The Water Industry Commission for Scotland has said that that insufficient attention has been paid by both the regulator and Scottish Water to futureproofing levels of service and that the water company will need to do  more work on maintaining long-term assets.

The warning comes in a series of Intial Decision Papers published this week by WICS setting out the Commission’s current thinking on the upcoming 2021-27 price control.

The papers provide the Commission’s views on:

• Strategic issues facing the industry that will impact levels of service beyond the next regulatory control period;
• The prospects for customers’ charges during the next regulatory control period;
• Issues that directly and materially impact the charges that customers will pay in the next regulatory control period;
• The potential for Scottish Water to engage even more effectively with its customers; and
• The approach to the Strategic Review of Charges 2021-27.

In the Commission’s view the regulatory framework to date has not focussed sufficiently on the effective maintenance of long-term assets. According to WICS, the price setting process has sought to ensure that the regulated company faces a hard budget constraint over the regulatory control period.

However, the paper says:

“ While this has been very successful in improving operational efficiency, it appears that insufficient attention has been paid (by both regulator and regulated company) to futureproofing levels of service.”

Scottish Water operates an asset base with an estimated replacement cost of more than £60 billion. There are 48,000 km of water mains, 50,000 km of sewers, 244 water treatment plants and 580 sewage works, together with many smaller assets.

The regulator says that Scottish Water will need to improve their understanding of the costs that will be incurred over time as assets approach the end of their lives and need to be replaced to enable a fair allocation of costs between current and future customers.

The Commission has agreed an approach with the water company to improve industry understanding containing five stages:

• Scottish Water plans to understand fully the maintenance profile at the PFI sites and the lessons that can be learned;

• Scottish Water intends to confirm its understanding of the MEAV of its assets, the proportion of expended life and the most important failure modes and consequences;

• Scottish Water is continuing to develop detailed asset maintenance plans covering all its ‘critical assets’

• Scottish Water is currently setting out its plans to improve its understanding of assets in the second ‘pro-active management’ category; and

• Scottish Water is also reviewing the assets that it considers can be fixed if and when they fail.

However, the Commission has recognised that this will take some time and acknowledges it will not be complete before the next regulatory control period, commenting:

“For each of these steps, joint work is underway exploring areas such as the information required, the financing of the investment, the monitoring of the assets and the communication with stakeholders. This is a long-term project covering multiple areas and may take many years.”

"Likely that customers will face higher costs associated with asset maintenance and replacement in future"

WICS also says it seems likely that customers will face higher costs associated with asset maintenance and replacement in the future:

“Scottish Water seems to be doing a good job of maintaining its performance with the current allowed for level of maintenance, but this level looks likely to be insufficient to maintain and replace assets over the longer term. “

The Scottish regulator has set out three ways in which it could potentially address this maintenance challenge as follows:

• to continue to make allowances consistent with demonstrated need.
• to make additional annual provisions such that major asset replacement can be managed without any material adverse impact on customers’ bills (a ‘sinking fund’ or ‘project finance’ approach).
• to follow the lead of Dwr Cymru and reduce the level of outstanding borrowing such that there will be available borrowing capacity when assets reach the end of their life.

Each of the options has significant implications for both the Scottish Government (both as owner and policy maker) and Scottish Water.

In a separate Decision Paper, WICS has identified an initial range for capital investment during the next regulatory control period of between £3.4 billion and £3.8 billion (at 2012-13 prices).

The regulator’s methodology for the Strategic Review of Charges 2021-27 also explained that Scottish Water is likely to have to invest more and may have access to less borrowing, and that it would be in “ the customer interest to ensure that Scottish Water faces a hard budget constraint.”

The work by the Commission on the price control, which will be finalised in March 2020, has, in effect, to consider the cash resources that Scottish Water will need over the regulatory control period.

The level of borrowing available to Scottish Water is capped: the Commission could decide to advise the Scottish Ministers to make less borrowing available to Scottish Water, but could not decide that more borrowing would be appropriate.

The borrowing cap applies irrespective of the source of the debt finance (for example, Scottish Water’s overdraft facility at the Bank of Scotland).

Click here to access WICS Initial Decision Papers