Q4 2023
Water Sector: Will the rising tide of Capital Delivery lift all boats
Water companies are facing intense public scrutiny and supply chain challenges in both cost and availability. Against this backdrop, the task to deliver record capital programmes for AMP8 (regulatory period for English and Welsh water companies covering 2025-2030) becomes even more acute. Whether water companies can rise to the challenge will require careful navigation to satisfy all stakeholders.
Sector outlook and scale of delivery
The water sector in England and Wales is experiencing a tough time. Calls for increased investment, cries that our rivers are hazardous to public health and attacks that those in positions of authority are not up to the task have grown into a wave of public and political opinion demanding change.
Few contest the cause of the current situation, historic under-investment leading to aging infrastructure and high gearing means money is used to service debts and is diverted away from upgrading the network, leading to poor performance.
The weighted average gearing across all UK water companies is currently 68.5%, while their combined debt levels are over £61bn[1]. Over 50% of this debt is index linked and while customer bills are also tied to inflation, which can offset this problem, sustained high inflation results in more money being diverted to service debt. However, another issue is that bills may not rise as fast as debt, causing liquidity problems as witnessed with Thames Water earlier this year.
The overall size of the AMP8 obligations is dependent on finalised public sector regulation and price setting approvals. It is widely anticipated that the next regulatory asset management period – AMP8 will be on an unprecedented scale with some estimations that the capital expenditure could be twice that of AMP7.
In addition to the Capital Programmes, RAPID (Regulators' Alliance for Progressing Infrastructure Development) is also pushing forward 14 Strategic Resource Options[2] schemes valued at £13bn (2020-21 price base) with construction of these starting mid-late AMP8.
Price fluctuations
As has been widely reported and experienced, significant inflation has affected all sectors. While water companies can increase customer bills in line with inflation, the regulatory mechanism for this is through CPIH. However, actual prices for construction costs have seen increases far in excess of the CPIH measure. Between 2015 (ie the beginning of AMP6) and 2023, CPIH inflation measured 31%, yet materials (typically accounting for 40-50% of overall project costs) have increase by 54%. Over the same period, labour (which accounts for 40-50% of overall costs) has only seen an increase of 25%. However, looking forward to mid AMP8, current forecasts show all cost elements will significantly outstrip CPIH inflation. This further exacerbates the challenge to deliver significantly larger portfolios.
So how can the water sector successfully deliver the increased outputs of AMP8 with a shrinking supply chain?
The imperative mitigations might include strengthening the supply chain (retaining incumbents, re-engaging former suppliers, attracting new entrants etc) and smoothing the demand (working to avoid pinch-points through planning and innovative procurement).
This includes having open, clear and consistent communication with the supply chain, sharing prospective procurement pipelines and a commitment to ensure that risk is apportioned to the party that is best placed to manage it. This enables effective commercial relationships and sets the right foundation to undertake strategic supply chain management.
Acquiring benefits through supply chain management
Water companies can approach this unilaterally, with individual clients engaging the market directly and competing for resource. However, this strategy perpetuates the status quo of trying to ‘beat the market’, putting stress on the supply chain and other fellow clients in the sector. Rarely does the first-to-market buyer succeed in retaining a suppliers’ A-team due to the pressures on contractors to secure turnover and seek better margins offered by latecomer buyers. These latecomer buyers, however, are themselves unable to negotiate or impose low rates in a constrained market.
Instead, water companies can leverage their buying power through collaboration and co-operation. By strategically planning their demand and procurements, they can make capital investment more efficient for investors and shareholders while delivering the benefits demanded by society. Simple acts such as providing pipeline visibility and giving certainty of opportunity can also help grow the resilience of the supply network.
Conclusion
The water sector is constantly under intense pressure to perform, and it appears that the challenge is set to grow in future AMPs. While there is potential capacity within the industry – be that in professional services, construction firms or the education system that replenishes the workforce – there is evidence that people are turning their back on the water sector. The question is, how can client organisations rekindle the fire and reignite the appetite for people and organisations to engage with the sector?