The Water Industry Commission for Scotland Scottish Water Scottish Water

Transcription

1 The Water Industry Commission for Scotland Scottish Water Scottish Water Reporter s Report SR10 2 nd Draft Business Plan Appendix C Investment and Outputs Plan April 2009

2 SCOTTISH WATER REPORTER S REPORT SR10 2 ND DRAFT BUSINESS PLAN APPENDIX C INVESTMENT AND OUTPUTS PLAN CONTENTS C1 INTRODUCTION 1 C1.1 General...1 C1.2 Reporter Guidance...1 C2 KEY POINTS 4 C3 REVIEW OF THE STRUCTURE OF TABLE C 5 C4 OVERHANG FROM Q&S2 AND Q&S3A 10 C5 PROFILING EXPENDITURE AND OUTPUTS 13 C5.1 Introduction...13 C5.2 Definition of Milestones...13 C5.3 Profiling Capital Expenditure...14 C5.4 Profiling Operational Expenditure...16 C5.5 Profiling Outputs...17 C6 CONSISTENCY WITH THE TECHNICAL EXPRESSION 18 C7 PROPORTIONAL ALLOCATION 19 C7.1 Introduction...19 C7.2 Allocation of Expenditure by Different Purpose Categories...19 C8 LINKS BETWEEN FORECAST EXPENDITURE AND HISTORIC EXPENDITURE 22 C9 INFLATION 23 C10 RISK 24 C10.1 Introduction...24 C10.2 Risk management for on-going projects...24 (i)

3 Document issue details: B&V project no Client s reference no. SR10 2 nd draft Business Plan Version no. Issue date Issue status Distribution Issue Draft Scottish Water Issue Final WICS and Scottish Water Notice: This report was prepared by Black & Veatch Limited (BVL) solely for use by Scottish Water and the Water Industry Commission for Scotland (WICS). This report is not addressed to and may not be relied upon by any person or entity other than Scottish Water and WICS for any purpose without the prior written permission of BVL. BVL, its directors, employees and affiliated companies accept no responsibility or liability for reliance upon or use of this report (whether or not permitted) other than by Scottish Water and WICS for the purposes for which it was originally commissioned and prepared. In producing this report, BVL has relied upon information provided by others. The completeness or accuracy of this information is not guaranteed by BVL. (ii)

4 SCOTTISH WATER REPORTER S REPORT SR10 2 ND DRAFT BUSINESS PLAN APPENDIX C INVESTMENT AND OUTPUTS PLAN C1 INTRODUCTION C1.1 General This report on Scottish Water s SR10 Investments Output Plan has been prepared for the Water Industry Commission for Scotland (WICS) by the Reporter in response to the Reporter Guidance set out in the SR10 guidance issued by WICS on 15 October The guidance is reproduced in Section C1.2 of this report. This report was initially prepared as a stand-alone report to then form Appendix C of the Reporter s Report on Scottish Water s 2 nd draft Business Plan. The remainder of this report is set out as follows: Section C2 Section C3 Section C4 Section C5 Section C6 Section C7 Section C8 Summarises the key points arising from this report. Provides an overall review of Table C Provides a summary report on overhang from Q&S3A and Q&S2 Describes the profiling of expenditure and outputs. Reports on consistency with the Technical Expression agreed with the quality regulators. Reports on proportional allocation by purpose. Reports on links between forecast and historic expenditure. Section C9 Reports on the approach to inflation in Table C. Section C10 Comments on the methods adopted to include risk in the forecast expenditure. C1.2 Reporter Guidance The following Reporter guidance was given in the reporting requirements for the first draft Business Plan: The Reporter is required to assess the scope and efficiency of Scottish Water s investment proposals in each area of the programme. It is expected that this will be done both at a programme level, through an assessment of the major elements of the programme (e.g. (C-1)

5 Drinking water quality programme, UID programme, Sewer flooding etc.), and also at a project level through sample auditing of individual scheme solutions. The Reporter is also required to comment on whether the delivery timescales provided in the table for meeting the major project milestones are realistic and consistent with the delivery of Minister s objectives. The Reporter should ensure the proposals for early start of some projects are consistent with information provided in Tables 5 & 6. The Reporter should confirm that the information contained in the Investment and Outputs table is consistent with the programme output and expenditure overview information in Tables 2, 5 and 6. For the Quality and Standards 2 and 3a overhang, the Reporter should confirm that the information provided is consistent with Scottish Water s quarterly capital investment returns to the Commission. The allocation of projects to drivers should be checked on a sample basis and the consistency of the overall outputs to be delivered with the Ministerial objectives for the relevant period should be established. The Reporter should seek confirmation from SEPA and DWQR that they are content that Scottish Water s proposed investment programme meets, and does not exceed, the Ministerial objectives. The comments by the Reporter on the work included in the Investment and Outputs Plan should address both capital and operating cost impacts. On a sample basis, the Reporter should establish whether Scottish Water has, in establishing the solutions required to meet the objectives, placed any undue preference on either operating or capital investment solutions. Where any undue preference is established the Reporter should estimate the possible impact on Scottish Water s expenditure forecast. Opex should not be simply proportionally allocated to maintenance and quality. Only the additional costs compared to that reported for the last year of unmodified works should be considered for allocation to enhancements. In particular the reporter should: confirm whether Scottish Water can justify the inclusion of the investment proposals in its plan confirm whether Scottish Water has reviewed the options open to meet each new obligation and has chosen an efficient and cost-effective solution verify the basis of the cost estimates, and confirm whether the methodology is consistent with that used by Scottish Water in compiling the cost base information also included in the 1st draft business plan confirm whether the operating costs are only the net additional costs. The Reporter should review and challenge Scottish Water s commentary on its overall approach to forecasting capital expenditure and specifically: set out its judgement, and the basis for that judgement, as to whether Scottish Water s approach to proportional allocation is line with requirements, paying particular attention to the allocation of projected expenditure between the different purpose categories: (C-2)

6 o o o o o base service drinking water (including environmental improvements relating to water resources eg Water Framework Directive) environmental programme customer service enhancement programme supply/demand. highlight any changes in Scottish Water rules or policy on proportionally allocating expenditure compared with those used for previous reports particularly verify the link between the forecast expenditure and actual cost data for completed schemes. set out its views about how representative the forecast expenditure is of the historic costs experienced by Scottish Water. verify that all expenditure has been reported in prices and has been inflated to in a consistent manner provide an appraisal of Scottish Water s process for evaluating risks, uncertainties and opportunities for value improvements. Where Scottish Water has provided information about specific risks the reporter shall comment on the robustness of the evidence set out by Scottish Water and provide its judgement about whether the forecast expenditure represents the most likely costs. (C-3)

7 C2 KEY POINTS 1. Scottish Water (SW) maintains clear and well structured audit trails for the allocation of expenditure outputs from the 2 nd draft Business Plan project assessment to Table C. SW adopts a structured and rigorous methodology to complete these tables which is subject to check review and reconciliation. 2. The essential programme reported in Table C includes Scenarios A1 and B1 of the Business Plan. The desirable programme in Table C is limited to Scenario B2 of the Business Plan. 3. The expenditure reported in Table C is at mid prices inflated to a COPI value of We have been able to confirm the drivers and outputs against the Technical Expression which forms the programme control document which is agreed with the quality regulators. 5. On a sample basis we have been able to confirm consistency of outputs and expenditure between the assessments carried out by SW, Table C and the summary tables in the 2 nd draft Business Plan submission. 6. The additional OPEX reported in Table C is the cumulative additional OPEX up to A material element of additional OPEX as a result of the investment programme is first incurred in as the full impact of the programme is realised. This additional OPEX is included in the summary tables in the 1 st draft Business Plan submission for and beyond. 7. The additional OPEX reported in Table C is that arising from the capital investment programme only. It excludes additional OPEX from adjustments to the base OPEX, PPP concessions and to improve the OPA score. 8. The additional OPEX is reported in Table C pre-efficiency. 9. SW has not been given deadlines for completion of the enhancement programme other than the overall completion date of 31 March SW has carried out work to profile the investment in an efficient manner, aiming to level the expenditure profile and avoid peaks and troughs in resource utilisation. SW has proposed beneficial use dates for projects which can be linked to drivers as a result of this exercise. It is for others to confirm that these beneficial use dates are acceptable or, if necessary, set out any other programme constraints. 10. SW has identified an overhang from the Q&S3A and Q&S2 programmes beyond 31 March This overhang is dominated by a limited number of large projects, some yet to be developed and scoped. For example, the overhang includes work on the Airdrie and Coatbridge and Meadowhead UID s to be undertaken under the Q&S3A Strategic UID programme. In some cases, lack of definition and delivery risk associated with these projects results in a higher risk of variation to project costs than the portfolio of other projects in the programme. (C-4)

8 11. The programme profiling exercise carried out by SW is based on a series of profiling templates derived from an analysis of historic projects. These profiles give time to reach each project milestone and the proportion of project expenditure between each milestone. For the Q&S3B profiling exercise SW has adopted project durations which are longer than the average from historic projects. This approach increases the spread of expenditure across a longer duration. At a practical level, it allows SW to develop the programme at an early stage increasing the opportunities to manage expenditure efficiently and reducing the risk of a programme overhang beyond 31 March A key element of SW s overall plan is to carry out significant expenditure in the period to develop the programme and scope sufficient project work in detail to allow construction to begin at 1 April This has the advantages of: a. Smoothing construction resource over the full 4 years of the Q&S period. b. Utilising development and design resource when work load would otherwise fall away at the end of the Q&S3A programme. c. Ensuring that a portfolio of projects is developed in advance, allowing effective management of the programme and reduction in the impact of key risks. We believe that the approach adopted can improve the overall efficiency of programme delivery. The early spend on design and development will require careful management to ensure that outputs are delivered. 13. Table C contains an allowance for early start expenditure on the Q&S4 programme within the Q&S3B period. This allows for the development and design of projects ensuring that a portfolio of project have been developed in advance of Q&S4, mirroring the approach adopted for Q&S3B described above. The expenditure was developed as a series of dummy projects mimicking the Q&S3A programme. In Table C the expenditure has been rolled up into three project lines covering water, wastewater and support services (49001 to 49003). Table C includes expenditure in and only and does not include expenditure on delivery of Q&S4 projects in and beyond. To ensure that this investment is effective, it will be necessary for all parties to develop Q&S4 outputs in advance of C3 REVIEW OF THE STRUCTURE OF TABLE C C3.1.1 Cols 1-3 = Project identification Block A provides the: Project Autocode which is intended to provide a unique project reference which be maintained through the life of the project. (C-5)

9 The Project Name which again should be a unique reference which will carry through the life of the project. Most of the data for capital maintenance, growth and customer service investment is reported in lines which represent sub-programmes of work. Individual project autocodes will be generated for individual projects as the programme is delivered. We understand that the subprogramme lines will be maintained with the budget drawn down as work is identified against individual projects. The unsatisfactory intermittent discharge (UID) programme covering improvements to CSOs is listed in Table C by a number of clusters of UIDs within each catchment. Individual unsatisfactory CSO outputs are listed in the Technical Expression where they are linked to autocode. The clusters presented in Table C represent SW s current assessment of how individual UIDs will be linked in projects. In delivery SW may move UIDs between clusters as more analysis is undertaken and further options considered. In addition, SW may combine clusters into larger contracts or sub-programmes of work. The projects in Table C (Essential) cover Scenarios A1 and B1 of the Business Plan. The projects in Table C (Desirable) are limited to Scenarios B2 of the Business Plan C3.1.2 Cols 4-13 = Project Information Project information includes the infrastructure/non-infrastructure allocation of projects. Where a specific project allocation is not available, the following infrastructure noninfrastructure allocation has been applied to the main asset groups based on an analysis of the depreciation allocation of historic projects, modified by the judgement of SW: Water treatment works 96% non-infrastructure Wastewater treatment works 98% non-infrastructure Wastewater sludge treatment 99% non-infrastructure Wastewater pumping stations 97% non-infrastructure CSO s 16.65% non-infrastructure C3.1.3 Cols = Actual and Forecast Expenditure Actual and forecast expenditure Forecast expenditure is presented before efficiency assumptions have been applied. Expenditure is reported at mid prices. Project efficiency is determined on a project by project basis. The efficiency is calculated by applying SW s efficiency assumptions (which are specific to different project types) resulting in the same efficiency percentage adjustment for ranges of projects. SW has applied a uniform efficiency adjustment over the profile of the project. (C-6)

10 Grants and contributions Table C does not include any grants and contributions against the investment included in the business plan. It is generally assumed that any grants and contributions received will relate to additional work which SW might be asked to undertake by developers or funding agencies over and above the statutory duties funded through the strategic review of charges. SW has identified an omission of 5 million in respect of contributions associated with service relocations. Impact of project on SW's gross MEAV The impact of a project on SW s gross MEAV is the sum of Q, E and G from the project QBEG allocation. The MEAV impact is present pre-efficiency. The total for Q&S3B essential programme is the total pre-efficiency investment of 2, million less 1, million of base capital maintenance expenditure. Impact of project on operating expenditure We have comment on OPEX estimates in Section 5 of our main report on the 1 st draft Business Plan. The additional OPEX set out in Table C is the additional OPEX arising from the investment programme only. It excludes: Adjustments to the base OPEX. Additional PPP costs. Operating expenditure to achieve improved OPA. The additional OPEX of million reported in Table C for the essential programme is the cumulative additional OPEX incurred by the end of year The additional OPEX reported for the year that a scheme is commissioned is related to the commissioning date. For example, the additional OPEX reported for a scheme commissioned at 31 December is approximately 25% of the total annual additional OPEX arising from the scheme. The remaining 75% of the additional OPEX will be incurred in the subsequent year. Because many major projects have commissioning dates in , this methodology has a material impact on the additional OPEX reported in Table C. The full OPEX impact of the schemes reported in Table C is million with and additional million additional OPEX occurring in C3.1.4 Col = Project Drivers and Project Outputs We were able to map the project drivers in Table C from the Technical Expression which served as the basis of our sample audits. On a sample basis, we were able to confirm the project outputs in the Technical Expression and Table C against our project audits. (C-7)

11 Many individual project lines on Table C address one driver only and it has not been necessary to undertake a project allocation of expenditure by driver. For the wastewater treatment projects with a quality driver, a site assessment has been made which considered maintenance, quality and growth. The maintenance work required at the site to continue to meet the current consent was assessed and costed. The enhancement work is the additional investment required to deliver the new consent standard at the future design population equivalent. The enhancement investment was allocated between growth and quality on the basis of the current and future population equivalent. The quality investment was allocated between drivers on the basis of an allocation of the assets provided to meet each driver. For areas of the quality programme other than the wastewater treatment works, the cost of quality enhancements has generally been divided equally between the number of quality drivers. C3.1.5 Col = Milestone dates and expenditure The project milestones reported in Table C map to the WICS Codes and SW CAPEX milestones as follows: WICS Code WICS Code Definition CAPEX Stage Table C Milestone S1 Inception: project has been identified but no detailed appraisal has been completed CAPEX 1 S2 Appraisal: initial detailed appraisal has been completed CAPEX 2 M1 S3 Project appraised and under development before construction CAPEX 3 M2 S8 Works under construction M3 S10 Beneficial use achieved Acceptance M4 S12 Regulatory sign off of output obtained M5 Reported expenditure is the cumulative expenditure to that milestone date. We have checked and confirmed that the reported project milestones and project expenditure profile in Table C is consistent with SW s methodology which is described in Section C5 below. In a number of instances SW does not report milestones dates in Table C. This generally relates to expenditure on programmes of work on asset maintenance or development which will be allocated to individual projects, each with their own milestone dates and expenditure profile, as needs are identified. (C-8)

12 The profiled expenditure in Table C is in k as opposed to the million indicated in the titles line. (C-9)

13 C4 OVERHANG FROM Q&S2 AND Q&S3A SW has identified an overhang from the Q&S3A and Q&S2 programmes beyond 31 March This overhang is dominated by a limited number of large projects, some yet to be developed and scoped. For example, the overhang includes work on the Airdrie and Coatbridge and Meadowhead UID s to be undertaken under the Q&S3A Strategic UID programme. In some cases, lack of definition and delivery risk associated with these projects results in a higher risk of variation to project costs than the portfolio of other projects in the programme. The total estimated expenditure post-march 2010 for overhang projects m m. For the large majority of projects this expenditure consists of minor completion items for projects where construction work will be completed before SR10. Numbers of projects showing overhang spend are as follows: Q&S2 Projects Projects with overhang: Number Total estimated cost m Zero m - 0.2m m - 0.5m m - 1m > 1.0m Q&SA Projects Projects with overhang: Number Total estimated cost m < 0m = Zero m - 0.2m m - 0.5m m - 1m > 1.0m It can be seen that the bulk of overhang cost is concentrated in a small number of projects with significant SR10 expenditures. The Q&S3A programme includes two projects with a value less than zero. These are: Autocode Description Value m UIDs Holding Code Q&S3A Base Maintenance Holding Code Total (C-10)

14 SW has advised us that: The negative value in the UID Holding Code reflects the difference in the funding allocated to the 7-Stage deliver process and current estimates in the individual project lines. SW expects that there will be a corresponding increase in funding to address this difference. The negative value in the UID Holding Code assumes that this additional funding is outside the Q&S3A plan. However, we note that it is not included in the Q&S3B Business Plan and we note the need for careful consideration to avoid either overlap or omission of this expected expenditure. Capital maintenance budgets allocated to individual projects lines within the current programme will be constrained at approvals stage to ensure that the overall capital maintenance programme budget is not exceeded. The negative value in the Base Maintenance Holding Code reflects this plan. In the Q&S3A programme SW retains one other holding budget line for Q&S3 Risk Management Fund Holding Code (Autocode 40020, million). This addresses risks to delivery not allocated to the project delivery budgets. Programme Autocode Description Value m Q&S3A UID - Airdrie & Coatbridge Transfer Sewer Work Package Q&S3A Glencorse New WTW Q&S DUNOON SEWERAGE SCHEME Q&S3A UID WP6.2 Gatehead Tank to Meadowhead Inlet Works Transfer Scheme Q&S3A UID WP6.3 Irvine Transfer Scheme Q&S3A UID WP6.1 Kilmarnock Gravity Transfer Scheme Q&S Campbeltown WWTW Interim Measures Q&S3A Q&S3 Risk Management Fund Holding Code Q&S3A Blackpark WTW - Upgrade Q&S3A WOA Milngavie M3-DMA Copland Rd- WSZ Mugdock Q&S3A Ardersier WWTW - Growth Q&S3A Killylour WTW - Upgrade Q&S3A Howden - New CWT Total for schemes with carry over > 2 million (C-11)

15 A material element of these schemes relate to major UID schemes at Airdrie & Coatbridge and Meadowhead/Irvine/Kilmarnock with a carry over of 45 million. There continues to be a high degree of uncertainty around these projects as scope is developed and construction prices re-evaluated. (C-12)

16 C5 PROFILING EXPENDITURE AND OUTPUTS C5.1 Introduction The quality regulators have identified a limited number of key dates for the delivery of quality programmes. Within this constraint SW has sought to profile capital expenditure to deliver a sustainable profile of capital investment and resource utilisation. SW has given particular consideration to the time and resource required to promote projects and carry out the detailed appraisals and design necessary to create a more sustainable and efficient programme of construction over a four year Q&S period. These assessments result in proposals for investment in preparatory work for Q&S3B in 2008/09 and 2009/10 totalling million at prices (pre-efficiency). C5.2 Definition of Milestones The key milestones adopted by SW for profiling expenditure and outputs which map to the milestone dates in Table C and the WICS project status codes set out in the Annex 2 of the WICS Guidance for Appendix C as follows: WICS Code WICS Code Definition CAPEX Stage Table C Milestone Milestone Definition S0 Investment need recognised, but no specific project yet identified M0 SW definition of project start milestone. S1 Inception: project has been identified but no detailed appraisal has been completed CAPEX 1 S2 S3 S4 S6 Appraisal: initial detailed appraisal has been completed Project appraised and under development before construction Project abandoned Tender awarded CAPEX 2 M1 Milestone 1 is defined as Preferred Option Identified and is equivalent to WICS progress code S2 and the SW Capex 2 - Preferred Option authorisation milestone. CAPEX 3 M2 Milestone 2 is defined as Financial Budget Approved and is equivalent to WICS progress code S3 and the SW Capex 3 - Budget Approval authorisation milestone. S8 Works under construction M3 Milestone 3 is defined as Work started on site and is equivalent to WICS Project status code S8. This milestone is achieved when substantive work on the project (C-13)

17 WICS Code WICS Code Definition CAPEX Stage Table C Milestone Milestone Definition commences on site, or equivalent for M&G or studies where that is the purpose of the project.. S10 Beneficial use achieved Acceptance M4 Milestone 4 is defined as Beneficial use achieved and is equivalent to S10, SW s acceptance date. This is ahead of the SW Capex 5 - Beneficial Use authorisation milestone. S12 Regulatory sign off of output obtained M5 This milestone is achieved when, where relevant, the project has been signed off by the relevant regulator through the approved OMG sign-off process. Relevant projects are all projects which appear in whole or in part on the OMG Technical Expression. S13 Works and expenditure complete project financially closed CAPEX 6 Project is not financially closed until Capex 6 following the 2 year maintenance period. C5.3 Profiling Capital Expenditure The quality regulators have identified a limited number of key dates for the delivery of quality programmes. Within this constraint SW has sought to profile capital expenditure to deliver a sustainable profile of capital investment and resource utilisation. The expenditure profile has been driven by the key milestones for the project included in Table C as described above. Sub-programmes of work with continuous delivery such as planned and reactive capital maintenance have been profiled as annual rolling expenditure. For specific projects with defined outputs, SW developed profiling templates for expenditure on different types of assets as follows: Project Type Number of Templates UIDs Non-infrastructure projects Infrastructure projects 8 - depending on estimated project value 8 - depending on estimated project value 8 - depending on estimated project value (C-14)

18 Project Type Number of Templates Studies 8 - depending on estimated study value Management and General 1 Reactive projects 1 Quick Hit projects 1 Total 37 The templates were based on an analysis of CAPEX approvals of historic projects to determine: The time taken to obtain each stage of CAPEX approval. The expenditure incurred between each stage. The data was totalled to generate typical timescales and percentages of total spend for each project stage for each profiling template. In some cases the profiles were moderated on the judgement of SW. For some projects, where the project outputs and scope are well defined, a shorter preparatory stage has been allowed. The resulting project profiles were applied to programme Q&S3B and generate expenditure profiles. The standard template timescales are based on the 80%-ile of the data used to generate the particular profile. The 80%-iles were calculated for the period of time between each milestone. The addition of durations for a series of stages each based on an 80%-ile suggests that the total project duration used in the analysis is greater than the 80%-ile for historic project durations. In addition, some of the historic project durations used to develop the profiles may include programme management techniques which artificially increase the time recorded against project development. For example, in the past there have been block allocation of projects to delivery teams who then begin the project at a later date within a managed programme of work to suit the availability of resources. Because of this we conclude that the durations contained in the profile templates are longer than actual average durations of projects experienced by SW in the past. However, this approach does reduce the risk that the use of average durations will lead to a material programme overhang beyond 31 March SW has given particular consideration to the time and resource required to promote projects and carry out the detailed appraisals and design necessary to create a more sustainable and efficient programme of construction over a four year Q&S period. This has the advantage of ensuring that SW has developed sufficient projects to CAPEX3 to provide choices in its management of the programme and identify and address difficult projects at an early stage. During our audit for the second draft Business Plan we reviewed SW plans for managing and delivering this expenditure. We noted that: A clear list of CAPEX3 dates had been identified up to the end of SW had started to make progress in delivering CAPEX3 outputs. (C-15)

19 The definition of CAPEX3 outputs delivered appear to be reasonable and in advance of projects we have audited in the past and the same CAPEX stage. Plans by SW continue to be disrupted by changes in the expected outputs and, as a result, there is likely to be some inefficiency and abortive work in the development work. SW s plans for resources over the coming year appear to be realistic given the level of investment currently being achieved and the reduction in other workloads. SW has assumed that work on site will not begin on Q&S3B projects until the 1 April The programme allows for some projects to be developed to CAPEX3 in and then parked for a start date of 1 April 2010 to allow for a levelled, efficient use of design and development resource. SW has assumed that a small level of expenditure will be incurred after Milestone M5 Regulatory sign-off to complete the project. SW has assumed that it will take a period of three months from beneficial use to Regulatory sign-off. It is assumed that the outputs cannot be counted until regulatory sign-off has been achieved. This approach taken it results in the general expenditure profile being brought forward to allow outputs to be counted with in the Q&S3B period. An exception to the 3 month rule between beneficial use and regulatory sign off is the water distribution programme where a period of one year has been assumed between beneficial use and sign-off to allow a period of monitoring to confirm the success of the work. It is assumed that the DWQR will not require an additional period to sign-off the project in addition to the one year monitoring period. Some projects in Table C roll up multiple outputs from the Technical Expression with different delivery dates into a single project line. For example Project for Drinking Water Safety Plans under driver DW16. The latest deliver date is given Table C. The underlying investment profile is based on phasing the individual plans to meet the dates set out in the Technical Expression and provides a practical programme for delivery. C5.4 Profiling Operational Expenditure We have commented on the process adopted by SW for estimating OPEX in Section 4 of the Reporter s main report on the 1 st draft Business Plan. Operational expenditure has been assumed to start at the beneficial use date (milestone M4). At this stage, the works will be operational and SW will incur the additional operational costs. In the year that beneficial use is achieved, the additional OPEX is the total additional OPEX factored by the number of days from the beneficial use date to year end. The additional OPEX begins the day after beneficial use. The calculation is over a 365 day year with no adjustment for leap years. For each subsequent year the total additional OPEX is included in the profile. During our audit we checked and confirmed that this approach had been properly (C-16)

20 applied to create the profile of additional OPEX presented in the relevant tables of SW s main submission. C5.5 Profiling Outputs SW has profiled outputs against the M5 milestone (regulatory sign-off). During our audit we checked and confirmed that the approach outlined above had been properly applied to create the profile of outputs presented in the relevant tables of SW s main submission. (C-17)

21 C6 CONSISTENCY WITH THE TECHNICAL EXPRESSION SW provided a copy of the Technical Expression Version 6.1a. By mapping autocode/driver combinations it was possible to confirm that drivers in the Table C are taken from the Technical Expression. (C-18)

22 C7 PROPORTIONAL ALLOCATION C7.1 Introduction The Reporter is asked to set out its judgement, and the basis for that judgement, as to whether SW s approach to proportional allocation is line with requirements, paying particular attention to the allocation of projected expenditure between the different purpose categories. The Reporter is asked to highlight any changes in SW rules or policy on proportionally allocating expenditure compared with those used for previous reports. In most cases forecast expenditure was developed by SW against individual purpose categories and the need to allocate projected expenditure between individual project categories was limited. We comment on the different programmes below. C7.2 Allocation of Expenditure by Different Purpose Categories C7.2.1 Allocation of expenditure to base service Much of the expenditure allocated to base service provision has been determined through a process of bottom up estimates for sub-programmes of maintenance work. The resulting expenditure has been presented as sub-programmes of capital maintenance investment and management and general investment and no assessment made of overlap from other programmes. A more detailed assessment has been made of the maintenance expenditure associated assets included in the wastewater treatment enhancement programme including the back-log quality programme. Capital maintenance needs were assessed as part of the overall site assessment. The maintenance element of the works is included as a base maintenance element against the enhancement project for the works in Table C. Base service includes an allocation of the sewer flooding programme which is 40% of the cost of reducing the risk of flooding at emerging properties. The allocation of the flooding programme is described in greater detail under customer service enhancement. SW has allocated all the costs of developing the Business Plan for Q&S4 to base service. SW has allocated an element of the Q&S4 start early programme to planning and developing to base maintenance to ensure efficient continuity of maintenance work at the start of Q&S4. The allocation is notionally based on the allocation of projects in the Q&S3B programme. C7.2.2 Allocation of expenditure drinking enhancement programme The allocation of forecast expenditure to the drinking water enhancement programme relates to the drinking water quality drivers. C7.2.3 Allocation of expenditure to the environmental enhancement programme The allocation of forecast expenditure to the environmental enhancement programme relates to the environmental quality drivers. (C-19)

23 The UID programme, including the associated strategic studies, has been allocated to quality only. No allowance has been made for any maintenance or growth associated with the existing overflow. Given the nature of the asset, we believe that this is reasonable. The bathing water directive study programme has been allocated to quality. The sewage treatment works programme has been allocated between quality, growth and maintenance as follows: A specific assessment was made of asset maintenance needs for works including in the quality programme. The remaining expenditure on enhancement of the asset was allocated between growth and quality in proportion to the estimated current and future population equivalent served by the works. Expenditure on failing works upgrades (Driver WQ01) has been allocated to quality. The forecast expenditure on the enhancement of sludge treatment facilities has been allocated to quality. This element of the programme relates to the provision of odour control on the sludge facilities to prevent loss of sludge management licence. The expenditure has been allocated to the sludge driver EC06. C7.2.4 Allocation of expenditure to the customer service enhancement programme Expenditure on customer service enhancement covers the following investment: Odour management at wastewater treatment works. Maintain level of properties at risk of internal flooding (essential programme) and reduce the number of properties at risk of flooding (desirable programme). Improvements to supply pressure. The range of improvements and development projects related to climate change which relates to flood risk mitigation. Investment is included in the essential programme to address emerging properties at risk of flooding to maintain service levels at March 2010 levels. This investment has been allocated as 60% growth and 40% capital maintenance. SW advises that this is consistent with their understanding of companies approach in E&W. Investment is included in the desirable programme to achieve a net reduction in the number of properties at risk on internal flooding on SW s at risk register. This expenditure has been allocated to enhanced service level. (C-20)

24 C7.2.5 Allocation of expenditure to the supply/demand programme The main component of the expenditure allocated to supply demand balance is the programme of work required to address new demand. The programme of work has been assessed at a works level for those works where new developments are likely. SW has made a specific assessment of growth expenditure for wastewater treatment works included in the quality programme. Expenditure on enhancement of the works was allocated between growth and quality in proportion to the estimated current and future population equivalent served by the works. Supply demand balance includes an allocation of the flooding programme which is 60% of the cost of reducing the risk of flooding at emerging properties. The allocation of the flooding programme is described in greater detail under customer service enhancement. (C-21)

25 C8 LINKS BETWEEN FORECAST EXPENDITURE AND HISTORIC EXPENDITURE The Reporter is asked to: Verify the link between the forecast expenditure and actual cost data for completed schemes. Set out its views about how representative the forecast expenditure is of the historic costs experienced by SW. Where possible, SW has based its future estimates on SW s own cost data. For example: The EES estimating system used to estimate capital costs is populated with SW s own historic project data. The estimates of additional OPEX are based on unit rates derived from SW s current costs of labour and consumables. Future projections of PPP costs are assessed on the basis of current and future unit rates taking account of the contract mechanisms for inflation. In some instances, future cost estimates have been based on unit costs which are not based on SW s historic costs. For example: The use of GAP models in the EES estimating system. These are cost functions developed as bottom up estimates by consultants where SW has not been able to obtain sufficient historic cost information to create robust cost models for material elements of the 1st draft Business Plan. In some cases, the detailed scope of works included in a cost estimate is captured in the cost function. In other cases, the estimate is dependent on a generic design calculation to size the works and generate the yardsticks applied to the cost functions. These might be simple parameters such as the flow through the works; or more complex design assumptions applied to prepare the estimate. As well as linking the costing functions used in the 2nd draft Business Plan back to historic cost data, we have also considered the generic design parameters used to scope items of work. On a sample basis we considered whether the design parameters used were reasonable and linked the parameters used back to standard practice documents or historic projects. In a limited number of cases we noted that the way in which cost functions based on historic data were applied was different from the way the cost data had been developed. These errors break the link between forecast expenditure and historic costs. We believe that the impact of this is limited. (C-22)

26 C9 INFLATION The Reporter is asked to verify that all expenditure has been reported in prices and has been inflated to in a consistent manner. Capital scheme estimates have been adjusted to prices of COPI through: Inflation mechanisms coded into the EES estimating system. Historic cost data points are held with a base date and which can be linked to a COPI index. A base COPI index is set each time a cost function is generated and all historic project data is inflated to that COPI index before the analysis is carried out to determine the best fit equation to represent the cost function. For SR10, the cost functions were initially generated for COPI = 162 and estimates were adjusted to COPI = following confirmation from WICS of the base COPI index for the 2nd draft Business Plan. Unit rates for SR10, Q&S2 and Q&S3 were also updated to COPI = Unit costs for operational costs have been determined at current prices in The base line estimate for PPP payments was determined at rates inflated using the various PPP contract inflation mechanisms. We were able to follow audit trails to source data to confirm that historic costs had been inflated. We concluded that all expenditure has been reported in prices and has been inflated to in a consistent manner using the base indices set out by WICS. (C-23)

27 C10 RISK C10.1 Introduction The Reporter is asked to provide an appraisal of SW s process for evaluating risks, uncertainties and opportunities for value improvements. Where SW has provided information about specific risks the Reporter shall comment on the robustness of the evidence set out by SW and shall provide judgement about whether the forecast expenditure represents the most likely costs. Risk is captured in project estimates in two different ways: 1. For current projects from Q&S2 and Q&S3A SW has used latest best estimate from its on-going project appraisal, development and management processes. These incorporate the current risk estimates for these projects. 2. SR10 estimates included average levels of risk from an analysis Q&S3A projects which had reached CAPEX3 stage as described in our report on costing systems (Appendix G). 3. SR10 also includes an assessment of scope risk across the programme for which SW has included 19m pre efficiency in Table C. This reflects a montecarlo simulation of SW s assessment of the remaining scope risks and opportunities within the plan. C10.2 Risk management for on-going projects SW s on-going project management processes include processes for assessing and managing risk through formal risk registers. Risk registers allow risks to be identified, recorded and managed. They are developed between the project delivery team, the delivery contractor and SW as client. They are developed through the life of the project with the detail of the risk register reflecting the stage of development and knowledge of the project at any one time. Each risk on the risk register is allocated a likelihood of occurrence and a likely outcome. The outcome can be defined in terms of cost or time by minimum, maximum and most likely value. The various risks are combined to give a most likely outcome which is incorporated into the project estimate. Risks are allocated between the parties involved in the project depending who is best placed to manage them. The allocation of risk partly reflects practicality. For example, SW will make final decisions on land purchase and is therefore best placed to manage the associated risks, but the contractor on site is best placed to make day to day decisions on dealing with site conditions or weather, and is best placed to manage the associated risk. In contractual terms, the allocation of risk between the parties will impact on the risk included in the target cost and whether compensation events result in a change to the target cost. The most robust estimate of risk is normally at CAPEX 3 where: The major programme risks (say land purchase) should have been resolved and scope risk reduced by development of the detailed design. (C-24)

28 The evaluation of risk has been subject to challenge within the commercial constraint of setting a target cost. Subsequent to CAPEX 3 the risk registers are updated to reassess risks. In most cases, this is to reduce risks or to remove them from the risk register as they pass. Risks may also be added to the risk register if new risks are exposed during the construction work. The risk management process adopted by SW is similar to the approach adopted by other companies. It is a means of managing uncertainty; it is not a means of eliminating that uncertainty. For on-going projects, the risk management approach provides the best estimate of the likely costs of a project at any one time. (C-25)