The Institution of Civil Engineers has written to the Competition and Markets Authority expressing its concern over Ofwat’s backward looking econometric historical model and calling for it to be replaced with a more forward looking model at future Price Reviews.

The leading UK civil engineering organisation has written to the CMA following the publication of the CMA’s Provisional Findings in September 2020.

ICE said it is primarily focused on civil engineering assets which are long life – its main aim in writing was to “reemphasise the need for revisiting the approach to asset maintenance for future Price Reviews.”

Writing to Kip Meek, Chair of the Special Reference Group conducting the CMA inquiry,  David Hirst Chair, ICE Management Expert Panel, said that although deterioration may be slow, assets can fail catastrophically, jeopardising system resilience and appropriate monitoring and maintenance was therefore required, commenting:

“Much of the existing infrastructure was designed and built decades if not a century ago to different design standards which may no longer be appropriate for recent changes in the severity and frequency of extreme climatic conditions and changes in societal expectations.”

In ICE’s view, despite the addition of new assets, the overall age of water company assets is increasing, accompanied by associated deterioration in condition and impacts on serviceability.

“This means that targeted monitoring and more maintenance is required to maintain, let alone to improve system resilience,” the letter says.

According to the engineering body, while the frequency and severity of interruptions to water supply and failures of the sewerage system may be greater on older assets, the risks to newer assets should not be overlooked.

The letter cites innovative materials introduced in the 1960s and 1970s, such as pvc pipes and unlined ductile iron pipes with lower capital costs, which have aged faster with greater risk of bursts than conventional materials such as lined cast iron pipes.

Hirst said that ICE was pleased to see that CMA has recognised the importance of resilience as a crucial element of water sector infrastructure and had provided additional funding to allow for more resilient networks, as well as enabling the companies to achieve substantial reductions in leakage.

However, he went on to warn:

“ ICE considers that disproportionate emphasis has been placed on the assessment of econometric models based on historical costs and that little weight has been given to future requirements based on engineering assessments of asset health, condition, and serviceability.”

“ICE is concerned that there has been overreliance on econometric models to assess the capital maintenance needs of assets which have a working life of many decades.”

The letter says ICE was pleased to see CMA’s acknowledgment of the argument that “…Ofwat’s cost assessment is backward looking” and the CMA’s suggestion that the regulator should enhance its analysis with “a forward-looking element that will assist in triangulating results from its econometric modelling of historic costs.”

ICE believes that Ofwat’s models do not incorporate sufficient consideration of the assets’ ability to continue to deliver a service to the customer nor predict the investment needed to maintain it.

The letter says:

“These assets now have a presumed working life which exceeds their original design lives and the period over which there is reliable data. As such, there is a growing concern that the sector is heading for increased asset failure (in both number, frequency, and consequence) as the projected working life of assets lengthens “

“The industry has a historic tendency of reducing capital maintenance expenditure (often badging it as efficiency) to meet the constraints of the funding, as calculated using the econometric models, rather than the long-term investment needs of the assets.”

ICE  is calling for future Price Reviews to incorporate the following:

• The outputs of econometric modelling should be interpreted with engineering judgement aimed to ensure that the water sector’s multi-generational assets remain fit for purpose into the future;
• The requirements for capital maintenance must be forward looking not backward looking;
• The treatment of Infrastructure Renewals Expenditure (IRE) solely as an operating cost funded by current customers should be reviewed;
• Consideration should be given to splitting the price controls for maintenance from enhancement, with the former for a much longer period (25 years) linked to outputs and with only minor adjustments every 5 years;
• “Best-value” considerations, rather than “Least-cost” should be the basis for the appraisal of alternative infrastructure options; and
• Use of best practice asset management approaches from all infrastructure sectors.

David Hirst concludes:

“ICE would welcome the opportunity to participate in the consultations on Ofwat’s methodology for PR24 in the early stages when the thinking is being developed.”