Ofwat has told the water companies that they have more to do on developing their long-term delivery strategies - at PR24, Ofwat expects companies to develop their five-year business plan in the context of a clear 25-year strategy.

Writing to Regulatory Directors at all the water companies yesterday, Aileen Armstrong Senior Director, Company Performance and Price Reviews has set out the regulator’s reflections on development meetings which have taken place with the companies on PR24 long-term delivery strategies.

Long-term delivery strategies are being produced for the first time at PR24. in April 2022 Ofwat published PR24 and beyond: Final guidance on long-term delivery strategies setting out how it expects companies to develop their strategy, so that it can “meaningfully inform decision-making as part of the price review.”

Explaining this in context, Aileen Armstrong says:

“The challenges facing the water sector require a clearer focus on the long-term needs of customers, communities and the environment. We expect the strategies to represent a significant shift towards long-term adaptive planning in the sector. Delivering against higher stakeholder expectations will require major new investments at PR24 and beyond, creating upward pressure on bills. This underlines the importance of strong adaptive planning, so that the right investments are made at the right time.”

Ofwat’s expectation is for strategy to be developed in the context of a wide range of future scenarios - via adaptive planning, companies should ensure their actions and investment programmes take account of uncertainty and can efficiently adapt to different futures.

According to Aileen Armstrong, this will help to deliver long-term ambitions and targets, “for example on leakage, greenhouse gas emissions, and storm overflows, in a way that maximises best value.”

She went on to say:

“While we have been encouraged that our ambition to increase the focus on the long term is widely shared across the sector, some companies have significantly more to do to meet our expectations.”

In particular, Ofwat has identified key concerns in the following areas:

• Core and alternative pathways: some companies need to do more to identify low-regret investment in line with Ofwat’s definition, establishing what activities are needed now, and where decisions can be scheduled later in the timeline.
• Scenario testing: companies should ensure their strategy is robust to a wide range of futures. This includes applying the common reference scenarios for technology and abstraction reductions in line with Ofwat guidance, alongside other common and company-specific scenarios.
• Delivering improvements from base expenditure: Ofwat is concerned that some companies are not sufficiently challenging themselves to deliver stretching levels of performance from their base allowance, in the short and long term.

PR24 submissions that don't meet Ofwat's minimum expectations "will receive financial, procedural, and reputational penalties”

The strategies will inform Ofwat’s assessment of proposals for enhancement investment at PR24. The letter says:

“They will be a key part of the evidence to justify the scale and timing of need for investment in 2025-30. They will also form part of the evidence base that the proposed investment is the best option for customers in relation to whether operational, phased or modular, or more flexible options may be more appropriate…..

“Long-term delivery strategies will be assessed as part of our quality assessment at PR24, where submissions that do not meet our minimum expectations will receive financial, procedural, and reputational penalties.”

The letter is accompanied by a detailed Annex setting out Ofwat’s further reflections on the development meetings and the key points of feedback companies need to address when finalising their strategies.

In September 2022, Ofwat invited each water company to a meeting to discuss the development of its strategy and to prepare a presentation demonstrating how they are developing their strategy in line with Ofwat’s guidance.

The Annex repeatedly flags up that the best presentations on a number of key issues demonstrated that the company's approach is following the regulator’s guidance most closely.

"Limited evidence that technological development is informing decision-making around how enhancement activities should be phased over long term"

The Annex also makes specific reference to the need for technological developments to inform phasing of activities, saying:

“While most companies stated they were testing our common reference scenarios for technology, we saw limited evidence that technological development is informing decision-making around how enhancement activities should be phased over the long term.”

It goes on to point out:

"It is important that an adaptive strategy does not assume technological development is static over time and is informed by scenarios where technological development could be faster or slower than current trends.

"Technological development and adoption, such as smart networks and low-carbon innovations, will play a significant role over the next 25 years to reduce costs and improve outcomes.

"We expect companies to use the reference scenarios to explore the potential impact of technological development on the relative costs and benefits of options. Companies should also consider the impact of a wider range of technological developments."

The Annex also references the regulator’s expectation for companies to engage with customers and wider stakeholders to develop their long-term delivery strategy, saying:

“..We consider most companies could have done more to demonstrate how this engagement was driving decision-making and culture change….

“Companies should use customer engagement to inform their ambition, the selection and sequencing of key investments, and considerations about affordability and fairness between current and future customers.

To enable a fundamental shift towards a long-term mindset, company Boards need to own and be accountable for their strategies…..company Boards should challenge company management to ensure the strategy is the best it can be.”

Click here to download the letter and Annex 

Click here to download Ofwat's PR24 and beyond - final guidance on long term  delivery strategies