THE REGULATED PROJECT. Report of seminar 163 held on 23rd March 2011 at the Institution of Civil Engineers, London SUMMARY

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1 THE REGULATED PROJECT D E L I V E R I N G I N R E G U L AT E D I N D U S T R I E S Report of seminar 163 held on 23rd March 2011 at the Institution of Civil Engineers, London SUMMARY

2 KEY CONCLUSIONS KEY CONCLUSIONS When projects are supported by public funding, political issues do impact on regulators. Often, public finance falls short of requirements and value for money business cases. Regulators anticipate breaches (before they occur) and work with key players to prevent them, ensuring appropriate change control mechanisms. Sectors working in safety critical and operationally important areas need a high level of redundancy (e.g. NATS) and require an appropriate understanding of investment needs. Client bodies should prepare regulator submissions thoroughly, engage all customers, ensure regulators understand the business and support the approach adopted. Comparisons of project costs across sectors are difficult. There is a wider cost base in water, but rail has to be compared against European projects, whereas aviation lacks similar projects. Regulators have to appreciate the importance of profit but will, increasingly, have an eye to the supply chain as well as the owners of the assets. Businesses need to make their assets resilient, deliver transformational change in their sector and be client centric throughout the supply chain. This requires treating long-term contracts as business ventures, collaborative working, supply chain feeding into submissions, an open approach to lean reviews and challenges, and the adoption of programme management principles. This requires humility on all sides. Regulated industries are different. They have visible accounting, exposure to public scrutiny, the build-up of quality data banks, and require long-term framework working. The challenges are the investment cycle, increasing efficiency targets, avoidance of complacency (during long contracts), and the need to record delivered added value. These are the views of Malcolm Noyce, Executive Director, MPA 2

3 INTRODUCTION Regulation has been in place for over 100 years: for example, the Railways Act 1889 laid down stringent rules for the UK and Ireland regarding operation and safety, particularly of signalling, interlocking and brakes on trains. The UK regulated industry now includes many other areas, such as the Post Office, water, aviation, power and communications. Regulators have established a common meeting place through the Joint Regulators Group, which meets regularly to look at alignment and areas of commonality that can be shared. Major projects in the regulated sectors have been the result of much investment in the economy over the last 30 years. In 2010 Infrastructure UK announced that around 200 billion of investment is planned over the next five years across economic infrastructure sectors such as energy, transport, waste, flood, science, water and telecoms, with much of the investment coming from the private sector. Through a mix of presentations and discussion the day s proceedings examined the regulated industries from the perspective of the regulator, the client, the consultant and the contractor. A REGULATORY PERSPECTIVE ON MAJOR PROJECTS The first session was presented by the seminar Chairman, Bill Emery, CEO of the Office of Rail Regulation (ORR). It started with a description of some of the characteristics common to regulated major projects for example they are large both in size and scope, complex to implement, and the life cycles from approval to delivery are typically long. The session went on to look more specifically at the rail sector. In line with other regulated industries the sector is subject to the periodic review process, a five-yearly agreement between regulator and provider. For instance the Periodic Review of 2008 determined the appropriate financial and incentive framework for Network Rail for the years , which involves a 12 billion enhancement programme. Project funding falls into one of three categories: government funded as part of the periodic review, government funded through an investment framework, or third party funding by train operators, private companies or local authorities. continued 3

4 perspective continued The overall objective of the ORR is to ensure successful delivery of the end-user benefits. This requires monitoring of outputs and obligations year by year, anticipating breaches of obligation before they occur and working with key players to prevent them. Providing assurance to funders and other stakeholders is also required, for instance through a comprehensive public reporting regime on progress made, and a steady flow of information from Network Rail to the ORR and from the ORR to the funders. The ORR s involvement in two recent rail projects was described, and the presentation concluded by drawing out some general observations on a range of critical issues for regulators for example the challenges of aligning stakeholder objectives, achieving clarity of overall scope, monitoring delivery and controlling cost, and appropriate allocation of risks. THE CLIENT S PERSPECTIVE The client s perspective of regulatory control was discussed by NATS, which through its privatised subsidiary NATS En Route plc (NERL) is responsible for en route air traffic control through the UK and the North Atlantic airspace. NATS, which operates under licence from the Civil Aviation Authority (CAA), has to be capable of meeting, on a continuous basis, any reasonable level of overall demand; it has to permit access to airspace for all users whilst making the most efficient overall use of airspace. Other air navigation service providers in the world are entirely owned by governments, but NATS has shareholders consisting of the Government, the UK Airline Group, BAA and an employee shareholder trust. NATS Holdings has two operating companies: NERL, which is licensed and regulated by the CAA, and NATS Services Ltd (NSL), which is unregulated. NSL functions as a separate company, bidding in the competitive market for requirements such as control towers and other support operations. NERL has a long-term investment programme focused on upgrading the critical national infrastructure that enables UK air traffic to negotiate UK airspace safely. Recent highlights of this programme include the opening of the new Prestwick Centre in Ayrshire. Duration of projects can range from a few months to six years or longer, and thus may stretch over several regulatory control periods. The presentation concluded by exploring the issues and challenges presented by the recent regulatory consultation, which was carried out against a backdrop of economic difficulties for NERL s airline customers, and a decline in air travel. This review agreed the terms and conditions of the licence under which NERL will operate for the next four years, covering aspects such as service performance, customer prices and the capital investment programme. Key lessons in achieving a satisfactory outcome included the importance of preparing thoroughly, formally engaging with customers, and ensuring that the regulator supported the process. 4

5 MAJOR REGULATED PROJECTS IN THE AGE OF AUSTERITY: APPRAISAL AND FINANCING OPTIONS In the present economic climate, where government funding is more constrained than in the last two decades, projects need to be prioritised, the use of cost-benefit analysis (CBA) becomes increasingly important and other solutions for financing major projects have to be considered. Focusing on the rail and water industries, this presentation from Halcrow explored a funding approach based on Regulatory Asset Base (RAB) financing. RAB-based models are already widely used across the regulated industries and may provide an efficient, cheaper alternative to finance public infrastructure than private finance initiatives or other funding options. It looked at the function of these models, and explained how they work and are implemented under current regulatory approaches. Looking to the future, such models are likely to be extended beyond the regulated utilities, because they guarantee a stable revenue stream over a set period, with an expectation that the return will continue beyond that period. CBA is an appraisal technique used in the assessments of regulated projects by regulators and regulated companies. The second theme of the presentation discussed the importance of undertaking CBA, both as a tool for making well-informed investment decisions and for ranking investment projects. It was noted that CBA allows for the consideration of industry-specific issues, such as time savings and safety benefits in the rail industry, and leakage reduction and water efficiency in the water industry. Drawing on practical experience of the rail and water sectors, examples of how different project-related costs and benefits are treated were outlined. THE CONTRACTOR S PERSPECTIVE The final presentation of the day looked at the role that Balfour Beatty plays in the regulated sector, and how the regulated industry is different to other markets. Underpinned by examples drawn from major project alliances, frameworks and partnerships, the session drew on experiences and lessons learned from the downstream delivery perspective. As noted in the key conclusions above, the regulated industry differs from the unregulated sector in a number of ways, and delivery partners face a number of challenges. For instance issues such as social accountability and responsibility drive different behaviours and demand innovative responses. Specific initiatives are being used to unlock efficiencies and deliver contract outcomes that meet the aspirations of clients and the challenges set down by the regulators. Examples include adopting integrated alliancing models, being actively involved in developing the regulatory submission, undertaking lean reviews and taking responsibility for managing risk. It was noted that the demand to demonstrate value throughout the life of a regulated framework drives the need for collaboration and shared risk, so as to unlock real business advantage to both parties. continued 5

6 perspective continued The presentation went on to consider what else could be done to meet these challenges, and which of the lessons learned from the regulated industries could be applied more generally across UK plc. In conclusion, the importance of trust, openness and sharing was stressed: trust the client, trust the supply chain and work with the whole delivery team. CONCLUSION Through the day s presentations and discussions, this informative seminar looked at issues regarding the regulated industry from a number of viewpoints. It teased out some of the lessons learned, and examined where to focus attention in order to deliver what society requires in terms of the economy, the environment and customer needs. A number of interesting issues were raised through the discussions, including the five-year cycles, benchmarking regulatory practice, the need for regulators to understand business imperatives, and the importance of learning lessons from across sectors. The Chairman noted that the Major Projects Association has a role to play in looking at the lessons learned and collating them across sectors to improve the regulatory framework. 6

7 PARTICIPATING ORGANISATIONS 3G Communications Limited Arup BAA plc Balfour Beatty plc Bircham Dyson Bell LLP Capita Symonds CH2M HILL CMS Cameron McKenna LLP Costain Ltd Defence Estates EDF Energy Halcrow IBM (UK) Ltd Imperial College London Major Projects Association NATS Office of Rail Regulation Olympic Delivery Authority Siemens UK plc The Nichols Group Turner & Townsend Winckworth Sherwood 7