Total UK capital expenditure on water and sewerage has fluctuated over recent years, with spending tending to fall at the start and end of five-year spending cycles. During the latest period, known as AMP5 (2010-15), capital spending initially dropped by 4% in 2011, but increased by a strong 17% in 2012 as capital investment projects planned for the period got off the ground. This was followed by moderate increases in the following three years, with annual growth slowing from 4% in 2013 to just 1% in 2015. The slowdown in the latter year reflects a shift in the industry’s focus to preparing work for AMP6 2015-20.

Workloads during AMP5 continued to be cyclical, despite the industry tendering contracts early to counteract the usual delay at the start of five-year spending cycles. However, the downturn at the start of AMP5 was not as severe as in previous periods.

Companies have focused capital expenditure on networks, capital maintenance and small projects to improve operational expenditure and energy efficiency, with a relative lack of major projects and new builds. The largest capital projects during AMP5 were undertaken by Thames Water as part of the London Tideway Improvement Programme, including the construction of the £635 million Lee Tunnel, which was built between 2010 and 2015.

Figure 1: UK capital expenditure on water and sewerage services, 2010/11-2014/15

Source: Ofwat, individual company annual reports and MBD estimates

Expenditure on non-infrastructure maintenance accounts for the highest proportion of sewerage capital expenditure in England and Wales, representing 35% of the total in 2014/15. Investment in sewerage infrastructure enhancements increased by a substantial 77% between 2012 and 2015, partly reflecting the construction of the Lee Tunnel by Thames Water.

Water-related capital expenditure in England and Wales was increased in most years during AMP5, except for an 11% decline in 2012 and a moderate 1% reduction in 2014. The fall in the latter year was more than offset by a 4% increase in 2015, taking water-related capital spending to £2.27 billion. In 2014/15, water and sewerage companies in England and Wales invested £926 million in non-infrastructure maintenance, accounting for 41% of total water-related capital expenditure.

Figure 2: Analysis of sewerage capital expenditure in England and Wales by water and sewerage companies, by type, 2014/15

Source: Individual company annual accounts

Figure 3: Analysis of water capital expenditure in England and Wales by water and sewerage companies, by type, 2014/15

Source: Individual company annual accounts

For the current asset management period, running from 2015 to 2020, Ofwat has introduced a move towards total expenditure (totex), combining capital and operational expenditure. Ofwat believes this will remove a bias toward capital programmes, as capital expenditure has often been preferred over operational expenditure in delivery solutions due to the design of the regulatory framework. The move towards totex should encourage companies to deliver solutions as efficiently as possible.

High expenditure on capital projects in recent asset management periods reflected a focus on replacing and upgrading a largely antiquated asset base and investments to meet new EU legislation, such as the Urban Waste Water Directive. This has increased capital expenditure on building new facilities, including treatment works, interceptor sewers and outfalls. Many of these capital projects have now been completed and the industry is shifting its focus towards operating, maintaining, and managing these assets, and ensuring that inefficiencies are minimised during such activities. With the shift towards totex, effective asset maintenance will become increasingly important as prolonging the life of existing assets will be favoured over capital replacement.

The largest capital project during the next decade will be the construction of the 25km Thames Tideway Tunnel (TTT) by Thames Water. This major £4.2 billion project is designed to tackle the problem of London’s sewers overflowing into the tidal River Thames, and is necessary to secure compliance with the Urban Waste Water Treatment Directive. The government gave the project the official go-ahead in September 2014. The main construction period of the tunnel is expected to start in 2016 and be completed in 2023. In August 2015, three joint ventures were awarded the contracts to build the west, central and east sections of the tunnel.

Figure 4: Capital expenditure in the water and sewerage industry during AMP6 in England & Wales, 2015/16-2019/20

Source: Ofwat and individual company data

The industry has invested around £50 billion since privatisation on quality and service improvements, with river and bathing water quality both significantly improved. However, numerous legislative obligations remain, including the Water Framework Directive, Urban Wastewater Treatment Directive, Habitats Directive, and Bathing Water Directive. These will require further investment by the industry to ensure compliance.

New sentencing guidelines introduced in 2015 are also leading to much larger fines for environmental pollution by water and sewerage companies. The higher penalties should help raise awareness on the requirement for environmental compliance. However, there are also concerns in the industry that significant fines could potentially distort investment away from real improvement.

This is expected to influence the availability of water resources and demand for water. More extreme weather patterns make flood resilience a continued priority. Companies are also likely to want to try and reduce carbon emissions due to rising concerns about climate change, while environmental pressures are likely to lead to greater emphasis on sustainable abstraction.

Water companies have substantial scope to generate costeffective renewable energy. This increased self-generation not only contributes to carbon emission reductions, but also offers long-term protection against volatile energy prices. For example, Southern Trent aims to increase its self generation of renewable energy to around 50% by 2020.

The UK population is projected to increase to 73.3 million by 2037, up by 14% from 64.1 million in 2013, while the number of households in England is expected to rise by 23% between 2012 and 2037. Population growth is also expected to be faster than average in water-stressed areas, such as London and the south east. Increases in population and housing are expected to put significant pressures on supply levels and the cost of investment to maintain services.

Income equality has risen since privatisation, and water poverty will continue to be an issue for the poorest and most vulnerable in society. This has been exacerbated by recent welfare reforms that have hit more deprived local authorities hardest. Water companies therefore need to think about how to balance the need for continued investment against affordability for poorest customers.

The water industry has successfully introduced new technology to improve services and reduce costs. However, existing technology is not sufficient to meet future challenges posed by changing legislation, resource, and energy pressures. The speed at which the water industry embraces new technology will have to accelerate to meet challenges presented by the changing world. New technology will also be required to meet existing legislation, such as to reduce phosphorous levels in final effluent.

The Water Act 2014 is a major step in the government’s liberalisation of the water industry and its provisions. A key area of the act is the introduction of retail and upstream competition in the water sector from 1 April 2017. From that date, all businesses, charities and public sector customers in England will have the freedom to switch suppliers, while different parties will be able to enter the water industry as retail providers. Changes under the act should also make it easier for new providers of water sources and sewerage treatment services to enter the upstream market, with the aim of stimulating efficiency and innovation. These changes, however, are not expected to be introduced until after 2019, following the opening of the retail market. The government has not expressed any intention to expand competition to include household customers.

There is a clear move towards long-term thinking across the water and sewerage industry, largely driven by changes to Ofwat’s approach to five-year asset management periods and the adoption of 25-year strategic plans.

The move towards long-term thinking has also changed the way water companies are procuring firms to deliver work during AMP6, with many opting for alliances or frameworks that run beyond the traditional five-year AMP period. Although a number of companies started to embrace alliances and frameworks during the last spending cycle, AMP6 requires water companies and their supply chains to be even more integrated and collaborative to achieve desired outcomes through the most efficient solutions possible.

AMP6 investment plans also tend to be designed with a consistent profile of expenditure, rather than the ‘boom and bust’ profile that has traditionally characterised water companies’ investment plans. This should enable the supply chain to resource and plan work more efficiently and, in turn, deliver cost savings.

Successful partnerships between water companies and their supply chain will depend on building close integrated relationships and having fully aligned long-term goals with a strong emphasis on collaborative teamwork, innovation, efficiencies and long-term outcomes and values.

For the current asset management period (AMP6 2015-20), a number of changes have been introduced in the regulatory environment, which will shift the industry’s approach to infrastructure investment. The most significant is a focus on total expenditure (totex) rather than capital expenditure, which means effective asset maintenance will become increasingly important, as prolonging the life of existing assets will be favoured over capital replacement. The adoption of the totex approach also means that companies need to embrace a whole life cost approach. This should also encourage innovation, drive down capital spending, and improve efficiencies.

The reformed regulatory framework’s impact on project investment and delivery will undoubtedly continue to pose significant challenges to water companies and their supply chain for the foreseeable future. The major changes require companies to adopt a different mindset in their approach to asset management, and accept totex principles across all levels of their organisation, from on-the ground operations and maintenance staff to senior executives. Breaking down barriers and resistance to change will therefore be imperative to the successful adoption of the totex approach across the industry.

Successful partnerships between water companies and their supply chain will also strongly depend on building close integrated relationships and having fully aligned long-term goals with a strong emphasis on collaborative teamwork, innovation, efficiencies and long-term outcomes and values.