Investment and Asset Management Report
2000-02
East of Scotland Water Authority
North of Scotland Water Authority
West of ...
Ochil House Springkerse Business Park Stirling FK7 7XE
telephone: 01786 430 200
facsimile: 01786 462 018
email: enquiries@...
WATER INDUSTRY COMMISSIONER FOR SCOTLAND




Foreword

This is the first Investment and Asset Management                  ...
INVESTMENT AND ASSET MANAGEMENT REPORT 2000-02




In my Strategic Review of Charges 2002-06, I advised          The role ...
WATER INDUSTRY COMMISSIONER FOR SCOTLAND




Contents

Foreword
Executive summary                                         ...
INVESTMENT AND ASSET MANAGEMENT REPORT 2000-02




Executive summary

Introduction                                        ...
WATER INDUSTRY COMMISSIONER FOR SCOTLAND




this was actually required. Consequently, some £87 million                 Fr...
INVESTMENT AND ASSET MANAGEMENT REPORT 2000-02




Table 2: Reconciliation of direct investment to                       T...
WATER INDUSTRY COMMISSIONER FOR SCOTLAND




Condition of Scotland’s asset base                                           ...
INVESTMENT AND ASSET MANAGEMENT REPORT 2000-02




Table 4: Percentage of assets in performance                Key message...
WATER INDUSTRY COMMISSIONER FOR SCOTLAND




Chapter 1

Introduction
This is the first annual Investment and Asset
Managem...
INVESTMENT AND ASSET MANAGEMENT REPORT 2000-02




Chapter 2

Investment in water and                                     ...
WATER INDUSTRY COMMISSIONER FOR SCOTLAND




Figure 2.1: Costs to replace Scotland’s water and                 Table 2.1: ...
INVESTMENT AND ASSET MANAGEMENT REPORT 2000-02




purchases each year a quantity of refurbished mains           Investmen...
WATER INDUSTRY COMMISSIONER FOR SCOTLAND




The absence of a coordinated approach to investment                     part ...
INVESTMENT AND ASSET MANAGEMENT REPORT 2000-02




Legislative drivers during 2000-02 included:               the view tha...
WATER INDUSTRY COMMISSIONER FOR SCOTLAND




We would like to see a similar framework adopted in
                         ...
INVESTMENT AND ASSET MANAGEMENT REPORT 2000-02




Chapter 3

Historic investment in Scotland                             ...
WATER INDUSTRY COMMISSIONER FOR SCOTLAND




Over the six year period, £27 more per property has                         T...
INVESTMENT AND ASSET MANAGEMENT REPORT 2000-02




In the analysis in the Strategic Review of Charges                     ...
WATER INDUSTRY COMMISSIONER FOR SCOTLAND




• There             appears to be no evidence to support the                 ...
Investment and Asset Management Report 2000-02
Investment and Asset Management Report 2000-02
Investment and Asset Management Report 2000-02
Investment and Asset Management Report 2000-02
Investment and Asset Management Report 2000-02
Investment and Asset Management Report 2000-02
Investment and Asset Management Report 2000-02
Investment and Asset Management Report 2000-02
Investment and Asset Management Report 2000-02
Investment and Asset Management Report 2000-02
Investment and Asset Management Report 2000-02
Investment and Asset Management Report 2000-02
Investment and Asset Management Report 2000-02
Investment and Asset Management Report 2000-02
Investment and Asset Management Report 2000-02
Investment and Asset Management Report 2000-02
Investment and Asset Management Report 2000-02
Investment and Asset Management Report 2000-02
Investment and Asset Management Report 2000-02
Investment and Asset Management Report 2000-02
Investment and Asset Management Report 2000-02
Investment and Asset Management Report 2000-02
Investment and Asset Management Report 2000-02
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  1. 1. Investment and Asset Management Report 2000-02 East of Scotland Water Authority North of Scotland Water Authority West of Scotland Water Authority
  2. 2. Ochil House Springkerse Business Park Stirling FK7 7XE telephone: 01786 430 200 facsimile: 01786 462 018 email: enquiries@watercommissioner.co.uk www.watercommissioner.co.uk March 2003
  3. 3. WATER INDUSTRY COMMISSIONER FOR SCOTLAND Foreword This is the first Investment and Asset Management Overall, the report concludes that levels of investment Report produced by my office. It examines the and the condition of the assets are comparable with investment performance of the three Scottish water those in England and Wales, but that more prudent authorities during the financial years 2000-01 and management and better information would help 2001-02. It covers the period of the first Quality and achieve better value for money for customers. Standards process and my interim Strategic Review of Charges1. • The Quality and Standards process has brought a welcome degree of clarity and coordination, but it is The report provides objective information on important that this transparency is further developed investment in the water industry in Scotland. It also in the future. examines the current overall condition and performance of the industry’s assets. In particular, it • Investment in England and Wales increased addresses the following five issues: significantly in the early years after privatisation in 1989. Investment in Scotland did not begin to • The level of investment undertaken by the three accelerate significantly until after 1996. However, by authorities during the period 1996-2002. the end of Quality and Standards I, the Scottish industry had begun to invest more per property than • How this level of investment compares with that in in England and Wales. England and Wales. • Even without the investment committed through the • The condition and performance of water and Private Finance Initiative the cumulative investment sewerage assets in Scotland. levels per property, since the three authorities were formed, are similar north and south of the border. • How these assets compare with those in England and Wales. • The effectiveness of this level of investment has been reduced as a result of inefficiencies in both the • Whether the correct processes are in place properly strategic planning and procurement of capital to identify and deliver efficiently the investment needs projects. of the water industry in Scotland. • The condition and performance of the assets in During Quality and Standards I the three authorities Scotland, however, still appear to lie within the range invested over £880 million. This represents nearly £170 of comparable companies in England and Wales. for every individual in Scotland, or around £380 for each property. • Independent research commissioned by my office has indicated that significant scope for improvement Customers will want to be sure that investment is taking remains in all areas of the investment performance of place at the right levels and in the right way - that the three authorities. problems are neither being stored up for the future, nor that assets are being ‘gold-plated’. 1 Interim Strategic Review of Charges 2000-02, published in December 1999. PAGE 01
  4. 4. INVESTMENT AND ASSET MANAGEMENT REPORT 2000-02 In my Strategic Review of Charges 2002-06, I advised The role of regulation is to ensure that the interests of Scottish Ministers on the factors that should be taken customers are safeguarded and that customers receive into account in setting the level of charges in Scotland. good value for money. I believe that it is important that It was clear that there needed to be significant all stakeholders are aware of the investment that is improvements in levels of understanding relating to planned for the industry in Scotland and are clear about assets in Scotland and that this would play a vital role the benefits this will bring for customers, in terms of in allowing the industry to improve its capital efficiency. improvements to service, to the environment and to public health. This annual report will help customers to Investment is now the largest single area of understand more fully the improvements they have a expenditure for the industry in Scotland. As such, right to expect. customers will need to be reassured that the Scottish industry will achieve the capital efficiency targets set I will give credit when the industry delivers the out in the Strategic Review of Charges 2002-06. objectives of the investment programme in an efficient Failure to achieve these targets could result in one or and targeted way. However, I will also ensure that any more of the following undesirable outcomes: shortfalls in performance are immediately highlighted. To this end, I intend that my office will continue to adopt • deteriorating asset condition and performance; a rigorous and challenging approach in regulating the investment performance of the industry. • higher prices; • lower levels of customer service; • lower levels of compliance with environmental or public health targets than has been agreed; and Alan D A Sutherland • a greater burden on public expenditure. Water Industry Commissioner for Scotland March 2003 PAGE 02
  5. 5. WATER INDUSTRY COMMISSIONER FOR SCOTLAND Contents Foreword Executive summary Page 04 Chapter 1 Introduction Page 09 Chapter 2 Investment in water and sewerage services Page 10 Chapter 3 Historic investment in Scotland Page 16 Chapter 4 The condition and performance of assets Page 20 Chapter 5 Investment performance by the three former authorities Page 23 Chapter 6 Conclusions Page 27 Appendix 1 Investment appraisal audit report: summaries Page 28 Appendix 2 Asset condition and performance grades Page 38 PAGE 03
  6. 6. INVESTMENT AND ASSET MANAGEMENT REPORT 2000-02 Executive summary Introduction The first Quality and Standards report originally envisaged total investment of £740 million over two This is the first annual Investment and Asset years. This compares with a total asset replacement Management Report. In the Strategic Review of cost of some £25 billion. Table 1 outlines the original Charges2 we recommended to Scottish Ministers that Quality and Standards plan split as shown between we should publish three annual reports on progress in drinking water and sewerage. the Scottish water industry3. Table 1: Investment required to meet Quality and These were: Standards I 4 2000-01 2001-02 Total • a costs and performance report; Investment in drinking water £185m £235m £420m • a report on the investment and asset management of Investment in sewerage £165m £155m £320m the industry; and Total £350m £390m £740m •a report on the level of service provided to In the interim Strategic Review of Charges, we customers. recommended increasing the level of investment in maintaining the assets, believing that Quality and This Investment and Asset Management Report Standards I had not fully recognised the extent of addresses the following issues: investment required simply to maintain the current level of service to customers. • The level of investment undertaken by the three authorities during the period 1996-2002. These higher revenue caps would have allowed more investment in infrastructure renewal. Sarah Boyack • How this level of investment compares with that in MSP the then Minister for Transport and the , England and Wales. Environment, modified this advice, reasoning that the • The condition and performance of water and poor quality of information available about sewerage assets in Scotland. underground assets would reduce the effectiveness of investment. The revised revenue caps did, • How these assets compare with those in England however, make in excess of £150 million available for and Wales. investment beyond the spending outlined in Quality and • Whether the correct processes are in place properly Standards I. to identify and deliver efficiently the investment needs of the water industry in Scotland. This gave a revised total forecast expenditure for the Quality and Standards I period of £890 million. The This first report covers the financial years 2000-01 and authorities’ actual capital expenditure of £888 million is 2001-02. It therefore relates to the final two years of consistent with the budget set by the interim Strategic operation of the three regional water authorities: East Review and it would appear reasonable that all of the of Scotland Water Authority, North of Scotland Water obligations under Quality and Standards I should have Authority, and West of Scotland Water Authority. This been delivered in full. was also the period covered by the first Water Quality and Standards process and by the interim Strategic Concerns arise, however, in relation to operating costs Review of Charges 2000-02. allowed to pay for Private Finance Initiative (PFI) projects5. The interim Strategic Review allowed the authorities’ forecast costs to PFI contractors of £144 million. Many of the schemes were then delayed, and only £57 million of 2 Strategic Review of Charges 2002-06, published in November 2001. 3 All amounts in this report are in prices of the day unless otherwise stated. 4 Investment totals do not include PFI. 5 PFI operating costs are the contracted annual costs faced by the water authorities for the service provided. The capital element of these projects is typically delivered early in the contract period and is paid for gradually along with operating costs incurred by the contractor over the life of the PFI project. PAGE 04
  7. 7. WATER INDUSTRY COMMISSIONER FOR SCOTLAND this was actually required. Consequently, some £87 million From this there appears to be considerable scope for had been raised from customers beyond what was improvement in the planning and delivery of actually required. Of this, £19 million reduced the investment. projected total debt of the three authorities, and £68 million appears to have gone on higher operating The first step is to ensure that asset condition, costs than were originally budgeted. performance, capacity and operation is understood as fully as possible. Best practice requires that this fact Additional concerns arise in relation to the targets that base is at the heart of all decisions about investment in were set under Quality and Standards I. The targets set and the operation of assets. were at a very high level. In reality it has not been possible to monitor the impact of capital expenditure in Investment levels achieving those targets in a consistent or thorough way. It would certainly have been better for customers if Making direct comparisons between the levels of clearer and more detailed information about specific investment in England and Wales and in Scotland is not investment projects, and their expected outcomes, had a straightforward process. As well as the obvious been available. differences of geography and population density, adjustments also need to be made to reflect both Greater transparency would ensure that customers and differences in the timing of investment and the other stakeholders could be confident that their significant use of the Private Finance Initiative in expectations are being met. It would also help ensure Scotland. that effective delivery of the capital programme brings better value for money for customers. Use of PFI means that the effective investment spend in Scotland during 1996-2002 is higher than it appears. Until such levels of transparency are achieved, it is From a customer’s perspective the method of delivery important to assess whether investment by the three is not important as long as value for money is achieved. authorities is being carried out effectively. Figure 16 We have therefore adjusted reported direct investment shows our assessment in relation to industry best in Scotland downwards as a result of relative practice. inefficiency7 but have added investment delivered through PFI. Figure 1: The position of the three authorities in relation to industry best practice Areas for urgent Industry improvement best practice Strategic approach to long-term investment planning Strategic asset management plan Risk based approach to long-term investment Operating cost systems and data reliability England and Wales Capital programme management utility companies Project appraisal Asset information Asset condition and performance data Key: This is the level of performance achieved by all three authorities. This is the level of performance achieved by the best performing authority in that area. 6 This figure summarises the conclusions of the consultants who worked with the Water Industry Commissioner for Scotland on the Information Project. 7 Inefficiency results where customers’ money has been spent unnecessarily. The efficient level of investment is that level of spending required to achieve the planned outputs. Adjusting for inefficiency ensures that a fair comparison of improvements to assets can be made. PAGE 05
  8. 8. INVESTMENT AND ASSET MANAGEMENT REPORT 2000-02 Table 2: Reconciliation of direct investment to The condition and performance of assets efficient effective investment In the report, we examine the condition and Year 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 performance of assets in Scotland, and compare this Direct investment with England and Wales. We also assess the extent to in Scotland £252m £277m £346m £397m £428m £460m which poorer condition or performance may restrict Less: Assessed opportunities to achieve benchmark efficiency. capital inefficiency £60m £78m £107m £139m £163m £175m The regulatory return provided to us each year by the Efficient direct water authorities contains information about both the investment £192m £199m £239m £258m £265m £285m physical state of the assets (condition) and also their Investment delivered ability to carry out their function (performance). through PFI £3m £15m £15m £136m £170m £126m Total efficient Asset condition should be monitored continually, so that effective investment £195m £214m £254m £394m £435m £411m investment takes place at the point where the costs of ensuring that an asset can perform adequately exceed Absolute levels of investment do not, by themselves, the annualised costs of replacement or refurbishment. give the full picture. A more appropriate indicator is the In this way, customer charges over the medium to long level of investment per property. Table 3 outlines the term are minimised and service levels are maintained. adjusted total investment in Scotland on a per household basis and compares this with England and Customers have an interest in how well the water Wales. Even after this adjustment for inefficiency, industry’s assets perform, because performance has a investment on a per household basis in Scotland is direct and often immediate impact on the environment broadly on a par with that in England and Wales. and on public health. Table 3: Efficient effective investment per The performance of an asset reflects its ability to fulfil household its purpose, and is a function of: 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 Scotland £84 £92 £109 £170 £188 £177 • its condition, England • how it is operated, and and Wales £144 £167 £167 £166 £125 £136 • its capacity to carry out its required role. This is shown in Figure 2. It is possible for an asset in reasonable condition and of adequate capacity to perform badly through poor Figure 2: Levels of capital investment per property operating practice. Similarly, an asset which is not in (adjusted for relative efficiency) the best condition can, through skillful management, be 200 made to perform acceptably. 150 £ 100 50 0 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 Year Scotland England and Wales PAGE 06
  9. 9. WATER INDUSTRY COMMISSIONER FOR SCOTLAND Condition of Scotland’s asset base Figure 5: Sewage treatment works in condition grades 4 and 5 We have used the information provided in the most % of sewage treatment works recent regulatory returns available to compare the 35 condition of assets in Scotland with those in England 30 and Wales8. Asset condition is assessed on a scale of 25 1-5, with 1 representing ‘very good’ and 5 representing 20 ‘very poor’. 15 10 We focussed on the four main components of a water 5 0 and sewerage company’s asset base: water treatment Mean England & Wales Median England & Wales 2nd Lowest England & Wales Highest England & Wales 2nd Highest England & Wales Lowest England & Wales Scotland works, water mains, sewage treatment works, and sewers. These four groups represent some 80% of the replacement cost of the total asset base. Figures 3 to 6 show the respective position of the Figure 6: Sewers in condition grades 4 and 5 Scottish asset base for each of the four main asset categories. 30 25 % of sewers Figure 3: Water treatment works in condition 20 grades 4 and 5 15 10 % of water treatment works 45 5 40 0 35 Scotland Mean England & Wales 2nd Lowest England & Wales Highest England & Wales Lowest England & Wales 2nd Highest England & Wales Median England & Wales 30 25 20 15 10 5 0 Median England & Wales 2nd Lowest England & Wales Highest England & Wales 2nd Highest England & Wales Lowest England & Wales Scotland Mean England & Wales These results appear at variance with the commentary that we have received in the regulatory returns from the water industry in Scotland. This commentary has tended to indicate that assets are in a comparatively poor condition. Figure 4: Water mains in condition grades 4 and 5 Performance of Scotland’s asset base 60 50 % of water mains Analysis of asset performance is measured using a 40 similar, five-point scale. Here, 1 denotes an excellent 30 asset, and 5 represents a failing asset. 20 10 Table 4 overleaf gives the percentage of the four asset 0 categories that lie in performance grades 4 (borderline) Mean England & Wales Median England & Wales 2nd Lowest England & Wales Highest England & Wales Lowest England & Wales Scotland 2nd Highest England & Wales and 5 (fail) in Scotland. This is compared with the overall England and Wales average. 8 Scottish Water’s Annual Return 2001-02, England and Wales Annual Return 1997-98. Although there is four years discrepancy between the reporting years, this is a relatively short period for assets with long lives, such as pipes and treatment works. PAGE 07
  10. 10. INVESTMENT AND ASSET MANAGEMENT REPORT 2000-02 Table 4: Percentage of assets in performance Key messages for customers grades 4 and 5 Asset Water Water Sewage Sewers • Investment per household in Scotland is currently higher than that in England and Wales, even after the category/ treatment mains treatment country works works adjustments we have made above, for the following Scotland 2002 9% 38% 19% 30% reasons: England and Wales 1999 28% 29% 19% 7% - Scotland has a much longer coastline relative to its population than England and Wales. This Above-ground assets, such as treatment works, appear increases the impact of European directives such to perform significantly better than below-ground as the Urban Waste Water Treatment Directive and assets, such as water mains and sewers. The the Bathing Waters Directive. performance of below-ground assets seems to be - Scotland invested less in the water and sewerage poor relative to performance in England and Wales. industry in the period 1989 to 1996 than the companies invested in England and Wales after We noted earlier that condition and operating practices privatisation. are the two factors that most influence how well an asset performs. By analysing information about asset • The total cost to customers in Scotland of condition and performance, we are able to determine inefficiency in the investment programme since 1996 how operational policies may be impacting on is £752 million (in 2002 prices). This is equivalent to performance. If performance of an asset category £324 for every property in Scotland. relative to performance in other companies is worse • There appears to be no evidence to support the than its condition, this may imply that operational contention that by the end of the current regulatory policies could be improved. If performance is relatively period, there will be a significant backlog of better than condition, this would suggest that the investment in Scotland relative to the position in authorities’ operational policies were better. England and Wales. Table 5 assesses asset condition and performance in • If there is a backlog in investment, inefficiency in the strategic management, planning and procurement of Scotland relative to the England and Wales average, capital projects is likely to be one of the root causes. based on information presented above. A lack of funds for investment in recent years would not appear to be a valid justification either for poorer Table 5: Assessment of Scottish asset condition customer service or for poorer operational efficiency. and performance relative to England and Wales • It is imperative for Scottish Water to take steps to Asset Water Water Sewage Sewers gain a better understanding of both the condition and category treatment mains treatment works works performance of its assets through the development • • • • • • ◗ ◗ Condition • • of a detailed and accurate asset register. This would • • • ◗ Performance significantly improve investment decisions, to the Key: benefit of all customers. Better = • • • ◗ Broad equivalence = Worse = • The assessment appears to indicate that the condition of the sewerage infrastructure assets does not justify its relatively poor overall performance in Scotland. This implies that operating policies may be an issue. PAGE 08
  11. 11. WATER INDUSTRY COMMISSIONER FOR SCOTLAND Chapter 1 Introduction This is the first annual Investment and Asset Management Report. In the Strategic Review of Charges9 we recommended to Scottish Ministers that we should publish three annual reports on progress in the Scottish water industry. These were: • a costs and performance report; • a report on the investment and asset management of the industry; and •a report on the level of service provided to customers. The Investment and Asset Management Report compares levels of investment in Scotland with those in England and Wales. It also seeks to benchmark the condition and performance of assets in Scotland against those south of the border. Maintaining the condition and performance of assets over the medium to long term is key to ensuring that costs are minimised and a consistent service is provided to customers. This first report covers the financial years 2000-01 and 2001-02. It therefore relates to the final two years of operation of the three regional water authorities: East of Scotland Water Authority, North of Scotland Water Authority, and West of Scotland Water Authority. The report contains six chapters. Chapter 2 describes the asset base in Scotland and the drivers of investment. Chapter 3 compares historic levels of investment in Scotland with those in England and Wales. Chapter 4 outlines the condition and performance of the assets in Scotland and compares them with assets south of the border. Chapter 5 discusses how the three former authorities have performed in delivering their required investment programme and compares expenditure with the investment plan agreed at the start of the period. A short concluding chapter then follows. 9 Strategic Review of Charges 2002-06, published in November 2001. PAGE 09
  12. 12. INVESTMENT AND ASSET MANAGEMENT REPORT 2000-02 Chapter 2 Investment in water and recently (within the last 50 years or so) need to be upgraded or replaced with some urgency, in spite of sewerage services their much younger age. This may occur, for example, because new technologies prove to be unreliable or as In this chapter we describe the range of assets that are a result of flaws in design. necessary to deliver a water and sewerage service. We then examine the funding and strategic planning of Non-infrastructure assets also have relatively long lives. investment in the industry. Finally, we identify what For example, service reservoirs and water treatment information is needed to ensure that customers receive works can be expected to last in the region of between best value for money from investment in the industry. 30 and 50 years. Sewage treatment works also have similar useful lives. By contrast, other water and 2.1 Water and sewerage service assets sewerage above-ground assets, including pumping stations and valves, will typically have much shorter The assets required to deliver a water and sewerage lives - often less than 10 or 15 years. service can be divided into five broad types: Some support service assets (such as vehicles and • Water infrastructure - the underground network of information technology) have short lives of between pipes, pumps and valves through which potable three and seven years, whereas offices, depots and water is supplied to customers. Water infrastructure stores would be expected to last longer. also includes dams, reservoirs and raw water aqueducts. Current water authority assets • Water non-infrastructure - includes water treatment works, pumping stations, service reservoirs and Information provided to us by the three authorities10 list water towers. their assets as including: • Sewerage infrastructure - mainly comprises sewers that collect the sewage and storm water and • over 500 water treatment works, transport it to where it can be treated. This category • over 1,900 sewage treatment works, also includes sea outfalls. • 47,200km of mains, and • 30,300km of sewers. • Sewerage non-infrastructure - includes sewage treatment works, sewage pumping stations and 2.2 Funding investment sludge treatment facilities. • Support services - the operational assets that are To replace all of the water and sewerage service essential to the effective management of the assets (pipes, valves, treatment works and so on) business, including vehicles, information systems, would cost something in the region of £25 billion at offices, depots and stores. today’s prices. This gives a good idea of the extent of investment that has had to take place to achieve the water and sewerage service we have now. The five asset types have quite different useful lives. Infrastructure assets typically have very long lives. For Of course, this investment has taken place over a very example, many of our sewers and water mains were long period. As the useful life of each asset varies, so built in Victorian times and can still be relied upon to investment to maintain and renew those assets can provide a more than adequate service. Water mains take place on a rolling basis. This means that can generally be expected to last between 60 and 100 investment can be prioritised on a yearly basis in a way years. Sewers, if well maintained, should last between that allows service to be delivered to customers as around 80 and 120 years. Having said that, some effectively and efficiently as possible. sewers and water mains that were installed more 10 Regulatory returns dated June 2002. PAGE 10
  13. 13. WATER INDUSTRY COMMISSIONER FOR SCOTLAND Figure 2.1: Costs to replace Scotland’s water and Table 2.1: Replacement costs, average asset lives sewerage assets and required investment Total £24.9 billion Asset Approximate Minimum Maximum Maximum Minimum Water non- category value average average required required Support infrastructure life (years) life (years) annual annual services £2.1 billion £0.1 billion investment investment Sewerage non- Water infrastructure infrastructure £9,800m 60 100 £163m £98m £1.8 billion Sewerage infrastructure £11,100m 80 120 £139m £93m Water non- infrastructure £2,100m 30 50 £70m £42m Sewerage non- infrastructure £1,800m 30 50 £60m £36m Support Sewerage services £100m 5 10 £20m £10m infrastructure All assets £24,900m - - £452m £279m Water £11.1 billion infrastructure £9.8 billion Table 2.1 shows that some £280 million a year, as an absolute minimum, is necessary simply to maintain the Investment to maintain the assets current level of service. A more realistic sum for maintaining the current level of service is likely to be in The assets of any business have a finite life and need the region of £400 million to £450 million per year. replacing at the end of their useful lives if business is to continue. Any prudently managed business will How investment is funded recognise the value that it receives from using these assets. This value is typically recognised in financial The very long useful life of assets in the water and accounting by making a depreciation charge to the sewerage industry lends itself to effective forward profit and loss account, thereby reducing the profit planning. This is true also of the long lead times usually earned. allowed for the introduction of tighter environmental and public health standards. This allows investment The water and sewerage business is no different. plans to be adapted in a way that is efficient both Water authorities typically recognise two separate financially and operationally. depreciation charges, one for above-ground assets and a second for the underground infrastructure. A useful example is that of a typical water main. The average expected life of a water main of around The following table highlights the very considerable 70-80 years is broadly similar to average human life annual investment necessary to ensure that assets are expectancy. If, therefore, an individual lived in the same replaced in such a way that the service is maintained. house for the whole of their life, it would be reasonable to expect the water main supplying that property to be replaced once during the lifetime of that individual. Customers contribute to charges during each year of their adult life. Some customers will pay in advance of receiving a new water main, others will receive the new main earlier and will pay for it during the remainder of their life. In effect, the whole customer base jointly PAGE 11
  14. 14. INVESTMENT AND ASSET MANAGEMENT REPORT 2000-02 purchases each year a quantity of refurbished mains Investment to improve assets which will keep the system in a fully serviceable order. Although they will benefit only once during their life Investment in water and sewerage assets will from the replacement of the main, during all other years sometimes be necessary in order to meet higher customers will have access to a safe water supply. environmental and quality standards, rather than simply being replaced on a ‘like for like’ basis to maintain the In other words, in any one year, those who receive the service. new water main are borrowing from their fellow customers the excess of their contributions through To fund this new investment within the timescales charges prior to replacement of the main. The required by new obligations, water authorities may have customer who receives a new main to serve their to borrow capital, on behalf of all customers. Borrowing property before they begin to pay for the water service in this way allows the cost of new investment to be borrows the entire amount from fellow customers. The spread over time. customer who receives a new main half way through their adult life will borrow approximately half the cost of However, such borrowing will inevitably mean that the the main from other customers, the rest being funded water authority has to raise more money from its by contributions already made. customers in order to bring its revenue and asset replacement liabilities (ie the interest on and the Customers promise to continue to pay charges even repayment of principal of the capital borrowings) back after replacement of the main in settlement of their into balance. debt (to fellow customers), and each year these contributions allow for others to benefit from the A prudent and well-managed company will therefore refurbishment of the main that services their property. use borrowing only to fund asset improvements, not to maintain or replace those that have already been If the average rate of deterioration of the water main created and depreciated. were regarded as broadly similar, each householder would receive the same average service over any 2.3 The Quality and Standards process period of 70-80 years. It is in the interests of all customers that environmental The same principle applies to shorter life assets, such and public health standards are met and that deadlines as technology (which would have a very short asset life set out in legislation are complied with. Much of the of around 3-4 years) or water treatment plants (which legislation is instigated by the European Union and is have a useful life of 25-30 years). They would be enforced through infraction proceedings. Member replaced on average 25 times (for the technology states who fail to comply face fines that would asset) and three times (for a water treatment plant) ultimately have to be paid by customers. during the average customer’s life. Prior to 1999, there was no coordinated approach The result is that the portfolio of assets owned by a towards investment in the Scottish water industry. The water authority can be properly maintained by an Government, environmental and public health annual sum of money, which, if consistently invested, regulators and customer representatives independently will ensure that the serviceability of the network is communicated their own priorities on investment to ensured. each of the three water authorities. The result was a lack of consistency, with no clear mandate to address customers’ concerns about improving water quality and meeting the tighter environmental standards required by legislation. PAGE 12
  15. 15. WATER INDUSTRY COMMISSIONER FOR SCOTLAND The absence of a coordinated approach to investment part of the Commissioner’s remit is to advise Scottish carried a further risk to customers. Maintaining and Ministers on the factors which the water industry replacing assets that were nearing the end of their should take into account in developing their charges useful lives was unduly delayed because of the schemes. pressure on the water authorities to comply with legislative deadlines. Such delays could result in a When we conducted the interim Strategic Review of complete failure of a vital asset - leading to increased Charges we examined the investment needs outlined in costs for customers, unacceptable declines in the first Quality and Standards document. The interim customer service, or both. review signalled our concerns that insufficient attention was being directed towards maintaining and replacing The Scottish Executive recognised the need to improve those assets that were nearing the end of their lives. investment planning and coordination in the water We advised revenue caps that took account of this industry in Scotland. As a result, it initiated the Water concern. Quality and Standards process. This was an explicit attempt to bring together all stakeholders and to 2.4 What drives investment in the water develop a single statement of the investment needs of and sewerage industry the Scottish water industry. Investment can be divided into four broad headings: The outputs agreed through the Quality and Standards base investment, infrastructure renewal, quality process are similar to the Asset Management Plans enhancement and growth. that are drawn up by the privatised companies in England and Wales in consultation with the Base investment and infrastructure renewals12 Environment Agency and the Drinking Water Inspectorate (DWI). Maintaining and replacing above-ground and support service assets can be termed base investment. The Scottish Executive’s first Water Quality and Standards document11, published in November 1999, Base investment is the investment necessary to covered the two-year period from 1 April 2000 to maintain existing service levels to customers. It involves 31 March 2002 (referred to here as Quality and replacing equipment that is at the end of its useful life Standards I). with a similar asset. No improvement in the underlying average service results. It defined what the Scottish Executive expected the three former water authorities to deliver in terms of Infrastructure renewal is the process of replacing drinking water quality, safe and sustainable sewage infrastructure assets that have reached the end of their disposal and environmental protection. useful lives. The then Minister for Transport and the Environment, Base investment and infrastructure renewals accounted Sarah Boyack MSP welcomed the publication as “the for 41% of investment in Quality and Standards I. start of a process that will ensure that the water authorities’ customers and the Scottish water Quality enhancement environment benefit from a modern and efficient water and sewerage service at the best possible price”. This covers investment that is categorised as enhancing quality. The main driver for such The role of the Water Industry Commissioner for enhancement is usually a legislative deadline. Scotland was established at the same time as the initial Customer preference and political decisions can also Quality and Standards process was completed. A key influence this area of the investment programme. 11 Water quality and standards: Investment priorities for Scotland’s water authorities 2000-02. 12 Base investment and infrastructure renewals are sometimes referred to as capital maintenance. PAGE 13
  16. 16. INVESTMENT AND ASSET MANAGEMENT REPORT 2000-02 Legislative drivers during 2000-02 included: the view that the low level of investment in the short- term implied by Quality and Standards I could have an • The Control of Pollution Act 1974, adverse impact on both the level of service provided to • The Urban Waste Water Treatment Directive, customers and on compliance with investment and • The Bathing Waters Directive, and public health targets. • The Drinking Water Directive. The revenue caps set out in the interim Strategic Other drivers included: Review of Charges allowed for greater investment in capital maintenance. Sarah Boyack MSP modified the • The Cryptosporidium Direction, advice, reasoning that the poor quality of information • Surface Water Abstraction Directive, available about the underground assets would reduce • Freshwater Fish Waters Directive, the effectiveness of investment. The modified revenue • Shellfish Waters Directive, caps did, however, make in excess of £150 million • Sewage Sludge Directive. available for investment beyond the spending outlined in Quality and Standards I. Quality enhancing investment is necessary to ensure that such priorities are achieved within the agreed 2.6 Information and the capital timescale. Quality investment accounted for around maintenance framework 52% of total investment in Quality and Standards I. Effective capital maintenance is best achieved by Growth planning expenditure to address asset maintenance pro-actively. Asset management in Scotland is Growth investment is the investment necessary to meet hampered by the relatively poor quality of asset the demand for services from new and existing information available. However, it is in customers’ customers by providing new assets or increasing the interests for capital maintenance to be properly capacity of existing assets. Examples of growth prioritised and to prevent a lack of perfect information investment include removing a development constraint being used to justify inaction. or connecting a new property to the water and sewerage system. Growth investment usually accounts In order to improve value for money for customers, the for only a small proportion of total investment. water industry in the UK identified the need for a In Quality and Standards I, growth accounted for 7% of common approach to capital maintenance planning. total investment. UK Water Industry Research (UKWIR) was commissioned to develop a framework around which 2.5 Ensuring effective capital maintenance capital maintenance planning could be based. The Office of Water Services (Ofwat), the DWI, the Understanding the condition and performance of Environment Agency, the Water Industry Commissioner underground assets is a complex activity, requiring a for Scotland (WICS) and the Department of detailed knowledge of the infrastructure. This degree of Environment, Food and Rural Affairs (DEFRA) all understanding is essential when making decisions supported the initiative. about the timing and level of investment necessary to maintain these assets, and can have a significant The key output was to create a process that companies impact on the value for money provided to customers. could use to develop ‘serviceability indicators’. These indicators could then be used as the basis to measure In Quality and Standards I it was agreed that capital maintenance performance. Several water and infrastructure renewals should grow over time to sewerage companies in England tested the framework between 1% and 2% of the replacement cost of the and it is now in the process of being adopted by the underground infrastructure. Following consultation with industry south of the border (with support from all of customers, management and industry experts, we took the regulators). PAGE 14
  17. 17. WATER INDUSTRY COMMISSIONER FOR SCOTLAND We would like to see a similar framework adopted in • the operation of the water supply and drainage Scotland in the near future. This would ensure a proper systems; approach to the maintenance of assets in Scotland and • the condition and performance of assets (particularly would safeguard the condition of the network for future below-ground assets) on a consistent basis across generations. We expect the industry in Scotland to Scotland; strive to implement accepted best practice. • the extent of development constraints resulting from the capacity or performance of the water and 2.7 Key factors in delivering investment sewerage system. successfully Significant progress in these areas will be essential to In the interim Strategic Review of Charges, we made both the efficient operation of Scottish Water13 and the two key recommendations to help achieve success in efficient delivery of the capital programme in the next delivering the investment programme. These were: Quality and Standards period, ie 2002-06 (Quality and Standards II). • that management information parameters should be introduced, which would allow consistent efficiency targets to be set for the three Scottish water authorities and for proper comparisons to be drawn for benchmarking purposes; and • that the three authorities should introduce a common asset management process, which would also allow customers to be confident that best value in procurement and maintenance was being achieved. We commissioned an information project from a consortium of consultants including WS Atkins, Cap Gemini, Ernst & Young and Yorkshire Electricity to assist in implementing these two recommendations. The project highlighted the need to improve further the information that the authorities have about their assets. The information available to the authorities and to regulators has improved markedly over the last two years. This improvement is welcome, but more progress is necessary if we are to develop a greater understanding of: 13 Scottish Water replaced East of Scotland Water Authority, North of Scotland Water Authority and West of Scotland Water Authority on 1 April 2002. PAGE 15
  18. 18. INVESTMENT AND ASSET MANAGEMENT REPORT 2000-02 Chapter 3 Historic investment in Scotland Table 3.1: Total investment14 Year 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 In this chapter, we examine historic levels of investment Scotland in Scotland and compare them with investment in the excluding PFI £252m £277m £346m £397m £428m £460m water and sewerage industry in England and Wales. Capital element of PFI £3m £15m £15m £136m £170m £126m 3.1 Investment levels Scotland total £255m £292m £361m £533m £598m £586m Making direct comparisons between the levels of England and Wales investment in England and Wales and in Scotland is not total £3160m £3664m £3670m £3643m £2744m £2983m a straightforward process. As well as the obvious differences of geography and population density, Absolute levels of investment do not, by themselves, adjustments also need to be made to reflect differences give the full picture. One useful indicator is the level of in the timing of investment and to reflect the significant investment per property. use of the Private Finance Initiative (PFI) in Scotland. Table 3.2 indicates that, even excluding investment The level of investment in England and Wales delivered through PFI, Scotland has now overtaken increased significantly after privatisation in 1989. By investment levels in England and Wales. This is in spite 1996-97, the privatised companies were investing of the significant difference that existed when the three some £3.5 billion per year. A significant proportion of authorities were established. this investment was driven by the Urban Waste Water Treatment and the Bathing Waters Directives. Table 3.2: Levels of capital investment per property (excluding PFI) Investment in Scotland began to increase significantly after the formation of the three former water authorities Year 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 in 1996. Considerable use was made of PFI schemes Scotland £109 £119 £149 £171 £184 £198 England & to fund the investment required to comply with the Wales £144 £167 £167 £166 £125 £136 Urban Waste Water Treatment Directive and the Difference (£35) (£48) (£18) £5 £59 £62 Bathing Waters Directive. Using PFI in this way means that the effective investment spend in Scotland during Figure 3.1: Levels of capital investment per 1996-2002 is higher than it appears. property (excluding PFI) Investment in England and Wales has now stabilised at 250 around £3 billion per year. The Quality and Standards II 200 process, which begins immediately after the 2000-02 150 period discussed in this report (and covers the period £ 100 2002-06), foresees investment in Scotland stabilising at around £450 million per year. 50 0 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 Year Scotland England and Wales The cumulative level of direct investment per property over the same period is illustrated in Table 3.3. 14 Reliable information prior to 1996 is not available. PAGE 16
  19. 19. WATER INDUSTRY COMMISSIONER FOR SCOTLAND Over the six year period, £27 more per property has Table 3.5: Cumulative levels of capital investment been invested in Scotland than in England and Wales. per property (including PFI) Year 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 Table 3.3: Cumulative levels of capital investment Scotland £110 £236 £391 £621 £879 £1132 per property (excluding PFI) England and Wales £144 £310 £477 £643 £768 £904 Year 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 Difference (£34) (£74) (£86) (£22) £111 £228 Scotland £109 £228 £377 £548 £733 £931 England and Wales £144 £310 £477 £643 £768 £904 3.2 Levels of investment adjusted for Difference (£35) (£82) (£100) (£95) (£35) £27 efficiency Table 3.4 outlines the effective level of investment per In the Strategic Review of Charges 2002-0615 and in property since the three former authorities were our recent Costs and Performance Report 2001-0216 created. The impact of investment through PFI has we analysed the capital efficiency of the water and been added to the direct investment outlined above. sewerage industry in Scotland relative to that in England and Wales. Table 3.4: Levels of capital investment per property (including PFI) The analysis of capital expenditure in Scotland outlined in section 3.1 above does not take account of the Year 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 relatively poor capital efficiency of the industry in Scotland £110 £126 £156 £230 £258 £253 England Scotland. Our assessment of efficiency requires that & Wales £144 £167 £167 £166 £125 £136 the same, or a better, investment output is delivered for Difference (£34) (£41) (£11) £64 £133 £117 less money. This means that actual cash expenditure should be adjusted for inefficiency so that the effect on Figure 3.2: Levels of capital investment per the level of service, or on environmental and public property (including PFI) health standards, can be assessed objectively. 300 250 The following table outlines the percentage gap in 200 capital efficiency that was assessed in the Strategic £ 150 Review of Charges 2002-06 and in the Costs and 100 Performance Report. 50 0 Table 3.6: Capital efficiency gap relative to 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 England and Wales17 Year Scotland 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 East of England and Wales Scotland Water Authority 23% 27% 30% 34% 37% 36% The impact of PFI increases the relative investment North of committed per property in Scotland. Table 3.5 Scotland Water illustrates the cumulative level of investment per Authority 24% 28% 32% 35% 38% 38% property over the same six-year period. After proper West of Scotland account is taken of PFI, Scotland has invested £228 Water more per property than has been invested in England Authority 24% 28% 31% 35% 38% 38% Scotland and Wales. weighted average 24% 28% 31% 35% 38% 38% 15 Strategic Review of Charges 2002-06, Water Industry Commissioner for Scotland, November 2001. 16 Costs and Performance Report 2001-02, Water Industry Commissioner for Scotland, February 2003. 17 The gap is assessed in relation to Ofwat’s lowest submission for cost base benchmarking. This would understate the extra efficient, effective investment in Scotland per household relative to the Ofwat benchmark. The efficiency targets for Scottish Water in the Strategic Review of Charges 2002-06 were calculated relative to the less demanding Ofwat benchmark. PAGE 17
  20. 20. INVESTMENT AND ASSET MANAGEMENT REPORT 2000-02 In the analysis in the Strategic Review of Charges Figure 3.3: Levels of capital investment per 2002-06, we assumed that PFI capital investment was property (adjusted for relative efficiency) in £ delivered efficiently. The following table reconciles 200 actual direct spending in Scotland to the efficient effective investment spending that benefited customers 150 under the same assumption. £ 100 Table 3.7: Reconciliation of direct investment to 50 efficient effective investment 0 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 Year 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 Direct Year investment Scotland in Scotland £252m £277m £346m £397m £428m £460m England and Wales Less: Assessed capital 3.3 Key messages for customers inefficiency £60m £78m £107m £139m £163m £175m Efficient direct investment £192m £199m £239m £258m £265m £285m • Investment per household in Scotland is higher than Investment that in England and Wales, even after the delivered adjustments we have made above, for the following through PFI £3m £15m £15m £136m £170m £126m reasons: Total efficient effective investment £195m £214m £254m £394m £435m £411m - Scotland has a much longer coastline relative to its population than England and Wales. This increases the impact of European directives such Table 3.8 outlines the adjusted total investment in as the Urban Waste Water Treatment Directive and Scotland on a per household basis and compares this the Bathing Waters Directive. with England and Wales. Even after this adjustment for inefficiency, investment in Scotland on a per household basis is broadly on a par with England and Wales. This - Scotland invested less in the water and sewerage industry in the period 1989 to 1996 than the adjusted level of £820 compares with the actual £1,132 companies invested in England and Wales after that Scottish customers have financed. privatisation. After our adjustments the level of investment in Scotland overtook England and Wales in 1999-2000. • The total cost of inefficiency in the investment programme between 1996 and 2002 has cost customers in Scotland £752 million (in 2002 prices). Table 3.8: Efficient effective investment per This is equivalent to £324 for every property in household Scotland18. Country 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 Scotland £84 £92 £109 £170 £188 £177 • There appears to be no evidence to support the England contention that there is a significant backlog of and Wales £144 £167 £167 £166 £125 £136 investment in Scotland relative to England and Wales19. So although investment in England and This is shown in Figure 3.3. Wales was higher immediately after privatisation, the roles have recently reversed. 18 The total is £312 per property before the adjustment is made to 2002 prices (£1,132 less £820). 19 This assumes that expenditure required to maintain existing assets is broadly similar to expenditure required for new assets. PAGE 18
  21. 21. WATER INDUSTRY COMMISSIONER FOR SCOTLAND • There appears to be no evidence to support the 3.4 Conclusions contention that by the end of the current regulatory period, there will be a significant backlog of Comparing investment levels is not a simple process. investment in Scotland relative to the position in Important adjustments need to be made so that the England and Wales. method of investment delivery and the timing of investment neither exaggerate nor understate the true • If there is a backlog in investment, inefficiency in the state of affairs. strategic management, planning and procurement of capital projects is likely to be one of the root causes. Our analysis has indicated that while there was A lack of funds for investment in recent years would significantly less investment in Scotland during the not appear to be a valid justification either for poorer early 1990s than in England and Wales, the position customer service or for poorer operational efficiency. has altered markedly in recent years. • Given that per household investment is planned to be Levels of investment per property in Scotland have now significantly higher in Scotland during the Quality and risen above those in England and Wales. Even after Standards II period, it is likely that investment adjustments are made for capital inefficiency, it is likely expenditure on a per property basis over the entire that the industry in Scotland will have matched period 1989 to 2006 will have been broadly the same spending per household by the end of Quality and in Scotland as in England and Wales. Standards II. Figure 3.4: Actual and projected investment per property in Scotland and England and Wales 250 200 150 £ 100 50 0 2000-01 1996-97 2001-02 2002-03 2003-04 2004-05 2005-06 1997-98 1998-99 1999-00 Year Scotland England and Wales PAGE 19

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