets themselves? Will we see the big Asian infrastructure giants courted by George Osborne stepping in?

Whatever the answer, the UK needs some innovative solutions to the increasingly urgent environmental challenges we now appear to face.

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