The boom and bust effect

The five-year regulatory cycle does not work, writes Chris Hoggart of the EIC. Why not simply have staggered investment programmes so that water companies are not all running to the same cycle?

Over the years, since the water industry in England and Wales was privatised in 1989, many column inches in the general and trade press have been devoted to the challenges and difficulties associated with the five yearly regulatory cycle.

In recent years, however, much debate has centred on the financial and managerial inefficiencies and instabilities that this system engenders in the water industry's supply chain as a result of the uneven nature of expenditure that results. This boom and bust effect is clearly leading to significant procurement inefficiencies and ultimately to higher costs for consumers.

The Environmental Industries Commission (EIC) Water Pollution Control Group has run a high-level lobbying campaign with ministers and Ofwat to get recognition of this issue.

UK Water Industry Research (UKWIR) clearly recognised this issue as a potential problem last year when it initiated a project aimed at assessing the effect of the five-year investment programme on the industry as a whole.

The report from this project, produced with the support of Ofwat, entitled The regulatory cycle and its impacts on the efficiency of the supply chain delivery, was published in late summer 2007. Some of the important conclusions that emerged from this study were:

· Estimates of the potential efficiency savings that water companies thought they might realise ranged from zero to 3% (with an overall average of 1%)
· All of the water and sewerage companies stand to make multimillion pound annual savings by reforming the current system (based on AMP4 expenditure levels)
· Eighty-five percent of suppliers thought that the water industry's investment cycle had a negative impact on their businesses

The above shows that there are clearly some important financial savings to be made as, while the percentage savings might be relatively modest, the actual cash sums are significant and would require much more effort to save by other means. The report's authors rightly conclude that there is strong economic justification for system reform.

Supply chain
It is also interesting, however, to look slightly beyond purely financial considerations in view of the implications of the final bullet above. Undoubtedly, some of the 85% of suppliers mentioned were thinking of a negative financial impact on their business.

But I believe that many were referring to the fact that this system is creating a chronic skills shortage within the industry that is, in turn, leading to severe project resourcing difficulties.

Indeed, the authors of the UKWIR report make this very point when discussing the responses to their questioning of water industry suppliers as follows: "...whilst almost a quarter of suppliers indicated a shortage in resources to deliver the workload available at the start of AMP4 where none had indicated such a problem at the start of the previous AMP. This would seem to suggest that the capacity of the supply chain has reduced relative to the volume of work to be delivered. If this trend were to continue, it could affect the long-term capacity of the industry to deliver future investment programmes."

To those working day by day in companies within the water industry's supply chain, the only surprise in the above paragraph will be the presence of the slight note of astonishment that the supply chain capacity has been reduced.

Most of these people have been living with this skills shortage, particularly of engineers and scientists, for some years and can definitely see a day sometime in the near future when there is insufficient capacity in the supply chain to deliver the required investment programmes.

At the root of the problem is the roller coaster nature of employment that the five-yearly programmes generate.

The inevitable downturns in this cycle result in extended periods where many professionals employed in the sector are forced to look outside the water industry for work as job opportunities plummet - and, of course, many of these people never return.

Mega projects
A particular problem, in this regard, can be seen in the South-east where a number of recent and current mega projects - Channel Tunnel Rail Link, Heathrow's Terminal 5, the Olympics and Thames Gateway - have sequestered large numbers of engineers in particular.

Add to this the haemorrhaging of science and engineering staff generally, due to the fact that fewer young people are choosing careers in these disciplines, and you are looking at a potentially gloomy future for the water sector.

It is interesting to note that the Department for Education and Science (DFES - now the Department for Children, Schools and Families) recognised this issue as early as 2002. In its Utilities (Gas, Water and Electricity) - Skills Dialogue, the DFES comments that, in the water industry: "Regulatory demands have led to a cycle of bidding and contracting that fosters short-termism. Lack of long-term resource planning inhibits skills investment and planning, which will have a negative impact on sustainability and competitiveness."

Clearly this situation, which can only get worse as time progresses, might be relieved by allowing Ofwat to take a longer-term view of investment planning in the water industry.

In this way, the operating companies and their suppliers would be better able to plan investment and human resources strategies and thereby foster greater security of employment within the industry. That this has been agreed in the closely related gas industry can also be seen from this extract from the DCSF document referred to above: "OFGEM and the gas industry are now operating to a 30-year programme of investment and the industry is now able to plan for skills over the long term."

It is instructive to note, however, that the UKWIR study referred to above did not recommend such a radical extension of the AMP period cycle although why this solution was considered unworkable and ineffective when it seems to be aiding long-term planning in the gas industry is not clear.

Instead, however, UKWIR preferred a basket of recommendations for each of the industry stakeholders including allowing the five-year period to overrun slightly (i.e, a late finish as against the early start of previous years). This would, they argue, result in overlapping six- or seven-year programmes and in this statement may lie the nugget of an alternative solution.

Why not simply have staggered investment programmes so that water companies are not all running to the same cycle? Not only would this effectively smooth out investment but it might also make life a bit easier for many of the stakeholders including, of course, the regulators.

EIC has written to environment minister Phil Woolas MP setting out the problems and will shortly be meeting with the minister to stress that to meet the challenges of climate change we need a water industry that is fit for purpose - and that means change to the regulatory system.

Chris Hoggart is chair of the EIC's Water Pollution Control Group. www.eic-uk.co.uk

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