AMP 8 – A new transformative period begins

This year, for everyone with the merest of toes in the water sector, today marks something much more significant than the anniversary of Panorama’s 1957 feature on the ‘Swiss spaghetti harvest’. Today we enter into AMP8.

AMP8 is the five-year regulatory period from 2025 to 2030, across which Ofwat has approved the investment and performance targets for water companies in England and Wales. It is set to be a transformative period, with a focus on achieving net zero emissions by the end of the AMP and addressing the problems raised in a challenging environment posed by the significant impacts of climate change, aging infrastructure and increased demands on water supply and treatment. Much will need to be done to replace existing infrastructure and to add capacity and to prevent pollution and spills.

The sector has been gearing up for AMP8 over the last 2 years. The water companies’ PR24 business plans were originally submitted to Ofwat in October 2023 and underwent a long period of scrutiny and challenge prior to being signed off in December last year. The levels of investment set out in the plans will cause an already hot market to get significantly hotter and the supply chain has commenced ambitious plans to prepare for this accordingly.

AMP 8 – record levels of anticipated capital investment

Ofwat announced its proposed spending package of £88 billion to be provided to water companies in July 2024. This figure was £16 billion short of the amount requested by water companies in their PR24 business plans. Ofwat noted that on its analysis, the sum signed off was adequate having disregarded or reduced costs it thought where insufficiently justified.

Ofwat’s final determination in December 2024 was for a £104 billion package, equating to a quadrupling of new investment over the next five years. The cost of this investment will initially be funded by shareholders or through borrowing, with the costs being recovered through customer bills in this AMP8 period and beyond.

One of the priorities of the plan is for investment in new infrastructure with £2bn of development funding to unlock £50bn investment for 30 major projects, designed to secure water supplies including nine new reservoirs and nine large-scale water transfer schemes.

AMP 8 – investment scrutiny and the need to see value

This all arrives at a point of heightened economic unease. The Chancellor’s statement last week was notably silent on net zero targets, leaving intact public spending plans for green initiatives, but cuts in other areas were implemented and the Budget in October is expected to be tough. The argument for strong investment is clear. The costs of failing to protect against the impacts of climate change could be severe, as the impacts of extreme weather are expected to get worse. A report published last month by Public First found that every £1 spent on flood resilience prevents around £8 of damage, of which £3 is a direct benefit to the UK government.

Water companies themselves are under fire for failures to invest adequately in infrastructure, with an official government report published by the Independent Water Commission, finding that water companies are escaping scrutiny by the regulator because there are “limited mechanisms” to check whether they are delivering on promised investment. The report is a precursor to the inquiry into the water sector, led by Sir Jon Cunliffe (former Bank of England deputy governor), which is anticipated to carry out a “root and branch” review of regulation across the sector.

We can therefore expect increased levels of public and regulatory scrutiny into the value for money provided by any investments.

So how will the investment in new infrastructure be implemented?

In addition to projects covered by individual water companies in their PR24 business plans, the scale of the challenges faced for both water treatment and supply requires solutions which span the boundaries of the water companies’ service areas. Strategic Resource Options (“SROs”) are nation-wide options to improve water resources across England and Wales which require collaboration between various water companies. They involve more complex commercial arrangements, and present new or more complicated challenges in relation to water sector regulation.

The Regulators’ Alliance for Progressing Infrastructure Development (“RAPID”) was established for PR19 to secure the UK’s long-term water supply, ensuring collaboration between the three main water regulators Ofwat, the Environment Agency and the Drinking Water Inspectorate and support progression of the SROs. Ofwat has noted that the RAPID programme has encouraged collaboration across the industry, with water companies now working together to design and deliver solutions across regions and sectors. It has also welcomed new partnerships into the programme to deliver solutions including the Canal & River Trust and the Mining Remediation Authority.

SROs sit within the RAPID programme and progress through its gated process. This enables the technical assessment of the project in parallel with resource planning to expedite construction. In Ofwat’s PR19 final determination, Ofwat allocated up to £469 million to investigate SROs to help secure the supply of water. These SROs were intended to enable 9 water companies to develop construction-ready projects and solutions for AMP8. Ofwat’s PR24 has continued to build on the momentum of SROs and PR24 final determinations allow up to £2.15 billion to be made available for the continued development of 10 new solutions for strategically important infrastructure.

DPC – For larger scale projects there is DPC

Direct Procurement for Customers (“DPC”) was introduced as part of PR19 as a process to enable water companies to competitively tender for a third party (a competitively appointed provider “CAP”) to design, build, finance, operate and maintain infrastructure. Ofwat’s goal was to deliver large scale projects more efficiently through the promotion of innovation, both capital and operational cost savings and reduced financing costs. The model involves water companies creating off-balance sheet special purpose vehicles backed by private investors.

Ofwat engaged in 3 consultations on DPC during 2020 which resulted in amendments to 5 water companies’ licence conditions. The amendments imposed controls giving Ofwat oversight of DPC delivery, required Ofwat consent at various points in a DPC project, provided mechanisms for companies to charge their customers for the charges of the appointed CAP and gives water companies the comfort that they will be funded if a DPC project is brought back in-house. The final guidance for DPC was published by Ofwat in 2023 which sets out that the DPC licence provisions will be extended for those companies that will be delivering DPC projects in the period between 2025 – 2030.

DPC – When is it relevant?

Water companies are required to use DPC as the default mechanism for all discrete projects above a whole life expenditure (“totex”) of £200 million. The approach applies to all parts of the water and wastewater value chains.

Whilst projects below £200m totex do not need to undergo an assessment for suitability of DPC, Ofwat reserves the right to explore the use of DPC if it considers that (i) the scale of the project when compared with the size of the company poses delivery or financeability challenges; (ii) multiple smaller schemes could be combined into an overarching programme; or (iii) there is a system which could form a bundled project.

Water companies were required as part of the PR24 plans to assess the extent to which projects were technically discrete. This assessment assumes that the more separate a project is from a company’s existing network/operations, the more suitable it is to be designed, built, maintained, and operated by a CAP. The test looks at factors including the programme scalability (i.e. size), construction risk and O&M risk and the ability to transfer those risks to the CAP.

DPC – Relationship with RAPID and designation at DPC

DPC projects may or may not be subject to the RAPID gated process used for SROs. Ofwat has sought to align the DPC approval process with the RAPID gated process to avoid duplication between the two. Under Ofwat’s DPC approval process, designation of the project as a DPC project occurs after Ofwat’s approval of Stage 2 submissions covering the approach to procurement plans and outline of the commercial model.

DPC – Commercial model

Whilst Ofwat’s contracting principles for DPC do set out requirements for topics including water company step in and early termination, force majeure and refinancing the principles are set out at very high level falling significantly short of precedent contract terms. Water companies therefore have flexibility around the development of contractual and commercial models to suit their project’s requirements.

There is a wealth of information on which water companies will draw in the development of such models. DPC has been developed specifically for the water sector and so there are certain aspects of the model which require an understanding of the regulatory environment in which water companies operate including, for example, the interface between payments and costs under the CAP agreement and their ultimate recovery from customers under the Allowed Revenue Direction and other price controls. However, the model itself is not “new” and shares many similarities with the public private partnership models which have been used (and are still being used) to deliver critical infrastructure across a wide range of sectors including highways, hospitals and schools.

In fact, Ofwat’s guidance for appointees (i.e. water companies) in delivering DPC projects which, amongst other things, sets out Ofwat’s expectations for the allocation of risk, specifically states that Ofwat had regard to the standard form project finance models that exist in the UK in developing the commercial model. Therefore, many of the concepts which have been used and which will need to be negotiated as part of any DPC project (including refinancing gains, change in law risk, service deductions and step in) will be familiar to those who have been involved in delivery of long-term infrastructure projects.

DPC – Pipeline

It is anticipated that around £14 billion of projects will be developed under the DPC model over the next decade. United Utilities’ Haweswater Aqueduct Resilience Programme was the first off the mark, but following PR24 there are now 21 SROs under consideration by the water companies setting out a strong pipeline of projects which may well be procured through DPC.

DPC – for the wider industry

Whist this is clearly an issue for water companies, the engagement of other stakeholders, and in particular sponsors, contractors and funders, will be crucial to ensure the success of the model. Given the intention to ensure that DPC documentation will be aligned with existing project finance models, together with the success of other privately financed projects in the sector (not least the Thames Tideway Tunnel), DPC is likely to be an attractive proposition for them. Early signs are promising: the preferred bidder for the Haweswater Aqueduct Resilience Programme is a consortium of Strabag and Equitix and, similarly to PFI we would expect to see the participation of international construction companies and funders in these major projects.

To conclude…

A significant amount of investment has already taken place in preparation for AMP8 and there is much to anticipate in the work that will take place across the industry. We look forward to navigating this with our clients in the water sector.