Ofwat is proposing to incentivise water companies to deliver on net zero at at the upcoming 2024 Price Review via the introduction of a common operational greenhouse gas (GHG) emissions performance commitment (PC) designed to encourage efficient expenditure.

Where companies have the ability to report on embedded emissions in a comprehensive and consistent way, the regulator is also proposing to allow such companies to develop a bespoke PC for embedded emissions at PR24.

Ofwat was outlining its plans in response to an open letter from the Secretary of State for Business, Energy and Industrial Strategy to the Chief Executives of Ofgem, Ofwat, and Ofcom, outlining its strategic priorities for the utilities sectors.

The letter also highlighted a role for regulators in achieving net zero through encouraging competition and innovation to secure the new infrastructure investment needed to meet net zero, as well as supporting the decarbonisation of existing infrastructure.

In particular, Ofwat was asked to consider the compatibility of its regulatory framework with the UK Government's Net Zero Strategy pathways to 2050 and interim carbon budgets.

While Ofwat does not have a specific formal climate change or net zero duty, the regulator takes the view that its duties, as outlined in the Water Industry Act 1991, are “sufficiently broad as to provide scope …to take climate change mitigation”, which the UK government's net zero target is aimed at, into account when carrying out its functions.

According to Ofwat, the regulatory framework is enabling water companies to deliver on both the government's interim carbon budgets and the Net Zero target for 2050.

Ofwat - "using markets to deliver for customers"

Ofwat’s response to Kwasi Kwarteng states:

“We are looking to the industry to identify the right approaches to net zero, encouraging the sector to innovate whilst also demonstrating the value and robustness of their responses through established accreditation standards, initiatives, and frameworks.”

“We believe this overarching approach, embedded in the context of using markets to deliver for customers, combined with growing clarity on our climate change expectations for water companies, will enable companies to respond in ways best tailored to local and regional circumstances.”

According to the water sector regulator, a market-based approach will “further enable companies to focus on outcomes, affording them the ability to innovate and tailor service delivery to the needs of consumers and the environment in their areas of operation.”

Ofwat described the price review process as its “key tool for incentivising and enabling companies to address the priorities of the UK and Welsh governments, not least in relation to net zero.”

The regulator also said that in developing its approach to net zero, it was “working to remove real or perceived barriers to company action in this space due to the regulatory framework.”

According to Ofwat, both current and planned water company actions are reflective of the UK government's Net Zero Strategy pathways, including:

• actions to decarbonise water and wastewater treatment
• technological innovations
• renewable energy generation and usage
• considering net zero in the development and delivery of strategic water resources solutions.

Ofwat drew the Business Secretary’s attention to its strategy, ‘Time to act, together', in which it committed to strengthening the sector’s approach to climate change mitigation and adaptation, saying:

“Ofwat has an important role to play in supporting the water sector to anticipate and proactively respond to the risks, opportunities, and uncertainties of climate change. In turn, we need to ensure the water sector meets the needs of current and future consumers in an operating environment that is decarbonising at an appropriate pace; is adaptive, accountable, and transparent; with inclusive partnerships, trust, innovation, and value for money at its core.”

The regulator described itself as “supportive of the water sector's work on net zero, welcoming the leadership and vision encapsulated by Water UK's 2030 Net Zero Routemap.”

However, Ofwat goes on to point out that the Routemap does not address embedded emissions, emissions from the use of chemicals, or disposal of sludge to land and it was not clear how interim and final net zero targets will be achieved.

Referring to its net zero principles position paper published in January 2022, Ofwat said the paper makes clear it expects the water companies:

• to ensure their net zero plans are clearly linked to national government targets;
• action on net zero to encompass both operational and embedded emissions;
• to prioritise the elimination and reduction of GHG emissions before the use of offsets

Ofwat’s response also sets out its proposal to consider bids on a competitive basis through a net zero challenge fund. This would allow additional net zero enhancement funding to drive further improvements, with funding concentrated on the most efficient companies.

Ofwat said this approach is designed to ensure additional and faster improvements are made at the lowest cost and that learnings from this investment process would be shared, allowing all companies to implement identified solutions.

Ofwat told the Minister that it expects all companies' plans for PR24 to make substantial progress towards national governments net zero targets and that it wants to see “concerted action to address both operational and embedded emissions in parallel.”

“We are focused on ensuring all companies report on these emissions in a more consistent and transparent manner. Over the course of the next price review period (2025-30), we expect progress to be made in the development of a suitable metric for the monitoring and reporting of such emissions,” Ofwat said.

Click here to download Ofwat’s Net Zero response to BEIS