Visit to GU Partnership, Watford, Tuesday 27 June 2000

Blackwell House, Aldenham Road, WD2 2LG

Main presenters

Mr David Alexander Managing Director, Three Valleys Water PLC

Mr Bob Taylor   Head of Network Asset Management, General Utilities Partnership

Mr Patrick Campbell Strategic Planning Manager, General Utilities Partnership

Mr Steve Boote   Engineering Technician, General Utilities Partnership

Introduction

1. GU Partnership provides management and engineering services, including laboratory services, for companies in the General Utilities Plc Group. The Group in turn manages the water interests of Vivendi UK. Vivendi (formerly Générale des Eaux) is based in Paris and is the largest water supply grouping in the world. As well as interests in Three Valleys, General Utilities controls the North Surrey, Folkestone and Tendring Hundred water companies.

2. During its inquiry the Committee received many memoranda expressing concern that Ofwat's "no deterioration" policy for asset maintenance (see paras 180-187) was leading to under investment in pipe maintenance. There was criticism that the method was failure-based and relied on historic trends rather than current assessments of the state of the assets. The aim of the Committee's visit was to learn more about the processes which Three Valleys Water are employing to determine: the state of the existing underground pipe network, the rate at which it is deteriorating, and the rate of renewal necessary to avoid an overall deterioration in the state of the assets.

Asset maintenance

3. Three Valleys keeps records of the composition of its network in terms of materials as each material has different properties which will impact upon its maintenance and life span. 72% of the company's pipe network is made up of ferrous pipes, the majority of which are cast iron (others include spun iron and ductile iron). Iron pipes, if not protected, corrode both internally and externally. Cast iron is a particularly brittle material which tends to crack very easily when the supporting soil moves as a result of the temperature changes or surface loading. The company also maintains records of the length of mains laid per year since 1900. These clearly illustrate peaks of building in 1931, the late 1930s, and late 40s to early 50s.

4. Pipes may burst because water finds a hole to blow or the pipe may become so thin that a slight movement in the soil is enough to break it. Three Valleys has the second highest pipe burst rate in England and Wales. This is mainly a result of the predominance of cast iron pipes and the difficult soil conditions in and around London. There are a number of contributing factors to pipe bursts. The key factors are: pipe material, soil conditions, internal pressure, diameter, age and traffic loading. The speed of corrosion is dependent on the soil type and its "aggressiveness". London clay is particularly corrosive and highly "aggressive" to pipes. Three Valleys has found that a large concentration of their bursts coincide with the location of London Clay.

5. Three Valley's main method of reducing the frequency of burst pipes is through a planned and systematic pipe replacement programme. A large proportion of leakage originates from the mains network and the company has emerging evidence that pipes are tending to leak badly before they burst. Three Valleys takes the view that, in the long run, the replacement of badly corroded pipes, with a poor burst history, is a cheaper option than repairing them as replacement is generally less socially disruptive eg in terms of required roadworks etc.

6. Since 1992, the company has amassed substantial data on the condition of the pipe network from pipe samples analysed in a purpose designed laboratory. This information has been used in conjunction with a computer-based model (see below) to ascertain the level of pipe replacement needed to avoid an overall deterioration in the network condition. Three Valleys considers Ofwat's "no deterioration" method to be a simplistic and inferior measure in comparison to the data which the company collects but Ofwat has maintained its current assessment methods. Three Valleys believes that this an unsustainable approach and predicts it will lead to a gradual build up of investment and maintenance back-log which will ultimately have to be undertaken by future generations.

7. Ofwat considers a number of serviceability indicators when judging whether the network is deteriorating. These include the length of time that water supply is interrupted and the number of pipe bursts. If neither trend is adverse Ofwat's maintains the company's current investment level. However, Bob Taylor (Head of Network Assets) explained that factors such as pressure management were likely to be masking the real situation on the ground. Managing the pressure at lower levels keeps burst rates down. Thus, the company does not score sufficiently badly against Ofwat's serviceability criteria to warrant extra funding but the pipe condition will continue to deteriorate.

Remaining Useful Life Modelling

8. GU Partnership has developed a pipe network corrosion model. This is illustrated by the schematic in Fig 1. Using multiple parameters, this aims to model and forecast the deterioration of the network (in time) by the corrosion process affecting all ferrous pipes 12² diameter and below ie almost 72% of Three Valleys' network. It also seeks to identify the length of pipes which need to be renewed—for any range of dates—to counter this permanent deterioration. Effectively this is a predictive model to estimate the time before categories and types of main reach the end of their useful life. In this way Three Valleys has provided data to Ofwat to support the requirements for its Infrastructure Renewal Allowance.

9. The model is based upon measured rates of corrosion and assumes the pipe will not burst until the wall is fully corroded. Three Valleys knows that, in practice, many pipes burst well before they reach this state and therefore they consider that, the output from the model, if anything, will tend to underestimate renewal lengths.

10. Samples of pipe are taken wherever possible and tested to determine the extent and distribution of corrosion and the remaining useful life of the main. The results of the pipe sample analysis are used, together with the soil corrosivity information, as inputs to the predictive model.

11. The Committee visited GU Partnership's pipe sampling workshop and were hosted by Steve Boote the Engineering Technician. The Committee were shown samples of pipe which had been sandblasted to remove graphitic corrosion material which then yielded a better indication of the condition of the pipe. This graphitic material covers weaknesses and holes in the pipe giving the appearance that the pipe is intact.

12. Three Valleys has found that the renewal rate needed to maintain the overall condition of the pipe network is significantly higher than the actual rate of replacement allowed in the PR 99 price determinations. The current replacement rate of approximately 0.5% per annum implies a 200-year asset life which Three Valleys feels is unrealistic. Three Valleys told us that strong evidence was emerging that the rate of deterioration of pipes laid in the post-war period was increasing, giving rise to a backlog of renewal work which is being continually deferred into the future. Three Valleys did not feel that this situation was acceptable and that the strong body of technical evidence available to support higher levels of replacement activity should now be recognised by Ofwat.

Visit to North West Water Ltd, Tuesday 4 July 2000

13. The Committee spent the day at the Fazakerley Waste Water Treatment Works in Liverpool owned by North West Water Ltd. The visit included a number of presentations by company staff as well as by Mr Justin McCracken and Mr Clive Gaskell from the local Environment Agency regional office. The Chairman of the local Ofwat Customer Service Committee, Mr Maurice Terry, was also present for part of the day's discussions.

14. The aim of the Committee's visit was to see how the Periodic Review process impacts upon a water company and its stakeholders at a practical level. North West Water (NWW) presented an interesting case study because the price limits of the 1999 Periodic Review enable the company to undertake the largest environment and water investment programme of the water industry to date, totalling some £3 billion over the next five years. One of every £4 due to be invested in drinking water quality and environmental improvements in England and Wales over this period will be spent in the North West.

15. The main environmental challenge for the North West is dealing with the pollution legacy of the textile, chemical and armaments industries. In addition, the region boasts the first city in the country to be sewered—Liverpool. However, the downside of this pioneering work is that the region has an ageing, largely Victorian infrastructure, which was oversized originally and one which Mr Harry Croft, Managing Director of North West Water, told the Committee had been neglected by generations of owners.

16. Mr Harry Croft provided the Committee with an introduction to North West Water Ltd. NWW is the second largest of the ten Water Service Companies providing water and waste water services in England and Wales. The company covers an area of 14,000sq km from Carlisle to Crewe and serves a population of 7 million people—2.7m domestic customers and 0.2m business customers. The main sources of supply for NWW are upland (60%) and rivers (30%) with only 10% of the company's supply coming from underground sources. This is in contrast to areas like London and East Anglia which rely heavily on underground sources.

Leakage

17. NWW is the most improved water company with respect to meeting leakage targets. It has shown a 40% improvement since March 1995 from 789Ml/day to 487 Ml/day. Maintaining this level of leakage requires a significant amount of investment but NWW told us that Ofwat now recognised that they were approaching the economic level of leakage, ie when the costs associated with finding and repairing a leak now outweighed the costs of losing the water.

Wastewater treatment

18. Wastewater quality and treatment is a key aspect of NWW's environmental programme. Mr Colin South (NWW's Wastewater Services Director) gave the Committee an overview of NWW's waste water and environmental programme. NWW has 613 Wastewater treatment works, 39,778 km of sewers, and treats 2950 Ml of wastewater daily.

19. Compared to the investment programme of 1995-2000, the 2000-2005 programme has a greater emphasis on Unsatisfactory Intermittent Discharges. These now represent 54% of the £1,200 million (May 1999 prices) budget compared to 18% of £880 million in the last review where the bulk of the wastewater quality programme (37%) was focussed on bathing waters. Previous quality programmes have meant that the North West is already seeing better water quality in the Mersey Basin and other areas, improved/stabilised bathing water quality, and secured (58%) agricultural recycling of sludge. However the company told us it was an enormous programme to deliver. There are nearly 2000 intermittent sewerage discharges in the North West of which over 900 are currently deemed to be unsatisfactory by the Environment Agency. By 2005 NWW aims to have only 27 such discharges.

20. The company anticipated that the delivery of the 2000-2005 investment programme, to time, would cause huge disruption in the region. Over 372 wastewater quality outputs had been achieved in the last five years and 1050 were planned for the current period. In delivering the last programme, the company experienced a bottle neck in the last two years.

21. NWW has secured £381 million (May 1999 prices) for the maintenance aspect of its wastewater investment programme—25% less than that allocated for the last 5 years. Mr South gave the Committee an idea of some of the factors to be considered in terms of investment and maintenance of wastewater projects. Many of the newer plants have a much higher proportion of mechanical and electrical components than was previously the case. The cost of these elements and installation can be as much as 60-70% of the cost of a project as demonstrated by NWW's own new sludge plant. However, such components have a shorter life and require higher capital maintenance than the buildings they may be housed in. Mechanical parts and electrics can be expected to last some 15 years in contrast to the surrounding civil structures which might be expected to last around 60 years. As new plant tends to be added on to existing plant as upgrades this adds another dimension to judging maintenance needs.

22. Mr South gave the Committee an idea of the costs and time scales involved in asset maintenance. NWW estimates that the notional asset life of their above ground assets is 68.5 years. This figure is based on a Gross Modern Equivalent Asset value (GMEA) of £2,300m and a maintenance allowance of £33.6m/pa. For below ground maintenance, there is a Notional Asset life of 426 years based on a GMEA of £18,170m and a maintenance allowance of £42.6m/pa. Many of the sewers were laid in the 1950s and 1960s because of major housing developments so this means that there were likely to be particular cohorts coming up for renewal/rehabilitation at the same time.

23. NWW explained its maintenance policy. The company has a target of rehabilitating critical Class 4/5 sewers. (Class 5 refers to a broken or collapsed sewer and Class 1 is a new one). NWW do not rehabilitate sewers at Class 3 or below. It typically costs £1000/2000 per metre (linear) for large sewer renovation such as lining with cement mortar. Replacement would typically be twice the cost of renovation. For critical sewers (ie those of strategic importance) NWW has adopted the industry's standard that it is more economic to repair them before they collapse, however, for non-critical sewers the economics are generally reversed and they are repaired after failure.

24. NWW felt that it had made clear to Ofwat that it had not been given enough funding to "maintain serviceability". The company had taken a number of approaches: historic, forward planning, surveying and strategic but was not clear of the best way to demonstrate its maintenance needs to Ofwat. The company recently commissioned the consultancy OXERA to look at methods of assessing the non-infrastructure (above ground assets) investment needed.

25. Flooding from sewers is a major problem for the company (see para 189). In the period 2000-2005, NWW will have £29 million (May 1999 prices) to deal with 560 properties. However, the cost of dealing with sewer flooding is typically £100,000 per house and the company had proposed to remove the risk from 1000 properties. NWW admitted that foul sewer flooding was a major cause of complaints from customers but pointed out that Ofwat's Final Determination was insufficient to address the policy and had not allowed any financial resource until 2002.

Environment Agency

26. Mr Justin McCraken (Regional Director) and Mr Clive Gaskell (Regional Water Quality Manager) from the Environment Agency outlined the particular issues faced by the Agency in the North West.

27. The Environment Agency is keen that basic water quality is restored in the region. In all Agency regions the objective is to ensure that sewage discharges are properly treated and rivers are healthy for fish and wildlife as well as supporting recreation. In the North West, the Agency is faced with some particular problems: the lowest level of compliance with the Bathing Water Directive in England and Wales, one of the oldest sewage networks, some of the most delicate ecosystems eg the Lake District and the highest proportion of poor and bad quality rivers.

28. The high quality waters in the North West are very susceptible to change and the National Environment Programme for the 1999 Periodic Review includes important schemes to reverse adverse trends in the region. For example, delicate ecosystems such as those at Grassmere are being affected by basic sewage problems such as eutrophication. Major tourist resorts in the region such as Blackpool and Morecambe are failing to comply with bathing water standards and thereby posing a major risk to the tourist trade as well as health. In 1999, only 23 of the 34 coastal bathing waters in the region were compliant with imperative standards and only two sites complied with EC guideline standards.

29. The Agency told the Committee that the old "storm" overflows frequently discharged crude sewage and there were frequently pollution and litter problems. The Agency has identified over 900 problem overflows in the region (over a third of the total) posing both health hazards and barriers to recreation.

30. The Agency expects that the 1999 Periodic Review will improve 350km of river, meeting the modest objectives of: maintaining basic oxygen levels to support fish, to remove sewage derived litter, and to remove ammonia which is toxic to fish. However, the Agency was concerned that eight schemes (equating to around £80 million) had been excluded from NWW's environmental programme by Ministers, on Ofwat's advice, subject to re-evaluation. It believed that the exclusion of these schemes would impair the region's ability to meet Government targets for River Quality Objective failures (50% reduction by 2005) and that 84kms of river would be left in a "poor" or "bad" state.

31. The Agency acknowledged that the investment programme would still deliver substantial environmental and economic benefits to the region but it was concerned that if the full programme was not carried out, the poor state of rivers would threaten inward investment in the region by contributing to the "dirty" image of urban areas. Indeed the Chair of the local RDA, had written to the Environment Minister, Michael Meacher, asking for the environment programme to be reinstated in full because of the fundamental impact on urban regeneration and inward investment in the region.

32. The Agency was expected to submit further information on costs and benefits to aid the re-evaluation of the outstanding schemes to DETR later that month. However, the Agency did not feel that there was a clear protocol for this process nor was it clear how the benefits of schemes should be assessed.

Price Profile

33. Mr Stan Chaplin, NWW's Finance Director, outlined the impact of the Final Determinations on NWW. The price limits set by Ofwat mean that NWW has an average K factor of -0.5%. Prices will fall by 9.3% in 2000/2001 but are allowed to rise again in 2003/2004 and 2004/2005. This U shaped profile recognises the large investment programme required for NWW compared with the L shape for most of the industry. Wessex Water is the only other company which has this U shaped price profile. The quality investment of NWW adds £45 to the 1999/2000 average bill by 2004/5 but NWW told the Committee that past and future efficiencies assumed by the regulator of £55 more than offset this. NWW demonstrates roughly average efficiency on both operating and capital unit costs compared to the other water companies. However, Ofwat has penalised the company on service factors some of which were outside the company's control, such as bathing water quality and legacy issues relating to infrastructure.

34. Mr Chaplin outlined the extent of the challenge which NWW faced within the constraints of the pricing regime set by Ofwat. At the 1994 review, investment for 2000-05 was assumed to be £1.8 billion with prices tracking inflation. At the 1999 review investment nearly doubled to £3.1 billion with prices falling. NWW argues that it was originally envisaged that the waste water quality investment programme would run a further 15 years from 2000 but this had now been collapsed into five years adding further constraints. However the Agency disputes that the requirements of the Urban Waste Water Treatment Directive and domestic legislation ever set such timescales.

35. Mr Chaplin outlined the main pressure points for NWW as a result of the price review. The Final Determinations assume that the turn-out achieved on the capital unit costs of the 1995-2000 investment programme can be reduced by 27% and operating efficiencies of £300 million are required over the next five years to meet the regulator's assumptions. In the last five years the company has made cost efficiencies of £50 million. The £300 million of efficiencies to be delivered in 2000-2005 are additional to those delivered since privatisation and amount to a further 25% reduction in controllable costs, excluding potential cost shocks. The company is aware that it needs to manage the risk to its reputation as a result of the steep price increases.

36. The company's credit ratings had been downgraded by the debt markets as the industry was seen as more risky and this had a knock-on effect for borrowing as the cost and availability of funding depended on maintaining an acceptable credit rating. NWW had announced the loss of 400 jobs (200 had already been achieved through natural wastage) but these job cuts were not related to the Price Review. In contrast, the company informed the Committee that engineering jobs were actually increasing as a result of the large capital programmes underway.

The Periodic Review

37. Mr Chaplin explained how the company had engaged in the 1999 Periodic Review. NWW viewed the Review in three main phases: 1997—developing concepts and positions, 1998—developing numbers and 1999—finalising those numbers. NWW had made ten key information submissions to Ofwat from May 1997 to March 2000. NWW was critical of the early Ofwat consultations and Ministerial statements which the company believed had prematurely set the tone of the outcome—indicating that prices could fall by 10% with the environmental capex increasing.

38. NWW suggested some key areas of improvement for the 2004 Periodic review to the Committee. The company felt that there was a need for the process to: strike a better balance between price stability and sustainable development, to use cost information provided by competitive outsourcing and to take a longer term view bearing in mind that the industry's assets could last for centuries. NWW also felt that the process would benefit from more pragmatic interpretation of EU directives and more joined up regulation amongst its key regulators resulting in clearer regulatory contracts where the outputs of the review process were unambiguous. In particular, NWW would like to see the proposed Water Bill clarify the social and environmental obligations of the utilities and make sure that guidance to the regulator is clear on what must be funded. In this way, NWW believed it would be possible for Government, regulators and companies to co-operate better in the interests of current and future customers, and investors.

39. Looking to the future, Clive Elphick (Planning Director) told the Committee that NWW had been watching developments in the market with interest including Kelda's plans for mutualisation and efforts by the Government and Ofwat to further competition. United Utilities is itself restructuring and selling Norweb Energy because of the risks under the new energy e-trading arrangements. The Group is positioning itself so it will be able to bid for operating contracts with its new businesses: Licensed Asset Management, Contract Asset Management, and a new Customer Sales business.

Tour of the Fazakerley works

40. The Committee rounded off their visit with a tour of NWW's Fazakerley waste water treatment process works. The Fazakerley plant was among the eight schemes excluded from Ofwat's Final Determinations subject to re-evaluation. This investment was intended to improve 11km of the River Alt from "poor" to "fair". NWW has already invested over £16 million at the works, aimed at improving the quality of the river, but the Environment Agency would still like to see phosphate treatment installed.