Bristol Water plc A reference under section 12(3)(a) of the Water Industry Act 1991 Report Presented to Ofwat on 4 August 2010 Competition Commission 2010 Website: www.competition-commission.org.uk Members of the Competition Commission who conducted the determination Laura Carstensen (Chairman of the Group) Roger Davis Richard Farrant Professor Robin Mason Edward Smith Chief Executive and Secretary of the Competition Commission David Saunders Material has been omitted from the text of this report pursuant to section 15(6) of Water Industry Act 1991. Omissions are indicated by the insertion of the symbol [] in the text. iii Determination on a reference under section 12(3)(a) of the Water Industry Act 1991 Contents Page Summary .............................................................................................................................. 4 Findings ................................................................................................................................ 9 1. The reference ................................................................................................................ 9 2. Background ................................................................................................................... 9 Bristol Water .................................................................................................................. 9 Statutory framework ..................................................................................................... 11 The regulatory task ...................................................................................................... 12 Our approach ............................................................................................................... 13 An initial question on financeability and incentives ....................................................... 14 3. The capital investment programme of Bristol Water ..................................................... 15 Categories of capex and their appraisal ....................................................................... 15 Introduction to Bristol Water’s capex proposals............................................................ 16 Capital maintenance .................................................................................................... 17 Stable serviceability ................................................................................................. 17 Bristol Water’s proposals ......................................................................................... 17 Trunk mains relining scheme including Shipton Moyne to Tolldown ........................ 18 Mains renewal including the Axbridge–Barrow raw water main planned overlap programme ................................................................................................ 20 Purton raw water reservoirs ..................................................................................... 22 Chew Stoke ............................................................................................................. 23 The Asset Management Assessment process ......................................................... 24 Enhancement capex .................................................................................................... 27 Introduction ............................................................................................................. 27 Supply demand balance .......................................................................................... 28 Resilience schemes ..................................................................................................... 34 Applicable standard of resilience ............................................................................. 34 Bristol Water’s proposals ......................................................................................... 35 Durdham Down ....................................................................................................... 35 Southern Resilience scheme ................................................................................... 36 Oldford resilience scheme ....................................................................................... 37 Tetbury resilience scheme ....................................................................................... 37 Victoria pumping station .......................................................................................... 38 Quality enhancement expenditure ............................................................................... 38 4. Construction output price index and capex efficiency ................................................... 39 Construction output price index .................................................................................... 39 Capex efficiency .......................................................................................................... 41 5. Capital Incentive Scheme ............................................................................................ 42 The scheme ................................................................................................................. 42 The parties’ views ........................................................................................................ 42 Assessment and finding ............................................................................................... 43 6. Opex ............................................................................................................................ 44 Introduction .................................................................................................................. 44 Test for adjusting opex ............................................................................................ 45 Test for an NI ........................................................................................................... 46 Pension-related items .................................................................................................. 48 Deficit recovery payments ....................................................................................... 48 Ongoing contributions to defined benefit schemes .................................................. 49 1 Pension Act obligations with regard to defined contribution scheme ........................ 50 Error in pensions base opex .................................................................................... 50 Bad debts .................................................................................................................... 51 Opex adjustment ..................................................................................................... 51 NI ............................................................................................................................ 52 Energy costs ................................................................................................................ 53 Energy adjustment to base opex ............................................................................. 53 Energy NI ................................................................................................................ 53 Training costs .............................................................................................................. 54 Abstraction charges ..................................................................................................... 55 Highways Agency inspection costs .............................................................................. 55 Changes to water efficiency targets ............................................................................. 55 Adjustment to base opex ............................................................................................. 56 Enhancement opex ...................................................................................................... 56 7. Opex efficiency ............................................................................................................ 57 Ofwat’s opex efficiency targets .................................................................................... 57 Bristol Water’s objections ............................................................................................. 57 Finding ......................................................................................................................... 58 Base opex ............................................................................................................... 58 Enhancement opex.................................................................................................. 59 8. Other issues ................................................................................................................ 60 Tax changes ................................................................................................................ 60 Depreciation ................................................................................................................ 60 MEA revaluation ...................................................................................................... 61 Depreciation cross-check ........................................................................................ 61 Shortfall ....................................................................................................................... 62 Revenue .....................................................................................................................