December 2008
This note provides background information on the Capital Expenditure Incentive Scheme (CIS) baseline published by Ofwat.
Background
Every five years, the water regulator (Ofwat) sets price limits for water and sewerage services and the package of investment and service levels that must be delivered within these price limits.
Investments and prices for the 5 years from 2010 to 2015 will be set by Ofwat in November 2009, as the result of a detailed process lasting over two years. Already, there have been two key steps:
December 2007
Companies produced 25-year Strategic Direction Statements setting out their vision for the future of water and sewerage services
August 2008
Companies published Draft Business Plans setting out proposals for investment and prices after consulting widely with customers and other stakeholders
Whats happening now?
Since companies published their Draft Business Plans in August, companies and other stakeholders have been reviewing the plans. The next key step is new for this price review in December Ofwat published details of the draft baseline under the Capital Expenditure Incentive Scheme (CIS).
What is the draft baseline?
In their Draft Business Plans, water and sewerage companies proposed to deliver a range of outputs to meet the priorities of their customers. Most importantly, these included maintaining their assets to ensure that past gains in drinking water quality and environmental performance are safeguarded, and that services are resilient to climate change. Further environmental improvements were also proposed in total, companies plan to invest over £27 billion over the next five years.
In the draft baseline, Ofwat will set out their initial view of this proposed capital investment programme. This will cover both the scope of the programme where is investment needed and the likely cost of the programme how much investment is needed. It will, however, be an initial, draft view, as not all the information needed to set the final baseline is available.
What is the CIS?
At price reviews, Ofwat sets price limits, which include an amount for the capital expenditure which is required to maintain and improve services. If companies can deliver this investment for less than Ofwat assume it will cost, then they keep some of the saving as a reward giving companies an incentive to deliver investment efficiently.
This new CIS is similar to a scheme used in energy regulation. Ofwat intend it to build on the current arrangements, by improving incentives for companies when they plan and deliver their capital expenditure. The idea is that a company that sets itself and then beats a challenging target cost for delivering its capital investment will get a greater reward than a company that sets a less challenging target. How this will work in practice will depend on how the details of the CIS and baseline are set.
What happens next?
The details of the baseline and the CIS are complex, and companies will need to study and understand the technical information that Ofwat has provided to them. In particular, companies will need to confirm that the scope of investment specified in the baseline is consistent with the expectations of the quality regulators, the Environment Agency and the Drinking Water Inspectorate.
As Ofwat has said, there will be some outstanding issues with the draft baseline, and there may be some points where additional information is needed by Ofwat. Companies will work with Ofwat to resolve these issues, as far as possible before they publish their Final Business Plans in April 2009.
Rob Wesley, Policy Adviser
