In the final weeks of 2017, water sector regulator Ofwat confirmed changes that could create a new generation of construction opportunities.
Last month, Ofwat released the methodology for its next price review, due to take effect in 2019. Known as PR19, the review will set the price of water, the service standards that customers can expect, and – importantly – the investment water companies will make in their infrastructure.
As expected, the regulator has laid down the gauntlet to water firms with some challenging assessment criteria and objectives in areas such as customer engagement, price, service and long-term resilience.
Water companies must now respond in their business plans, planning for investment in projects ranging from new treatment facilities and pumping stations to pipe maintenance and energy projects.
But there is a crucial change under PR19. The regulator is strongly encouraging a new delivery model for investment in capital and operational projects: direct procurement.
This model enables private companies to tender for a project for its whole lifetime, including finance, design, build and operation. The PR19 methodology stipulates that direct procurement should be considered for any project worth £100m (capital plus operating expenditure).
The attractions for the regulator are obvious. Direct procurement can encourage private investment in infrastructure while driving greater competition, lower costs and increased efficiency.
Direct procurement is one of the recommendations from the Infrastructure and Projects Authority’s recent Transforming Infrastructure Performance report.
However, the only project to adopt this model to date is the £4.2bn Thames Tideway Tunnel. Tideway is a special case for at least two reasons: firstly, its huge scale; and secondly, it is being delivered under a project licence, granted by Ofwat and separating Tideway from Thames Water.
“Direct procurement promises new opportunities for high-performing enterprises, but the supply chain needs to adopt different commercial models to succeed”
In contrast, the new direct procurement threshold of £100m totex is very low. Suppliers will need to carefully assess the cost of tendering in a market where margins are tight. Could multiple projects be collated, so that suppliers bid for a programme of projects with the same water company, making it more economic? We don’t yet know.
Moreover, a project licence will not be possible for every scheme, leaving a question over how the finance and delivery spheres will overlap. Will investors make demands of the supply chain (for example on credit ratings) to manage the financial risks? Will they require bonds or retentions that could provide greater certainty, but would also push up costs for the client?
While there are still unknowns, clients and the supply chain need to prepare for this new model.
What needs to happen
Water companies will soon need to acquire project finance, manage conflicts, procure projects under a totex model – and carry the costs of doing so. This is new territory for many, and they will need to develop the capabilities to engage fully with the direct procurement model.
Investors, contractors and the supply chain also need to get ready. Direct procurement promises new opportunities for high-performing enterprises, but the supply chain needs to adopt different commercial models to succeed.
These models must prioritise efficient and effective delivery, potentially by introducing other performance-based incentives. Suppliers need to be more transparent and, in some areas, collaborate with their competitors to keep the risk and cost of interfaces low.
So what’s next? Water companies will submit their business plans to Ofwat in September, within detailed scrutiny by the regulator following through 2019.
The opportunities arising through direct procurement won’t be immediate, but the potential is significant. Clients, investors and the supply chain should be engaging, planning and working together to build capability and capacity now, so they are well placed to take advantage of these opportunities.
Emma Ferguson-Gould is national water sector lead at Turner & Townsend