Ofwat has published new guidance setting out its expectation for water companies in England and Wales to deliver all projects worth £200 million-plus via Direct Procurement for Customers (DPC) in their business plans for the 2024 Price Review.

In addition, the water sector regulator is also reserving the right to explore the use of DPC for major projects below this size threshold, where it could offer value for money for customers to do so.

Ofwat introduced the DPC process as part of the Price Review in 2019 (PR19) for water companies to competitively tender for a third-party Competitively Appointed Provider (CAP) to design, build, finance, operate and maintain infrastructure. For PR19, companies were required to consider DPC for discrete, large-scale enhancement schemes expected to cost over £100 million, based on whole life totex.

Introducing the new guidance, Ofwat said:

“This initiative has the potential to provide significant benefits for customers through promoting innovation and enabling capital and operational cost savings as well as a reduction in financing costs…..

“DPC promotes innovation and resilience by allowing new participants to bring fresh ideas and approaches to the delivery of key schemes.”

The guidance sets out the regulator’s expectations for the commercial model applicable to DPC projects and the approval and assurance processes to support DPC projects, including:

• the regulatory framework for DPC projects and how this interacts with the commercial arrangements;
• the approvals process and Appointee assurance processes for DPC projects
• draft principles for how Appointees should assess value for money (VfM) for DPC projects
• a standard, efficient risk allocation for DPC projects
• the commercial arrangements including incentives on the CAP and the water company;

Ofwat said the guidance is intended to provide confidence in the regulatory framework to ensure appointees and investors can understand Ofwat's requirements for DPC projects and the regulatory framework underpinning it.

The guidance is also aimed at enabling flexibility in the framework: Ofwat is also open to different approaches where a water company can explain why an alternative approach may be more appropriate and can demonstrates how this achieves best value for customers.

The guidance says that in general, the costs of a DPC project will not be part of a Price Review - instead, Ofwat will issue an Allowed Revenue Direction which will enable a water company to recover the costs payable to the CAP from customers. The CAP Agreement (and the Allowed Revenue Direction) are expected to be long term arrangements that will span multiple Price Review periods.

The water companies will need obtain Ofwat's consent at key points in the development process, the procurement process, and before entering into a CAP Agreement. In addition, there may also be clauses in the CAP Agreement that require Ofwat's consent during the life of the DPC project.

In terms of project lifespan, Ofwat expects the duration of DPC projects to be in the region of 25 years with flexibility for longer durations e.g., 40 years + where that reflects the requirements of the DPC project, and it represents best value.

“Factors which may be relevant in considering a longer-term contract may include the nature of the asset and the services required, the requirements of any likely providers of debt, the Appointee's pre procurement market engagement, value for money testing and the useful economic life of the assets,” the guidance says.

The guidance also points out that the commercial arrangements being considered by Ofwat are likely to be applicable to RAPID schemes delivered by DPC.

In developing the guidance, the regulator said it has had regard to sector specific infrastructure procurement template agreements, including:

• the Thames Tideway contract suite
• other regulated infrastructure procurements e.g. the Ofgem Offshore electricity transmission regime (OFTOs)
• standard form project finance models that exist in the UK (e.g. SOPC 49 and the Mutual Investment Model utilised by the Welsh Government).

The guidance says the project finance models may provide template drafting for many of the contractual processes and mechanisms that may be appropriate to be included in the CAP Agreement. They can also provide templates for much of the standard legal drafting that will need to be included in the CAP Agreement.

Ofwat has also referred to the Infrastructure and Projects Authority Project Development Routemap which has guidance for organisations embarking on infrastructure projects.

Commenting on the start of a revenue stream to to the CAP delivers best value for customers, the guidance says it is usual in project finance projects for payments to commence after the assets are constructed, commissioned and available for use. This approach puts construction, completion, and commissioning risk on the CAP (and its supply chain) responsible for delivering the project.

However, Ofwat cautions:

“We recognise that this approach may not always be best value for customers and in some cases, it may be better for customers to start paying before the end of construction.”

Ofwat is now seeking comments on the content and approach set out in the guidance – deadline to respond to the consultation is 7 October 2022. Click here to download the consultation document.