Ofwat has written to the water and sewerage companies to clarify its position on how renewable energy will be treated under the forthcoming PR09 Price Review. The water and sewerage sectors are directly responsible for approximately 1% of the UK's total emissions. Power costs resulting from energy intensive distribution and treatment processes form a significant percentage of operating expenditure.

According to Ofwat there is a real opportunity for the water and sewerage sectors to innovate and show leadership on the journey to a low carbon economy. Some of the sectors' core assets and processes can be harnessed to allow the generation of electricity - including the use of hydroelectric schemes at reservoirs, combined heat and power and methane from sewage sludge.

In March 2008 the regulator set out its position in 'Setting price limits for 2010-15: Framework and approach'  Where renewable energy is generated as a non-appointed business or is undertaken by an associate company, Ofwat expects the appointed business to be able to demonstrate that it is trading at arm's length. Ofwat wrote to all companies in February this year to ask how they were accounting for income, costs and assets relating to energy generation.

Ofwat said that as a result of this exercise it was clear that many companies were not following the existing guidance in the Regulatory Accounting Guidelines (RAGs) and that further clarification  of its guidance on accounting treatment was required. The regulator referred to clear inconsistencies in accounting treatment, particularly for Renewables Obligation Certificates (ROCs), levy exemption certificates and the national grid reserve service (NGRS). In Ofwat’s view the differences in treatment have implications for its assessments of relative efficiency and for price setting.

Ofwat has now set out a timetable for the changes which will result from the issue of revised guidance, starting in July/August 2008 when Ofwat will be following up with companies to clarify where income and costs relating to energy generation have been reported in the 2008 June Returns. In autumn 2008 Ofwat will provide its feedback on renewable energy proposals in the water and sewerage companies’ draft business plans in advance of post-draft business plan meetings.

Renewable energy is becoming an increasingly important issue for the water companies, together with shadow carbon accounting which is also likely to assume a key role. The publication of last week’s renewable energy strategy by the Government will be examined with interest by industry stakeholders and will undoubtedly drive energy use even higher up the water companies’ business agenda.