AMP7, Two years in

This article was first published in The Water Report

The water industry entered year two of the AMP under very challenging circumstances. Off the back of arguably the most demanding settlement in its history, multiple performance commitments in year one had been missed by many companies with, at worst, all of them missing the per capita consumption (PCC) commitment. With the Covid-19 pandemic beginning to ease, we could all have been forgiven for thinking that year two of the AMP would be more like plain sailing. It was not to be; although the winds have changed, the course has arguably been just as choppy and all the signs are that it is getting worse as we move into year three. We have examined performance in year two against a backdrop of global and sector pressures to understand how companies can continue to show their resilience and build a successful year three.

Back on course after Covid?
Year one of the AMP was difficult. All companies missed their PCC targets, 70% failed their internal sewer flooding targets and 63% missed CRI. These underlying issues from year one were compounded by a number of unforeseen factors in year two. In particular, economic pressures have increased significantly with inflation (CPI) breaching the government’s 2% target in May 2021, rising to just under 8% by April 2022. Continued labour shortages are impacting both costs and the ability of companies to deliver. Perhaps unsurprisingly, this has resulted in another difficult year in terms of meeting key performance commitments, as illustrated in the table. While the overall outcome is challenging, there are some positive signs. Companies generally performed significantly better on leakage, which has had significant media attention in recent times, and mains repairs. Achieving this increase in performance against a backdrop of labour shortages and extreme weather events is significant. The good work on leakage indicates that water companies are responding to the challenge set by Ofwat, ongoing media attention and societal awareness.

They should also be congratulated on mains repairs, which have improved from over half missing their target in year one, to just 6% in year two. However, year two saw an increasing number of penalties for sewage treatment works compliance breaches and water supply interruptions failures, with treatment work compliance failures seeing the largest increase in the proportion of companies incurring a penalty. Failure to meet PCC requirements saw penalties across the board in year one. However, following a consultation in 2021, and in the wake of ongoing uncertainty over water usage patterns post-pandemic, Ofwat released guidance that ODIs would be calculated at the end of the period. Notably, 86% of companies missed their year two targets for this PC, which is a material improvement from year one.

This recognises the efforts they are making, and also the changes in exogenous factors that are still at play, such as the proportion of people working from home compared to pre-pandemic levels. However, we should be cautious about drawing conclusions on the numbers meeting their PCC targets as water consumption patterns continue to change due to the geographical impact of working from home instituted during Covid-19. While Ofwat and societal pressure has arguably contributed to progress on leakage, there has been less progress on reducing pollution events, another PC that has come under recent scrutiny, as almost half of companies still missed their targets.

Gathering headwinds
Rising inflation and the energy crisis were already impacting companies in year two. This is now compounded by the drought which brings severe operational challenges and, perhaps more importantly, will increase the need for customer engagement. Inflation is a significant issue as it drives up costs for companies and this will get worse with the Bank of England now forecasting inflation will hit 13% in Q4. It is also important to recognise that the headline CPI inflation figure, which helps in form allowances under PR19,does not tell the whole story: the cost of several commodities and consumables, upon which the industry is reliant, rose at a rate far beyond inflation between April 2021 and April 2022. For example, the chlorine cost index rose by 63% and lime (Calcium Hydroxide) by 15%. Most notably, energy costs are projected to triple by the start of 2023.The current drought is likely to have a similar impact. The National Drought Group has declared an official drought. Water rationing may take place across the country, with fewer barriers for water companies who wish to ban customers from using water for specified activities.

This will increase the need for excellent engagement with customers and stakeholders. Customers will need to work with companies in managing water scarcity and it will be a challenge to maintain relationships. Affinity Water’s award winning ‘Save Our Streams’ (SOS) campaign is one recent example of how companies are taking a full multi-channel approach, including bringing together celebrities, support from politicians and the local population to great effect. Nearly 200,000 of Affinity’s households have now signed up to actively support the campaign to protect chalk streams in the region. Broader stakeholder engagement is also vital, including the media, where there is already considerable negative press on leakage in particular and growing interest in CSOs.

Steering the right course
All this begs the question: where do we go from here? Water companies have onerous targets to meet by the end of the AMP. They will need to balance meeting these targets with preparing themselves for AMP8, where the recent PR24 draft methodology indicates a continued focus on improving performance and driving efficiency. With many already struggling to deliver incremental improvement from the baseline so far in AMP7, new solutions will be needed to address enduring problems and manage increasing costs. Many of the negative events and pressures felt by companies over the last 12 months are largely out of their control. This means that they must target their efforts around how they respond and deal with their impacts. There are three key actions companies must take immediately in year three to set themselves up for success:

1. Engage the supply chain to build resilience – Contractors and suppliers are integral to the delivery of company operations. With so many complex challenges to overcome to be successful in AMP8 (and therefore be ready for AMP9), companies need to secure significant quantities of quality resources and apply innovation. However, contractors and suppliers are looking for stable revenue and cashflow, and with a booming UK infrastructure market, the sector will face stiff competition to ensure these skills and resource don’t go elsewhere. Longer term collaborative deals have been much talked about, but now is the time for companies and their supply chains to put these in place. These arrangements will provide stable access to expertise and innovation, critical to both delivering Long-Term Delivery strategies (LTDS) and also dealing with more reactive and unpredictable incidents which are increasingly common with ageing asset bases and greater extremes driven by climate change.

2. Build robust commodity strategies – Given current market conditions,there is limited benefit in companies trying to act if they are not already hedged on energy and power purchase agreements. But there is time to put in place forward measures to capitalise on energy from waste, photovoltaics, battery storage, and other energy self-sufficiency plans. The more they can lessen the impacts of market volatility, the greater their ability to focus resources on core (and ever challenging) operations and the achievement of customer and stakeholder ambitions. Buying club models can also combat inflation and scarcity of supply in other areas. We are seeing a significant uptake in willingness to collaborate on purchase of chemicals, critical spares and equipment which has uncertain or long lead times, but to do this companies need to have flexible procurement arrangements in place.

3. Asset insight driven long-term planning – There is no shortage of guidance on asset and system planning, with WRMP, DWMP and WINEP now being supplemented with a need for LTDS. To make evidence- based decisions to guide these plans and strategies requires stronger asset intelligence. This greater asset insight will allow companies to use their existing infrastructure and resource more efficiently. There is still much to do across the sector to improve the quality of asset data, how it is stored, maintained and used. Technology is not the constraint it used to be in gaining greater asset intelligence. Companies should focus on the insight required to develop plans and the quality of data needed to generate that insight. Committing to the unglamourous activities of data management and process compliance will help the industry truly understand the risk and resilience in its asset base, and Ofwat should provide a level of reward and recognition for this in how it adjudicates on base cost allowances.

Crisis to opportunity
The industry is at a tipping point, with drought now taking over from the CSO and pollution in driving public opinion about the sector’s performance. Affordability and customer service challenges persist, and financeability is emerging as a challenge given asset performance risk and uncertainty.PR24, and the requirement for LTDSs, present the perfect opportunity for companies to respond to this by doing something dramatically different – be that innovative supply chain engagement mechanisms and commodity purchase arrangements or approaches to asset insight generation. Now is the time to really make a step change. Ofwat is looking for ambition, and the industry is looking to commit to something different. The sector needs to shift its artillery towards building credible and exciting execution plans to deliver on the vision and ambition we all share for the sector.