The Commission for Energy Regulation (CER) the independent economic regulator of Irish Water, has told the water company to reduce its planned operational spend by €128 million and capital spend by €136 million over the next two years.

Irish Water’s submission to the CER had sought a spend  of €1.523 billion on operational costs and capital expenditure of €1.288 billion during the 2017-18 period. However, the regulator is only permitting an operational spend of €1.39 billion and capital spend of €1.152 billion for the next two years.

The CER has reduced the revenues Irish Water is allowed to generate over the period - the regulator has decided to allow €1,843 million for the 2017-2018 period - this represents a reduction of €165 million (or 8.2%) relative to Irish Water’s request  for €2 billion.

The lengthy decision paper published by the CER on Irish Water’s Allowable Revenue for the next revenue control covering the two year period from 1 January 2017 to 31 December 2018 outlines the efficiencies which Irish Water will be required to drive within its costs over the coming years.

The paper also includes a review  of the utility’s costs and performance over the first revenue control period, October 2014 to December 2016.

Setting out the background to the paper, the CER said:

“Irish Water faces significant challenges with respect to improving the quality and security of the public water and wastewater services in Ireland and providing an appropriate level of service to its customers.”

“From an environmental perspective, fundamental issues remain to be resolved following the transfer of water services assets from the local authorities to Irish Water in 2014. On the wastewater side, for example, raw sewage is being discharged without any meaningful treatment in 44 different areas in Ireland. For water, there are also compliance issues, for example, relating to boil water notices, E. coli and lead.”

“Issues such as these are compounded by poor quality data on the location and performance of assets that were transferred to Irish Water. This increases the difficulty associated with operating and improving the water services system.”

The work now being undertaken by Irish Water was previously the responsibility of 34 (and then 31) local authorities and a significant amount of work is still completed by the local authorities on behalf of Irish Water through Service Level Agreements (SLAs). The paper says this operating model may impede Irish Water’s ability to deliver cost reductions in the short term as it will take time to implement a unified approach and common systems and processes.

Irish Water required to improve services and drive efficiencies within a challenging environment

The CER has also flagged up the fact that in a wider context, the water company has faced challenges with respect to a lack of public support to its operating model and associated issues from a financing perspective (in relation to domestic water charges), commenting:

“ Irish Water is required to improve services and drive efficiencies within this challenging environment.”

The decisions follow on from a lengthy period of engagement by the CER with Irish Water which began in July 2015 and involved detailed analysis of submissions by Irish Water, meetings with Irish Water to clarify the submissions and the benchmarking of Irish Water’s costs and performance against international best practice.

This includes allowances for operating costs, depreciation and return on capital costs, and an adjustment for revenue relating to the two and a quarter years of the first revenue control period, October 2014 to December 2016.

For the previous two and a quarter years, October 2014-2016, revenue was recovered through a combination of domestic charges, non-domestic charges and Government subvention. For the coming revenue control, the CER has noted that domestic water and wastewater charges are suspended until at least 31 March 2017.

The CER is working on the basis that the revenue for 2017 and 2018 will be recovered through a mix of funding sources. In this context, the CER acknowledges the work recently completed by the Expert Commission following the publication of its report on domestic public water services. The enduring funding model for Irish Water will be determined by the Irish Parliament and is expected to be decided in the near future.

Irish Water operating costs “significantly higher” than other established water utilities

Commenting on its decision on operating costs, the CER said it had reviewed Irish Water’s submission and benchmarked its operating costs against comparable water and wastewater utilities elsewhere.

“Irish Water’s costs (inclusive of local authority costs) are significantly higher than those of established water utilities in other jurisdictions. To minimise any negative impact on service to customers, the CER expects Irish Water to drive efficiencies at a level that is broadly comparable to those achieved by other utilities at similar stages in their evolution” the paper says.

Irish Water is now required by the CER to deliver efficiencies of circa 20% within its base controllable operating expenditure over the period from the start of 2015 to the end of 2018.

On its reduction in capital costs allowed, the CER said it considers that Irish Water should be challenged to deliver the outputs and outcomes of its proposed investment plan more efficiently in the interests of customers.

The CER has decided on an efficiency challenge of €132m in relation to Irish Water’s capital costs for the period. A scope cut of €4m has also been applied. The CER will monitor Irish Water’s delivery of outcomes and outputs for customers for the allowed capital expenditure.

In line with the regulatory framework employed by the CER in the regulation of electricity and gas utilities, the CER has decided to put in place a number of incentives and penalties for the 2017-2018 period.

The regulator has decided that a combination of reputational incentives (through monitoring and publication) and financial incentives (through payments/penalties) will be utilised to incentivise Irish Water to improve its performance in key areas.

The areas where the CER has set financial incentives are:

• Rolling retention additional of opex efficiencies; and,
• Non-Domestic billing incentives.

The CER has decided to put in place a rolling opex incentive mechanism where Irish Water retains outperformance for a three-year period. This is intended to decrease costs to customers in the medium term. It has also decided to put in place the following three incentives relating to non-domestic billing:

• to allow for a 9.39% non-domestic bad debt provision for IRC1 and 5% for IRC2. This is intended to incentivise Irish Water to collect revenue from non-domestic customers to whom bills are sent.
• to allow Irish Water keep 42% of additional revenue billed if Irish Water can bill more connected properties above the baseline amount.
• to allow Irish Water keep 42% of additional revenue billed if Irish Water can bill customers correctly where customers have been charged less than they should have been charged.

The paper says Irish Water will be monitored under certain metrics through the Irish Water Performance Assessment - however, for the time being the CER has decided not to put financial incentives in place for these metrics.

It will also continue to monitor Irish Water’s compliance with the Customer Handbook - again, it has opted not to put financial incentives in place in relation to the handbook at this time.

Capex monitoring regime to be introduced in 2017

The CER is planning to introduce a monitoring regime in 2017 in relation to Irish Water’s delivery of capital investments under the  2017-2018 revenue control decision. It will monitor the delivery of capital investment at a global level by monitoring Irish Water’s performance against Irish Water’s stated targets associated with the final, approved capital expenditure allowance. The CER will also appropriately monitor other outcomes/outputs not captured directly in these targets.

The regulator will monitor Irish Water’s delivery of outcomes, outputs, timelines and budgets against an agreed baseline.

Larger projects with significant spend, including the WSP, Vartry, Cork Lower Harbour, the Greater Dublin Drainage Project and Ringsend, will also be monitored.

Irish Water will be required to report to the CER on a periodic a basis and reports on Irish Water’s delivery of capital investment will be published by the CER in an accessible format during 2017 post finalisation of the monitoring framework.

Click here to read the CER decision paper in full.