Every five years, Ofwat, the regulatory body for the water industry in England and Wales, undertakes regulatory assessments or ‘Price Reviews’ to determine the price limits water and wastewater companies can charge customers during each associated five-year Asset Management Period (AMP). Each review aims to balance the investment requirements for maintaining and improving infrastructure while ensuring customers do not overpay. As a part of this process, Ofwat requires each water company to produce a detailed business plan with proposals of what it aims to deliver, its investment plans, planned service improvements and the overall impact on consumers’ bills.
On 11th July 2024, Ofwat published its Price Review 2024 (PR24) draft determinations in response to the business plans submitted by England and Wales’s 16 water companies1. The final determinations for AMP8, which runs from 2025 to 2030, will be released in December 2024 after consultations are had with industry participants (see Figure 1). Per commentary from industry stakeholders in interviews conducted by Fairgrove, and based on historical revisions, we do not anticipate significant changes to be made between the draft and final determinations2. A new introduction for PR24 is the inclusion of long-term delivery strategies that set out how companies’ five-year plans fit into a wider 25-year strategy to meet future goals: long-term investment should result in capital being deployed more efficiently over a 25-year period.
Fig. 1: Timing of Regulatory Cycles
SOURCE: Fairgrove Research; Ofwat
What do Ofwat’s PR24 draft determinations include?
Public concerns over water quality, wastewater treatment and high-profile scandals have put a spotlight on the water sector. On 6th August 2024, Ofwat hit Thames Water, Yorkshire Water and Northumbrian Water with regulatory fines totalling £168 million for failing to manage water treatment works and breaching licence conditions. Inadequate management has been attributed to companies failing to upgrade or maintain and operate wastewater treatment works (For more information, see this Ofwat article). Furthermore, the proposed expenditure would impact customer water bills with the draft determinations meaning average bills would rise by £19 per year for water and wastewater companies, before inflation. However, this is a third lower than the original proposition in water company business plans which has led to a backlash from water companies who warn this will not be enough. Combined with environmental and financial underperformance and large executive pay packages, scrutiny of water companies is likely to persist in the public domain.
Substantial change necessitates significant investment, and Ofwat’s PR24 draft determinations support a considerable increase in spending. A record £88 billion spending package has been proposed by Ofwat for AMP8, which is 50% higher than the final determinations of £59 billion for AMP7 (See Figure 2). In the first three years of AMP7 (2020-2023), the water sector has overspent relative to its total cost allowances, almost all due to increases in base costs. Regarding enhancement expenditure for the same period, water companies have generally underspent with only 73% of forecast enhancement allowances being spent in the latest year with data (2022-2023). Ofwat have stated that it expects companies to improve delivery capabilities so that the water sector is in the best position to deliver the PR24 enhancement programme, but whether this transpires is still to be seen.
Fig. 2: Aggregated PR19 Final Determinations and PR24 Draft Determinations
N.B. The aggregate £91 billion total expenditure figure for PR24 does not equate to the headline of £88 billion cited in this article and the media because Ofwat does not split total expenditure after frontier shift and real price effects, so the data displayed excludes these effects.
The majority of the AMP8 package is expected to be spent on routine costs (i.e. day-to-day operational costs and maintenance of current infrastructure) while £35 billion is included as enhancement expenditure earmarked for investment into new infrastructure and resources needed to reduce pollution, improve customer service and water quality and to deliver a more resilient wastewater and drinking water ecosystem. With enhancement expenditure expected to be over three times higher in AMP8 than AMP7, we expect companies throughout the supply chain to be positively impacted. Private equity firms appear to be cognisant of this opportunity, with Fairgrove seeing early signs of an uptick in activity in the sector. Assuming the draft determinations do not change substantially going from draft to final, expenditure levels are set to be distributed between water companies as shown in Figure 3.
Fig. 3: PR24 draft base and enhancement allowances
See ‘PR24 Final Methodology – Glossary’ for a list of company acronyms.
What are the investment plans?
Ofwat’s draft determinations provide some indication of what and how different water infrastructure projects will be funded and delivered in AMP8. The two major investment buckets identified by Ofwat are ‘Improving our Environment’ and ‘Protecting our Water and Wastewater System’.
Improving our environment: Ofwat has proposed the largest environmental investment programme in the sector’s history (£20 billion). Of this, £10 billion is siloed for tackling storm overflows, with a target to reduce spills from overflows by 44% from 2021 levels. Examples of measures that have been introduced to reduce spills include investment in AI systems to help manage storm loads, the installation of in-sewer monitors to check flows and spot blockages early, and the recruitment and training of specialist staff.
Fairgrove has seen the impact that water infrastructure investment can have on the supply chain even prior to the ramp-up of AMP8. Fairgrove provided commercial due diligence services to NVM during its investment in MRO+ (Made up of MJ Wilson and Helix), a diversified industrial distribution group which has seen solid growth in the water market through the sale of water contaminant monitoring products.
Protecting our water and wastewater system: Due to the increasing pressure placed on our water system, Ofwat has included a package of water supply projects in the draft determinations, including building nine new reservoirs which will add a potential 670 million extra litres of water per day, once completed after 2030. Furthermore, seven new large-scale water transfer projects have been proposed in order to resolve drought issues and to preserve more sensitive water sites as well as 12 water recycling plants. Aside from new supply initiatives, Ofwat is challenging companies to reduce water consumption by 6 litres per person per day. To support this, £225 million of investment for demand-side improvements such as customer engagement and behavioural interventions has been included in the determinations, alongside a substantial smart metering programme (see Figure 4).
Ofwat has proposed a target to reduce leakage by 13% during AMP8 which will require £545 million of investment and the use of ‘smart technologies and better data’. This means that early detection (or even prediction) of leaks will be important, and operators may turn to novel techniques to manage them. For example, Fairgrove supported Gresham House in its investment in Rezatec, a geospatial data platform using satellite data and advanced analytical techniques to predict and identify pipeline leaks (among other offerings serving the forestry & agriculture sectors).
Fig. 4: Number of new meters and meter upgrades in AMP8
N.B. The proposed level of expenditure for new meters and meter upgrades is c.£1.56 billion. See ‘PR24 Final Methodology – Glossary’ for a list of company acronyms.
Innovation Fund: Additionally, Ofwat introduced an ‘Innovation Fund’ in PR19 (for AMP7), with the goal of increasing the sector’s innovative capacity through new, pioneering projects that go beyond standard industry practices. So far, it has supported over 90 innovative programmes including solutions for in-sewer heat recovery, smart meter gamification and open-source, scalable, digital models to help tackle waterbody pollution. Ofwat has proposed to double the size of this fund for AMP8 to £400 million.
Given that operators have historically struggled to manage assets, been hindered by ongoing supply chain difficulties, and are expected to meet stringent regulatory requirements (e.g. around Net Zero), they are likely to turn to specialist consultants for help. Fairgrove recently provided commercial due diligence support to BGF for its investment in Skewb, a leading provider of consultancy and digital transformational services that works with several water companies.
Conclusion
Despite this anticipated expenditure, the water sector is not without uncertainty: higher interest rates have caused issues in servicing debts and Thames Water has recently had its credit rating status slashed to ‘junk’ by S&P Global Ratings, leading to speculation around re-nationalisation. However, as we move into AMP8, record-breaking levels of investment are likely to create numerous opportunities for a broad range of suppliers to the water industry including manufacturers (e.g. infrastructure, sensors, water treatment equipment), software providers (e.g. AI-enabled blockage monitoring, supply-chain management) and consultancies (e.g. operational, recruitment, specialist). This opportunity is not isolated to the UK due to the widespread need for advanced technologies like real-time data monitoring systems and solutions for aging water infrastructure. International demand for modernisation, regulatory compliance, and sustainability offers a significant opportunity for UK-based companies, particularly for those companies offering products and services with widespread applicability.
We believe this environment creates a rising tide of investment opportunities for those firms seeking to capitalise on the growth potential within the water industry supply chain.
Our Experience
If you would like to discuss this article or are considering investment in the water and wastewater market, please contact Paddy Woods Ballard or Charlie Allen for queries relating to professional services firms serving utilities markets. For water and wastewater products and technical services, please contact Alex Bridle or Oli Lestner.
Footnotes:
- Ofwat’s draft determinations removed £16 billion from water companies’ business plans reflecting its analysis of those plans. This involved reducing unjustified costs including non-necessary expenditure, inefficiencies or for activity that has already received funding as part of the base expenditure.
- For PR19, the gap between the company’s final business plans and Ofwat’s final determination was 0.4% for base expenditure and only 5% across all Totex (See source 5, page 7).
Sources:
- [1] Ofwat – PR24 draft determinations: Sector Summary, Expenditure Allowances and Glossary
- [2] Ofwat – Thames, Yorkshire and Northumbrian Water face £168 million penalty following sewage investigation
- [3] Ofwat – Key facts and data from water company plans
- [4] Water Magazine – Ofwat sets out record £88 billion upgrade as part of the 2024 Price Review
- [5] Transcript of the Ofwat investor call (16th December 2019)
