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Benchmarking Irish Water Opex

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Benchmarking Irish Water Opex Benchmarking Irish Water opex 9 November 2018 Irish Water FINAL REPORT www.cepa.co.uk IMPORTANT NOTICE This report was prepared by Cambridge Economic Policy Associates Ltd (CEPA) for the exclusive use of the client(s) named herein. Information furnished by others, upon which all or portions of this report are based, is believed to be reliable but has not been independently verified, unless expressly indicated. Public information, industry, and statistical data are from sources we deem to be reliable; however, we make no representation as to the accuracy or completeness of such information, unless expressly indicated. The findings enclosed in this report may contain predictions based on current data and historical trends. Any such predictions are subject to inherent risks and uncertainties. The opinions expressed in this report are valid only for the purpose stated herein and as of the date of this report. No obligation is assumed to revise this report to reflect changes, events or conditions, which occur subsequent to the date hereof. CEPA Ltd does not accept or assume any responsibility in respect of the Report to any readers of the Report (Third Parties), other than the client(s). To the fullest extent permitted by law, CEPA Ltd will accept no liability in respect of the Report to any Third Parties. Should any Third Parties choose to rely on the Report, then they do so at their own risk. CEPA Ltd reserves all rights in the Report. Benchmarking Irish Water 1 CONTENTS Important notice ...................................................................................................................................................................... 1 1. Executive summary ......................................................................................................................................................... 4 1.1. CRU methodology for the estimation of the opex allowance ................................................................... 4 1.2. Limitations in the CRU methodology for assessing the efficiency gap..................................................... 5 1.3. Our methodology ................................................................................................................................................. 6 1.4. Results ..................................................................................................................................................................... 7 1.5. Implications........................................................................................................................................................... 10 2. Introduction .................................................................................................................................................................. 12 2.1. Scope of work ..................................................................................................................................................... 12 2.2. Structure of report ............................................................................................................................................. 12 3. Estimate-Step-Trend Approach ................................................................................................................................ 13 3.1. Introduction ......................................................................................................................................................... 13 3.2. Estimate ................................................................................................................................................................. 14 3.3. Trend and step .................................................................................................................................................... 16 4. Benchmarking methodology and data ..................................................................................................................... 17 4.1. Data preparation ................................................................................................................................................. 17 4.1.1. Pre-modelling adjustment to costs ........................................................................................................ 18 4.2. Modelling approach ............................................................................................................................................ 21 4.2.1. Cost drivers ................................................................................................................................................ 22 4.2.2. Model estimation method ....................................................................................................................... 25 4.2.3. Selection of models ................................................................................................................................... 25 5. Benchmarking efficient estimated OPEX ................................................................................................................ 27 5.1. Water Model Estimation Results .................................................................................................................... 27 5.2. Wastewater Model Estimation Results ......................................................................................................... 29 5.3. Quantified SCF: stringent licensing conditions ............................................................................................ 33 5.4. Non-quantifiable SCF ......................................................................................................................................... 33 5.5. IW 2017 Total Opex Efficiency ....................................................................................................................... 34 6. Step and trend adjustments ....................................................................................................................................... 36 6.1. Growth expenditure .......................................................................................................................................... 36 6.2. Dynamic efficiency and RPEs ............................................................................................................................ 37 7. Estimate-step-trend results ....................................................................................................................................... 38 7.1. Overview .............................................................................................................................................................. 38 2 Benchmarking Irish Water 7.2. Water opex .......................................................................................................................................................... 38 7.3. Wastewater opex ............................................................................................................................................... 39 7.4. Implications........................................................................................................................................................... 39 Population growth ..................................................................................................................................... 43 Benchmarking Irish Water 3 1. EXECUTIVE SUMMARY Cambridge Economics Policy Associates Limited (CEPA) has been engaged by Irish Water (IW) to provide economic analysis to support its operating expenditure (opex) submission for the RC3 revenue control. RC3 is a very important milestone for IW as it will be the first 5-year control that the Commission for Regulation of Utilities (CRU) will set the water and wastewater business. Consequently, it is very important that the benchmarking framework, and the methodology that is used to determine IW’s opex allowance, is robust to suitably challenge the business to improve its efficiency over the five-year revenue control, and account for the company’s unique operating environment and cost pressures in RC3. In this report, we consider how cost performance benchmarking has previously been used by the CRU to determine IW’s ‘efficiency gap’ which constitutes the basis of the ‘efficiency challenge’ that the CRU has set IW at each price review when determining the company’s opex allowance. Although CRU’s methodology for setting an opex allowance is in principle in line with that used by many other regulators such as Ofwat (pre-2014), it does not necessarily consider the actual differences between IW and the benchmarked companies. As a result, we propose several modifications that CRU could introduce in RC3 when assessing IW’s efficiency gap. We summarise below: The CRU’s methodology for the estimation of IW’s opex allowance and our views on the limitations of the approach used to assess the efficiency gap at previous price reviews. Our proposed methodology for evaluating the efficiency gap in RC3 and the findings of our analysis when benchmarking IW’s historical and forecast opex plans. 1.1. CRU METHODOLOGY FOR THE ESTIMATION OF THE OPEX ALLOWANCE The CRU’s approach to setting IW’s opex allowance at previous price reviews is commonly referred to in the regulatory literature as ‘base-step-trend’ methodology. This is a common approach for setting regulated utility company opex allowances adopted by regulators in the UK and internationally. The CRU has to date set IW’s
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