Wednesday, February 4, 2009

£19bn of water work expected in AMP5

The water industry in England and Wales is currently in the midst of a game of regulatory ping pong with its economic regulator, Ofwat.  Annabel Andrews explains what work contractors can expect.

£19bn of water work expected in AMP5

The water industry in England and Wales is currently in the midst of a game of regulatory ping pong with its economic regulator, Ofwat.

This process is called PR09 and will set out how much money companies can spend between 2010 and 2015, (the period known as AMP5).

Last August, the companies submitted draft business plans, containing their views on how much money they think they need to spend. The companies proposed ВЈ27.4bn capital investment during the period, including ВЈ493m individual large water projects and ВЈ1.3m on individual large sewerage projects.


£19bn of water work expected in AMP5


Ofwat countered companies' draft business plans in December 2008 by publishing its draft 'baseline'. This figure is the regulator's view of how much the companies should spend during AMP5. This cut proposed expenditure by 22%, to ВЈ19.1bn, although this didn't include London's huge Thames Tideway sewer scheme, which will be dealt with separately (panel, opposite).

If the baseline is anything to go by, capital investment in AMP5 will be slightly higher than that in the current five-year period, AMP4, which was ВЈ16.8bn. Paul Mullord, UK director of supply chain association British Water, says: "I think the expectation is that it will be higher this time and in the current climate that's good news."

With the economic downturn hitting contractors elsewhere, the ongoing, regulated investment in the water sector may be attractive to firms who haven't previously worked in the sector. Mullord says that in the 1990s downturn, new contractors rushed into the water sector with very low margins as work dried up elsewhere.

However, he adds: "They didn't actually know what they were doing, so they fell by the wayside. I think it's fair to say that although the companies benefited from those low prices, they suffered from those companies' lack of experience."

Terry Povall, head of utilities at consultants EC Harris, is a veteran of five price reviews. He accuses Mullord of being "a little bit protective of [British Water's] members". He says: "At the end of the day, a JCB is a JCB, whether it's digging a hole for a foundation or whether it's digging a hole for a pipe."

Shift in supply chain

He agrees that in the 1990s there was a "big shift in the supply chain" and "obviously there was some fallout", but cites a number of companies which made the move into the water sector and stayed there.

He says: "Galliford Try, for example, was a highways contractor. When that market deflated in the 1990s, it moved into water. It's got a fantastic track record now in terms of water, and good client feedback from several of the water companies. Interestingly enough, it is not a member of British Water."

His advice for both established and new-entrant water sector contractors would be: "What good contractors do is look for where they can really add value for the client, and not fool them about where they can't add value. That's the trick, and they are the ones that you see working period after period with the same client."

The water industry shouldn't, however, be seen as a magic solution to contractors' woes. The housing downturn is hitting here, too, as any large housing scheme shelved will reduce water infrastructure and connections work. In addition, there is traditionally a lull in capital works around the changeover of an AMP.

Duncan Wildgoose, business development manager at contractor ImTech, says: "What we've noticed is that in some water companies [the lull] has happened earlier. It is noticeable that a number have shelved or cancelled a number of schemes until the next period, as if they've run out of money."

But, Mullord says, there is no reason to despair: "It could be that they are more ready to start work early in AMP5, so it might be that the trough in the cycle has been bought forward."

Severn Trent Water is one of the companies that has made considerable headway into finding partners for it's proposed ВЈ3.2bn AMP5 capital investment scheme, which includes around ВЈ2.7bn work for contractors.

Paul Goddard, commercial director, says: "We've gone to market one year early. I think that was very much appreciated as we've broken the cycle of all the water companies tendering at the same time."

For the first time, contractors are vying for a 10-year contract with the company, for a co-located, integrated design and build model. "Obviously there's a huge investment in doing this in terms of time and money," says Goddard, "so we are putting in place contracts for 10 years with our contractors. This gives the supply chain opportunity to invest in people."

Severn Trent has been in negotiations with contractors for 12 months, with the initial 47 contenders whittled down through five stages to the current 12. The final cut will be announced in late February.

Goddard says: "The selection process has been predominantly about a fit of all the members of the supply chain. Can the contractors and ourselves work together? We were down to 12 contractors before we'd talked financial numbers at all. Only 20% of the final selection will be financial." The rest of the selection will be made on areas such as health and safety, corporate social responsibility and environmental factors.

Online auction

Once it was time to talk numbers, Severn Trent replaced weeks of negotiations with a one-hour-long online auction for fees, where contractors bid and were able to see their relative position in the pack and bid again. Goddard says: "We were able to get to a market rate much more quickly. Time is money - it's less effort for everybody."

Povall says that the shape of all the companies' proposed spend is different this time: "Our opinion is that the current AMP5 business plans actually represent quite a significant shift in the type of work than we've seen in the previous AMPs. It's more maintenance orientated rather than major refurbishment type works."

He cites as an example South West Water, which has gone public that the average size of each project within its ВЈ800m draft business plan will be about ВЈ75,000. Povall says: "That's a huge shift in the type and size of contract. That shift towards maintenance is also being reflected in other peoples' plans."

One area where Povall predicts we won't see much change is in terms of the type of contracts up for grabs. "Have they picked up and taken on board lessons learned from AMP4? The answer to that is probably no it's very much going to be business as usual, with a few frills and bows around the outside."

Water / sewerage capital programmes, 2010-15

Upcoming proposed water and sewerage capital programmes for 2010-15 broken down by company.

Thames Water ВЈ6.5bnUnited Utilities ВЈ4.0bnSouthern Water ВЈ2.6bnAnglian Water ВЈ2.5bn Northumbrian Water ВЈ1.3bn Severn Trent Water ВЈ1.3bnYorkshire Water ВЈ1.9bnWelsh Water ВЈ1.5bnWessex Water ВЈ1.2bnSouth West Water ВЈ0.8bn

In addition, in December 2008, regulator Ofwat estimated that the total investment by the water and sewerage companies between 2008 and 2010 should be in the region of ВЈ8bn, including ВЈ500m of investment that water companies have requested to bring forward from AMP5.

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