pr19 business plan re-submission cost adjustment claim for ... · funding package for amp7 leakage,...

PR19 Business Plan re-submission Cost adjustment claim for leakage - mains replacement component

1 April 2019

SES Water Leakage cost adjustment claim

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Contents

1. Introduction ................................................................................................................... 3 2. Evidence to support claim ............................................................................................ 5

2.1. Need for investment ............................................................................................. 5 2.2. Need for cost adjustment .................................................................................... 8 2.3. Management control .......................................................................................... 10 2.4. Robustness and efficiency of costs ................................................................. 10 2.5. Best option for customers ................................................................................. 12 2.6. Customer protection .......................................................................................... 13 2.7. Affordability ........................................................................................................ 13

3. Assurance .................................................................................................................... 14 Appendices ......................................................................................................................... 15


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Introduction

We are operating close to the frontier of leakage management and our network assets have

one of the highest levels of integrity within the sector1. This is a direct result of the legacy of

interventions we have made over the last 30 years and we take great pride in our detection

methods, practices and results. In the 1990s, we were one of the first water companies in the

UK to divide up our network into district metered areas (DMAs) to help us better understand

where leakage was occurring. Alongside this we were early adopters in pressure

management, a comparative low-cost approach to leakage reduction. We then introduced an

incentive-based leak detection contract which remains unique in the sector today and

focuses on reducing the water being wasted rather than just detecting leaks – introducing

this innovative approach was only made possible through all the network structuring and data

capture that had gone before. Finally, we have consistently invested at above-average levels

in mains replacement which is the most sustainable approach to achieving a stable network.

Our track record means we have met every leakage target set over the last 20 years,

achieving a balance between affordability and resilience, and this will not change for AMP7

as we target a further 15% reduction which is the first step towards more than halving

leakage by 2045.

Reducing leakage will come from innovating across three existing core areas to build a more

resilient approach that will enhance the integrity of our network and benefit current and future

customers and the environment:

• Active Leakage Control (ALC) (5%) – new leak detection technologies, the roll-out of

intelligent DMAs and the expansion of incentive-based contracts for fixing as well as

finding leaks

• Enhanced Pressure Management (5%) – systematic removal of remaining pressure

transients across our network and the development of more dynamic pressure

management control

• Targeted Mains Replacement (5%) – innovative but proven techniques that will be

new to the UK water sector to identify mains integrity via non-destructive testing to

better inform and optimise existing mains renewal modelling and interventions.

This cost adjustment claim (CAC) of £13.1m is being submitted for the mains replacement

component of our proposed 15% leakage reduction programme in AMP7. We are not

seeking additional funding to that set out within our original submission in September 2018,

but instead seek to further justify the criticality of this activity in achieving a material

contribution to the reduction in leakage in AMP7, whilst also creating a sustainable journey to

a reduction in leakage of at least 50% by 2045.

1 Based on SES Water’s overall performance on a combination of leakage per property and km of mains, burst rates, supply

interruptions and customer concerns about their water, as measured across the UK water sector


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The table below summarises our strategy, presents the costs and the estimated impact on

customer bills.

Strategy (% reduction)

Expenditure for

2020-25

2017/18 prices

Bill impact

Unit cost

(industry average

of £2.1m/Mld)

Enhanced Pressure

Management (5%) £1.9m £0.34 £1.6m/Mld

Active Leakage Control

(5%) £2.5m £1.72 £2.1m/Mld

Targeted Mains

Replacement (5%) £13.1m £2.36 £10.9m/Mld

Total (15%) £17.5m £4.44 £4.9m/Mld

In its Initial Assessment of our plan, Ofwat asked us to explain why our approach to

additional leakage control in the 2020 to 2025 period has resulted in our unit costs being

significantly above the industry average (£4.9m/Mld compared with £2.1m/Mld) for the supply

demand balance (SDB).

Whilst our ALC and enhanced pressure management costs (see table above) are either

lower than or consistent with the average shown in Ofwat’s unit cost spreadsheet for SDB,

the inclusion of targeted mains replacement costs in this calculation is, we believe, unique to

the industry in AMP7 and the sole reason for us being seen as an outlier in the sector. If the

longer-term benefits of targeted mains replacement are considered, our unit costs would

align with those of the sector.

In assessing our claim, we ask Ofwat to consider that in including mains replacement as

enhancement expenditure for supply demand balance costs, we have put forward a leakage

reduction strategy not directly comparable with the submissions from the rest of the sector

that results in our unit cost being higher.

For reasons set out within the detail of this CAC, the degree to which pressure management

can be adopted is limited. The balance of the leakage reduction must therefore come from a

mix of ALC and targeted mains replacement. Crucially, the alternative approach of increased

ALC does not deliver the additional benefits of the proposed mains replacement element of

the strategy which are:

• Creating a sustainable footing for our long-term aim of more than halving leakage by

2045

• Improved serviceability

• Current and longer term affordability

• Resilience to routine operational activities and (weather-related) events

• Greater certainty of delivery

• Reduced customer and environmental impacts.


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The following section provides information on the claim and evidence to support it. We also

provide a summary of the assurance carried out and the appendices provide the relevant

supporting third party evidence.

This claim should be read in parallel with the NERA report assessing Ofwat’s proposed

funding package for AMP7 leakage, included at Appendix A.CE3 to our resubmission

document.

Evidence to support claim

Need for investment

This claim puts forward the need to invest £13.1m into a targeted mains replacement

programme as part of our balanced strategy for a 15% reduction in leakage in AMP7.

We have committed to reduce leakage by 15% between 2020 and 2025 through extending

pressure management, ALC and targeted mains replacement. This balanced approach will

help us meet our challenging target and also contribute towards our longer term aim of more

than halving leakage by 2045 (in line with the recommendations of the National Infrastructure

Commission).

Targeted mains replacement is crucial to our approach for the following reasons:

• Modelling has shown that mains replacement will continue to yield and sustain

significant benefit for at least the next 40 years (or 8 AMP periods). We have limited

the period of benefit to 40 years as the accuracy of the modelling beyond this period

is reduced. This fits with our multi-AMP strategy for leakage reduction. See

supporting evidence from modelling in appendix 1 of this document (section 2.2 of the

Servelec report)

• It tackles the issue of an ageing infrastructure, understanding that we need to start

acting now to manage our assets for the future and not store up problems for future

generations

• Over short, medium and long-terms it remains affordable for our customers and

overall offers better value for money than the alternative short-term reactive strategy

of more ALC

• It will offer immediate benefits to the resilience of our network and our continued

ability to withstand events such as a repeat of the freeze/thaw event that occurred in

March 2018. Only four of our customers lost supplies during this time which

demonstrates our strategy of higher than average mains replacement rates has

increased resilience

• Mains replacement focuses on targeting background leakage as well as reactive

leakage. This will be needed to take leakage to new lower levels and is particularly

relevant for a company with upper quartile performance

• It is consistent with our wider network asset management interventions designed to

improve network operation and the service we provide to our customers

• It fits with the overall strategy for our network which includes a DMA structure,


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targeted mains replacement activities and the introduction of ‘smart’ fittings, sensors

and applications that will provide the opportunity to achieve a new higher level of

monitoring and control.

Our modelling has shown that pressure management is an efficient and sustainable

approach to reduce leakage, both in terms of its unit cost and for its positive impact on

extending the life of assets. We have already utilised pressure management extensively

across our network and so further opportunities are comparatively limited. Appendix 2 to this

document provides an excerpt from the Strategic Review of Pressure Management report by

Atkins which highlights the scope for remaining pressure management activities.

The modelling indicates that increased pressure management will contribute approximately

5% (1.2 Mld) of the overall reduction target. This is the modelled savings from wider

implementation of pressure control within the network. Above this level, the degree of

savings expected are harder to model accurately and are more likely to cause negative

impacts such as increased customer complaints about pressure. The work will lead to the

installation of more pressure control valves to reduce pressure in smaller parts of the network

and there will also be more complex control systems applied to existing pressure control

valves. Once completed, the scope for further pressure control in our network will be limited.

There are a number of reasons for this including the practical limitations associated with the

topography of our network and the diminishing returns on leakage savings due to

implementing smaller and smaller schemes as we approach the full saturation of possible

interventions.

Pressure management still offers a resilient solution and is therefore a fundamental part of

our strategy. We are confident that by looking for innovative solutions and adopting new

technologies we will deliver the 1.2 Mld savings that we have committed to and will continue

to be open to further savings if they are technically and economically feasible.

For the remaining 10% reduction required we have considered three main options:

• Option 1 (preferred) – Deliver a balanced reduction strategy giving equal weight to

both ALC and targeted mains replacement

• Option 2 – Deliver all of the remaining 10% reduction through increased ALC activity

• Option 3 – Maintain current ALC activity and deliver 10% reduction through

increased targeted mains replacement.

Option 3 has been ruled out on the basis that it would have resulted in much higher mains

replacement rates than we have ever conducted before which could impact on deliverability

over the five-year period.

For Option 2 our modelling indicated that the marginal cost of undertaking a 10% reduction

through ALC rather than mains replacement for the additional 5% of the programme is

noticeably higher than the initial 5% ALC component shown above, as can be seen from the

leakage cost curve given in appendix 3 to this document in a report by Artesia assessing our

Sustainable Economic Level of Leakage (SELL). We estimate that the second 5% ALC


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component would cost £3.6m and have a bill impact of £2.33. So, although the Ofwat unit

cost models show us as an outlier, the alternative approach would result in no material

difference to customer bills.

Option 2 looks favourable compared to other companies on Ofwat’s modelling for in-AMP

costs but masks some considerable underlying issues. There are currently industry wide

uncertainties in traditional approaches to ALC due to external factors such as the labour

market and the availability of skilled resource, and the relatively unknown and unquantified

benefits of emerging technologies designed to improve productivity and efficiency. We have

concluded that achieving reductions from ALC alone is high risk and does not address the

key issue of long-term resilience. We recognise the need to have a reduction strategy which

includes ALC but it cannot alone enable a 50% reduction in leakage by 2045. We need to

take a more balanced approach that targets the cause of the problem rather than just the

symptoms and targeted mains replacement achieves this.

Option 1 is the only one that addresses all the main themes of our Business Plan:

• It tackles leakage reduction whilst being cognisant of the environmental and social

benefits that lower leakage aims to achieve

• It remains affordable for our customers now whilst mitigating affordability concerns in

the future by not storing up significant and disproportionate expenditure requirements

for later Price Review periods

• It addresses medium to long term resilience by helping to stabilise the age profile of

our network assets and allowing us to continue to maintain resilient supplies which is

one of our customers’ highest priorities

Another consideration of our balanced approach is the need to tackle the different types of

leakage over the longer term. ALC targets visible leakage and we will focus on finding and

fixing leaks more quickly. Pressure management and particularly mains replacement target

leakage which may have been present for many years but has been undetectable through

conventional ALC methods. This is where sustained reductions can be achieved and can

only be delivered by taking a longer-term view of the investment requirements of our

infrastructure.

If discounted over at least the 40 years we have modelled, the overall cost of the mains

replacement proposed is equivalent to that for increasing ALC over the same period. When

assessed over a five-year period, mains replacement will be disproportionately more

expensive but accounting for it over a longer period is both the correct approach and more

appropriate for our customers and for the industry in general.

Sections 2.3 and 2.4 of the Servelec report in appendix 1 to this document show the outputs

from the modelling that has been undertaken to identify the best programme to achieve our

reduction target. The analysis supports our case for targeted mains replacements as part of

our balanced strategy.


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Need for cost adjustment

A cost adjustment is required if Ofwat continues to set an expenditure allowance based on a

median unit cost which will not provide adequate funding to allow us to deliver our leakage

reduction strategy and the benefits it will deliver to resilience. The published data for the unit

costs of SBD leakage activity suggests that we are inefficient compared to our peers. This is

because no other company has proposed to use mains replacement for leakage reduction so

our proposed approach invalidates the simple comparison of leakage costs and we therefore

seek an adjustment to address this issue.

The positive impact of mains replacements will be experienced over a number of periods so

it is right to reflect this in the way that the investment is accounted for in the cost models

used to compare company programmes of work. The cost of mains replacement should be

apportioned to reflect the ongoing future benefits for customers in subsequent Price Review

periods. ALC is unable to achieve these future benefits without continued and increased

investment over the same period.

We note that there is a wide range of unit costs that have been calculated from companies’

business plans, and that the approaches taken to achieve the reductions proposed will be

dependent upon each company’s own circumstances. Our approach is based on 20 years of

successfully achieving our leakage target at or below the economic level, despite extreme

weather events having an additional detrimental impact. It is also based on our upper quartile

performance, operating close to the frontier (see Figure 1 below). In our situation, relying

solely on ever increasing amounts of ALC inherently carries more risk and ultimately is not

sustainable or resilient.

Figure 1 – Data source: Discover Water


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Our cost model, underpinned by our calculated leakage cost curves (see appendix 3 to this

document) indicates that reducing leakage purely using ALC becomes disproportionately

more expensive as leakage becomes a smaller proportion of the overall water going into

supply. The increasing number of leaks that need to be detected, located and then repaired

will need an increasing amount of skilled resources and cause a far greater amount of

disruption to customers through unplanned works.

The table below demonstrates that despite higher costs in absolute terms and according to

the Ofwat unit cost model, our preferred approach offers an equivalent bill impact for

customers in AMP7. If Ofwat was to treat mains replacement expenditure as shown in the

Servelec report (appendix 1, section 2.3), then our unit cost would be reduced to £1.9m/Mld

and below the industry average. The table also shows that if we were to use the alternative

strategy of an additional 5% reduction by ALC then our unit costs would be greater at

£2.2m/Mld.

The bill impacts in AMP7 are largely consistent regardless of the strategy, showing that

customers will not be paying more for targeted mains replacements. It should be noted,

however, that comparing bill impacts excludes other longer term benefits such as greater

resilience to extremes of weather which have not been quantified and would make the

preferred option more favourable. The Servelec report presents a compelling argument as to

why targeted mains replacement will lead to a more resilient asset base for the future

(appendix 1, Section 3).

Strategy (% reduction) Allocated cost in

period

Unit Cost in Ofwat

Model

(industry average

of £2.1m/Mld)

Bill impact in

AMP7 (per

customer/year

Proposed balanced

strategy (PM, ALC and

mains renewal) – Ofwat

model

£17.5m £4.9m/Mld £4.44

Proposed balanced

strategy (PM, ALC and

mains renewal) –

Servelec approach

£6.9m £1.9m/Mld £4.44

Alternative unbalanced

strategy (PM and 10%

ALC)

£8.0m £2.2m/Mld £4.39

In summary, we have included £13.1m funding for mains replacement as part of our leakage

reduction strategy which we are confident will deliver the outcomes that our customers

expect. Failure to secure the funding will force us to take a more short-term approach which,

although may deliver the leakage savings in AMP7, will not be sustainable and deliver any

further benefits to customers and is not a repeatable strategy for future Price Review periods

to drive leakage to less than half its current level.


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Management control

As noted previously, this claim is not about additional costs. It refers only to the selection of a

particular programme of work to achieve a targeted leakage reduction between 2020 and

2025 that has longer-term benefits to resilience and service improvement. It therefore should

be accounted for differently by Ofwat in its assessment of efficient leakage reduction costs.

Our specialist consultant, Servelec, has modelled the impacts of mains replacement on

leakage and has identified an optimal schedule of mains to be replaced to deliver the

programme cost-effectively. The model has been developed over the last four Price Review

periods and has continued to be improved with the latest modelling approaches and up-to-

date data. Servelec considers the quality of our asset data to be the best in the industry and

this gives a high level of confidence in the modelling outputs.

We intend to continue to work with Servelec during the 2020 to 2025 period to ensure that

the selection of mains to be replaced remains optimised. Our mains replacement strategy

over many previous Price Review periods has ensured that our network is robust and

resilient - alongside leakage we have one of the lowest burst rates and supply interruption

rates in the industry and proven to be capable of withstanding shock events like the March

2018 freeze/thaw. We have achieved this through replacement rates higher than the industry

average and with effective targeting based on modelled outputs validated by expert local

knowledge of our asset base.

For AMP7 we are looking to the future and embracing more innovation. In preparation, we

have been working with industry (and outside of industry) specialists on industry-leading

approaches to accurately assess the condition of our assets to achieve a step change in the

ability to target the mains most in need of for renewal. We have developed an approach

which will allow us to non-invasively test our mains assets to ensure that we only replace

those where there is a genuine need. We will apply this technology alongside a holistic

network asset health assessment model that we have developed to maximise our network

performance. We know that in pioneering this we are leading the industry in this area and

should be supported in pursuing our strategy which could transform the way companies

approach resilience over the long-term and achieve the reductions in leakage that we and

our customers want to see.

The costs of this claim are therefore within management control. We want to avoid

insufficient infrastructure renewal taking place which would result in significant investment

being required in the future which would be more difficult to deliver and disproportionately

impact bill payers at the time.

Robustness and efficiency of costs

Our experience over the last 20 years of achieving our leakage target, sometimes in

challenging circumstances, and the rigour which is applied to our accounting practices to

allocate costs diligently and accurately, gives us confidence in the cost models that are

included in our analysis. Cost efficiency has been progressively achieved over successive


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periods through improved targeting of interventions and competitive procurement processes

for both materials and services.

The delivery of the mains replacement component of the leakage reduction programme will

be undertaken by our infrastructure term services partner under OJEU tendered schedules of

rates. This contract was awarded in July 2016 and has a minimum term of five years. It will

therefore be reviewed in 2021, at which point we will consider going back to market and

utilise the recently published Bid Assessment Framework to facilitate this process.

Furthermore, our work with other partners to introduce a new condition-based assessment of

mains allows us to improve the targeting of assets to be replaced and will assist in ensuring

efficiency.

We have a proven track record of delivering industry leading levels of efficiency in ALC. Our

ALC costs are based on sound data that has been collected, maintained and used for many

years as part of our SELL calculations and has formed a critical part of our Water Resources

Management Plan.

Servelec has used the ‘PIONEER’ investment planning optimisation system to select

interventions to maintain a stable level of serviceability at minimum cost, or to achieve a

step-change in serviceability where justified by customer priorities or regulatory requirements

(as in this case for leakage reduction). Servelec has confirmed from its modelling that the

incorporation of mains replacements as a part of our overall solution to achieving the planned

15% leakage reduction is cost efficient when the investment is matched to the longer term

benefits it generates.

The expectation to achieve one third of the overall reduction from mains replacement is

consistent with the unit costs of the ALC component when apportioned and discounted over

a 40-year period, and yet brings additional future benefits. Fundamentally, mains

replacement provides an opportunity for a ‘do it once’ solution. With modern materials and

installation processes, and contracts which incentivise ‘gold standard’ high quality

workmanship, we can create parts of the network which are truly ‘zero leakage’ and that will

not need further maintenance for the majority of the life of the asset. This contributes to

achieving reduced leakage in subsequent periods and creates a positional shift towards our

plan of more than halving leakage by 2045.

The additional expenditure in the 2020 to 25 period is as follows.

Expenditure for 2020-25

2017/18 prices Bill impact

Pressure management £1.9m £0.34

Active Leakage Control £2.5m £1.72

Mains replacement £13.1m £2.36

Total £17.5m £4.44


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The similarity of the bill impacts for the ALC and mains replacement components indicates

that we have achieved a balance in equally allocating the contributions of these activities and

comparable bills for customers.

In summary, our costs are based on credible data which has been subject to rigorous

analysis using best practice models and techniques. We are confident that the programme of

investment we have proposed will deliver the outcomes we have committed to and will be the

best solution in terms of risk and affordability. The cost estimates were in our original PR19

Business Plan submission in September 2018 and were assured by a third party as part of

the data tables submission.

Best option for customers

We set out in section 2 of the Wholesale chapter of our September 2018 Business Plan

submission why we consider the leakage reduction programme to be the best option for

customers. The following is a précis of what was included in that section.

Reducing leakage by 15% from 2020 to 2025 was supported by our customers. Our draft

plan proposed a smaller reduction, but customers gave their support for going further. The

reduction is set in the context of our long-term strategy to target further reductions of 15% in

each Price Review period from 2025.

Our balanced strategy, focused on the three core areas, will help us to deliver leakage

reductions in the most efficient and sustainable way for the long-term, whilst maintaining a

focus on – and improving – the resilience of our network. The modelling demonstrated the

benefit of balancing reactive and proactive leakage reduction interventions on both current

and future asset serviceability. This provides the optimal platform of cost, risk, resilience and

sustainability for us and our customers, while still maintaining the flexibility to adapt.

Although the three areas are extensions of activities already undertaken, we recognise the

need to enhance our approach to meet the stretching target we have set ourselves. For

instance, we will be aiming to reduce the time from initial detection of a leak to its repair from

the current 12 days to less than eight days. We will also fundamentally overhaul our

approach to addressing leakage from customer pipes. In extending our pressure

management approach we will leverage the new generation of smarter valves and controls

that maintain service levels whilst maintaining a ‘calmer’ operation of the network.

For mains replacement, our plan is to increase activity to 1% renewal per year, a higher rate

than in the current Price Review period but returning us to rates which we achieved in AMP3

and AMP4. Through advances in technology associated with condition assessment (as

detailed earlier), we will be better able to target the mains with the worst integrity to improve

our efficiency in delivery. This approach draws on our objective to create a resilient network

fit for future generations. Our modelling has shown that our proposed programme will deliver

a 5% leakage saving that is sustained over many Price Review periods.

In our planning for the 2020 to 2025 period we have used the PIONEER model jointly

developed over many years with Servelec to test leakage reduction scenarios. The modelling


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has tested scenarios delivered by mains replacement, alongside different scenarios of

increased ALC activity and enhanced pressure management. The model has then optimised

intervention outputs and provided mains intervention details including mains length and cost

of renewal.

The customer message we received through our engagement on leakage and network

resilience was clear: they wanted us to improve and they supported us investing in doing so.

Customers also want us to be proactive and not reactive, making targeted and steady

improvements to our network so that they never experience outages or lower than expected

service levels. We believe that our balanced approach which includes enhanced mains

replacement rates is the only way we can meet our customers’ expectations in these areas in

a way that is affordable for them both in the short term (the next Price Review period) and

over a longer-term planning period.

Customer protection

Customers believe that the current level of leakage is too high (even if we are meeting our

target) and expect us to do more to reduce it. Our performance is amongst the best in the

sector, but customers are willing to pay more to reduce it further. If the expenditure this claim

seeks to secure is cancelled, delayed or reduced in scope, then we would not be able to

reduce leakage by 15%. Customers are protected from our failure to do this by the leakage

performance commitment which incorporates an ODI with a financial penalty should we not

achieve the leakage reduction target. Failure to meet our leakage target would also have a

significant impact on our reputation.

Affordability

The primary affordability consideration of our leakage strategy is that it ensures affordability

in this price review period and maintains this over the longer term.

The mains replacement component of our leakage reduction programme does impact

customers’ bills (see cost table shown earlier). However, despite the noticeably higher cost

incurred in the period, the bill impact is comparable to those for ALC because the assets

installed will have a long life and be paid for over successive future periods. This reflects the

benefit that customers will realise from the assets in future periods. The replaced assets will

bring benefits in both serviceability and resilience.

Customers have accepted this plan for leakage reduction as part of a package of measures

which result in an overall reduction in bills during the 2020 to 2025 period and achieved a

76% acceptance level with our customers.

Our innovative willingness-to pay (WTP) research included leakage and is described in full

detail in the Engaging with our customers chapter of our original business plan submission.

Key findings included that our customers continue to value and endorse further investment to

make sure our strong track record in performance on burst mains, leakage and supply

interruptions is maintained for future generations through increased investment in mains

replacement. They also support a significant leakage reduction by 2025 and are supportive


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of contributing to the additional cost of delivering. In our draft Business Plan we proposed a

12% reduction by 2025 but tested doing more and doing less as part of our acceptability

research. Customers were asked to make a choice on the level of service they would prefer

to experience in the context of the impact that this would have on their water bill. There was

broad support for the draft Business Plan position but a significant proportion of customers

wanted to see more done to reduce leakage. Our final plan therefore targets 15% and we

were able to off-set some of the bill increase by reducing our social tariff target from the draft

business plan which customers were less supportive of going further on.

Assurance

Our technical assurers have reviewed this claim and a copy of their letter is in appendix 4 of

this document. Our Board has also assured this submission.

The assurance process provided a review of whether:

• The need for a cost adjustment appears to be justified in the context of Ofwat’s guidance

set out in its information notice IN 18/02 of March 2018

• The costs were likely to be sufficiently material as to be admissible

• Our cost modelling had used a reasonable approach to make a central estimate of likely

costs

• There was adequate checking of the calculations in the modelling

• There are other implications of the claim on customers and affordability.

In conclusion, our technical assurers found that our cost adjustment claim for the mains

replacement element of our leakage reduction strategy demonstrated that:

• Our approach allows us to take a long-term view of reducing leakage, that the need for a

cost adjustment is within Ofwat’s criteria and that it is reasonable to ask Ofwat to

consider our approach outside its main modelling approach

• The cost of the mains replacement in the leakage reduction programme is 5.5% of the

network+ totex and therefore well above the materiality threshold

• Our approach to modelling is in line with their expectations

• The claim was well supported by the detailed modelling

• Our approach to leakage reduction with the use of mains renewals means that there will

be a maintainable affordability in the future.

In addition, they concluded that our cost adjustment claim for leakage – mains replacement

component:

• Represents material costs that are the result of reasoned optioneering for reducing

leakage with a sustainable future focus

• Has been constructed in sufficient detail to allow a robust build-up of the costs.


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Appendices

Appendix 1 – Servelec report

Appendix 2 – Atkins strategic review of pressure management (excerpt)

Appendix 3 – Artesia report

Appendix 4 – Mott MacDonald assurance letter

Appendix 2 – Atkins – Strategic review of pressure management

The graph shown below was produced by Atkins as part of the output of a study to appraise

the opportunity for further pressure management across the entirety of the SES network. It

demonstrates two things:

• Pressure management opportunities exist that will achieve leakage reductions

• There is a limit to the amount of pressure management that can be delivered and this

due to a combination of technical/practical reasons, customer (service) reasons and

financial reasons where schemes become costlier with diminishing returns.

The modelling that underpins the graph is based on robust and well established techniques

used by Atkins for a number of other UK water companies. The Pressure Management

Review (PMR) tool has used SES base data and produced a high-level assessment of

potential pressure related leakage savings. The cost modelling as part of the processes has

been based on SES unit cost data which has been applied to the recommended

interventions using established and industry best practice techniques. The outputs from this

work have provided us with confidence that we can deliver the leakage savings through

pressure management as put forward in our plan.

Additional costs of around £250k are projected to be incurred in the development of the

detailed modelling and management of these activities, taking the overall cost to the forecast

£1.9m.

SES Water

Sustainable economic level of leakage (SELL) analysis for baseline WRMP19 forecast

Final

AR1169

15th September 2017

Report title: Sustainable economic level of leakage (SELL) analysis for baseline WRMP19 forecast

Report number: AR1169

Date: 15th September 2017

Client: SES Water

Author(s): Dene Marshallsay

SES Water

Artesia ref: AR1169 © Artesia Consulting Ltd 2017

Executive Summary

The economic analysis has been carried out using the ‘Marginal Cost of Water’ (MCW) approach defined in the Tripartite Report1. This produces an ‘Sustainable Economic Level of Leakage’ or SELL which is defined as the point at which the marginal cost of active leakage control equals the marginal cost of water. The Tripartite Report describes the best practice approaches for determining the ELL in England and Wales.

The SELL has been modelled using data collected from SES Water’s management and reporting systems for the year 2015/16. The average level of leakage during 2015/16 was 24.17 Ml/d or 91.7 l/prop/day based on 263,451 property connections.

Using data on leakage levels, leakage repair rates, active leakage control costs and the cost of water, a series of cost curves are created showing the leakage control costs and the costs of water lost at different levels of leakage. The total cost curve (including social and environmental impacts) indicates the cost to SES Water of operating at different leakage levels. The sustainable economic level of leakage (SELL) is level of leakage where the overall costs are minimised.

The SELL for SES Water has been calculated as 23.45 Ml/d or 89.0 l/prop/day, and lies within a range of 20.2 to 27.3 Ml/d (defined as being within 1% of the total cost of the SELL point). Hence the leakage level for SES Water in 2015/16 is considered to be economically efficient (see chart).

At the previous WRMP the company was considered to be below the SELL, however, the best practice relating to the background level of leakage has changed since then. Using the minimum achievable background leakage (MAbL) is now best practice. If the MAbL value is adjusted to the background level of leakage used for the last WRMP, then the SELL increases to 26.47 Ml/d; above SES Water’s current leakage level (in 2015/16).

1 See: www.ofwat.gov.uk/publications/commissioned/rpt_com_tripartitestudy

SES Water


Contents

1 Introduction 2 Leakage levels

2.1 Recent leakage levels 2.2 Background level of leakage

3 Leakage repairs 3.1 Leakage repairs and leakage costs 3.2 Analysis of repair data 3.3 Steady state analysis

4 Leakage control costs 4.1 Methodology for steady state leakage control costs 4.2 Methodology for transitional costs 4.3 Unit costs for base year

5 Economic analysis 5.1 Marginal cost of water SELL 5.2 The costs of achieving planned leakage reduction

6 Conclusions

Tables

Table 1 Breakdown of repairs by type for 2015/16 Table 2 Actual number of repairs for 2015/16 and steady state number of repairs Table 3 Fixed and variable costs - with and without environmental and social impacts Table 4 Costs for achieving a 0.5 Ml/d reduction in leakage in AMP6

Figures

Figure 1 Historic reported leakage levels and current leakage targets to 2020 Figure 2 Steady state and transitional costs and repairs Figure 3 Number of repairs carried out each month by repair type Figure 4 Leakage cost curves for current leakage control policy and updated MAbL Figure 5 Leakage cost curves with the policy minimum set to 49.73

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1 Introduction

This report sets out the analysis of the short-run sustainable economic level of leakage (SELL). The analysis has been undertaken using a marginal cost of water approach consistent with the findings of the Tripartite Report Method A2 (this describes the best practice approaches for determining the ELL in England and Wales).

SES Water operates its supply system as a single water resource zone and hence the analysis for the SELL has been carried out as a single resource area.

This short-run SELL approach compares the marginal cost of active leakage control with the marginal cost of water (where costs include environmental and social elements). The marginal cost of water is calculated by considering the cost of providing additional capacity from existing resource/treatment investment. The SELL is the point at which the marginal cost of active leakage control equals the marginal cost of water.

The ‘Least Cost Planning’ (LCP) SELL will be determined during the options modelling for managing the supply/demand balance over the planning period. Various alternative leakage options will be used (along with other supply/demand balancing options) in determining the optimum least cost strategy for balancing supply and demand. The leakage options will make use of the leakage control cost curves developed in this short-run SELL report.

The marginal cost of water SELL has been carried out using Method A in the Tripartite Report. Using ‘Method A’, the current costs are split into steady state costs (the cost of maintaining leakage at a given level) and transitional costs (the cost of moving from one level of leakage to another). This allows the development of leakage cost relationships which are used to predict how the on-going costs of leakage control will change if a different level of leakage is maintained. It also allows the transitional costs incurred in achieving the new target level of leakage to be assessed. The relationship is developed for the current leakage control policy (current leakage detection methods and technology). Costs of operating at different levels of leakage are calculated assuming the method of leakage control is unchanged and leakage is reduced through applying more of the same effort.

Detailed company data on leakage levels, leakage control activities, costs and repair rates for 2015/16 were used in the analysis. The report details what data has been used to generate the SELL. The report also sets out the baseline leakage forecast for the initial draft WRMP19 demand forecast.

2 Leakage levels

2.1 Recent leakage levels

SES Water monitor leakage levels through analysis of night flow data collected from about 295 DMAs (district metered areas). Flow data is recorded every 15 minutes and analysed in the Company’s leakage software, along with pressure data from each DMA.


http://www.ofwat.gov.uk/publications/commissioned/rpt_com_tripartitestudy

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One of the biggest challenges facing the Company when estimating leakage is distinguishing between leakage and increased demand at night during the summer months due to sprinkler usage – which is very common in the Company supply area. For this reason, an assumption is made for the leakage level during the summer months based on average levels – an approach that has been endorsed by Ofwat. The Company is currently developing a continuous night use monitor, which will be able to monitor increases in night use during the summer, and improve the robustness for reporting leakage during the summer months.

Historic leakage levels are shown in Figure 1.

Figure 1 Historic reported leakage levels and current leakage targets to 2020

The existing leakage targets are sown as the green line in Figure 1. In AMP 5 the target was 24.5 Ml/d as was determined using a policy minimum of 49.73 l/prop/day (the value of this factor becomes important in the next section). The targets for AMP 6 were set during the last water resource plan process to reflect customers view the leakage should continue to fall.

2.2 Background level of leakage

The previous economic level of leakage assessment used a policy minimum level of leakage. A key report published by UKWIR in 2013, ‘Factors Affecting Background Leakage’3, distinguished between minimum achieved and achievable leakage as follows:

Minimum Achieved Leakage (MAL) also known as the Policy Minimum Level defines the lowest level of leakage that can be achieved within a given active leakage control (ALC) policy and ‘reasonable’ effort.

Minimum Achievable Leakage (MAbL) also known as Background Leakage defines the lowest leakage possible given limitless resources.

3 “Factors Affecting Background Leakage” UKWIR 13/WM/08/49

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Following this, the EA, Ofwat & Defra commissioned a report (the SMC report4) that recommended Minimum Achievable Leakage (MAbL) be used for SELL calculations rather than MAL.

SES Water commissioned a report from Atkins that explored the MAbL value for SES Water’s network5. This report suggests that the MAbL for the network lies somewhere in the range of 22 to 36 l/prop/day. Therefore, in the modelling of the SELL we have used the mean of these two values for the MAbL; i.e. 29 l/prop/day. The upper and lower values will be used to explore the sensitivity of the SELL.

Previous determinations of the SELL for SES Water have used a policy minimum value of 49.73 l/prop/day6.

3 Leakage repairs

3.1 Leakage repairs and leakage costs

The economic analysis requires an understanding of the number of leakage repairs carried out in the base year to achieve the leakage levels for that year. This will allow the calculation of the steady state costs (the costs associated with maintaining leakage at a fixed level) and the transitional costs (the costs associated with moving from one level of leakage to another).

When leakage is being maintained at a fixed level it is assumed that on average, leaks are being repaired at the same rate at which they break out (if this were not the case, then leakage would either increase or decrease). The steady state number of repairs can be calculated by analysing the repair numbers and leakage over the base year period, this is equivalent to the leakage break-out rate.

In order to reduce leakage, additional repairs need to be carried out, and when the new desired leakage level is achieved, repair rates can be reduced to the steady state number of repairs (this is because there has been no change to the characteristics of the network to change the leakage breakout rate). Hence, the costs associated with leakage repairs are independent of the leakage level for a particular leakage control policy. The leakage control costs will increase, however, as the run time of leaks is reduced through more frequent surveying to maintain leakage at the lower level. This is illustrated in Figure 2.

4 “Review of the calculation of sustainable economic level of leakage and its integration with water resource management planning” SMC for Environment Agency, Ofwat, Defra, October 2012.

5 “Minimum Achievable Leakage Derivation, Atkins, 18th November 2016.

6 Final WRMP 2014 Appendix F Leakage management cost assessment, SES Water, June 2014

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Figure 2 Steady state and transitional costs and repairs

3.2 Analysis of repair data

Table 1 shows the number of repairs carried out in 2015/16. Figure 3 illustrates the number of repairs carried out each month by type. The average number of total repairs per month in the base year is 141.25.

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Table 1 Breakdown of repairs by type for 2015/16

Repair type Hidden Known Total

Mains repair 194 127 321

Communication Pipes 142 768 910

Ferrule 0 28 28

Meter 0 97 97

Stop cock 0 207 207

Supply pipes 13 118 131

Fire hydrant 0 1 1

Totals 349 1346 1695

Figure 3 Number of repairs carried out each month by repair type

3.3 Steady state analysis

Leakage has remained steady over the two years 2015/15 and 2015/16 (see Figure 1). The average number of repairs during this period is approximately 141 repairs per month and this has been set as the steady state number of repairs.

Table 2 Actual number of repairs for 2015/16 and steady state number of repairs

Average number of repairs per month

Repairs carried out in 2015/16 141.25

Steady state number of repairs 141

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4 Leakage control costs

4.1 Methodology for steady state leakage control costs

A cost curve is developed for the current policy by deriving the steady state costs to maintain the current level of leakage. The steady state relationship that is developed allows the cost of maintaining any target level of leakage using the current policy to be estimated. The starting point for the cost curve is the current annual level of leakage and the current ‘steady state’ ALC costs. A cost curve is generated by assuming that the runtime of leaks, and hence leakage level, is related to the frequency of leakage control surveys.

The form of the relationship will be affected by:

• the method of ALC,

• the run times for bursts and smaller leaks,

• the policy minimum (base) level of leakage.

Under steady state it is assumed that leaks are repaired at the same rate as they break out. Experience has shown that the breakout rate of total leaks is not generally affected by the level of leakage, although the split between reported and detected leaks can change significantly. To develop the cost curve ALC costs are split into activity costs. Each activity is specified as either ‘variable’ (costs which increase proportional to the number of surveys) or fixed (costs which are independent of survey frequency).

Cost factors are used to control the relationship between ‘variable’ ALC costs and the level of leakage. As a default it is assumed that the level of leakage above the base level will be half the current level if the frequency of surveys is doubled. A log power function is then fitted through these points to produce a continuous relationship. Activity costs are then summed to give the total cost curve.

4.2 Methodology for transitional costs

The transitional costs are based on the reduction in annual average leakage required to meet future leakage targets. The costs are calculated for each year by estimating the additional number of leak repairs required to achieve the reduction, which need to be found through leakage detection (in addition to those required to maintain steady state). The number of leaks is calculated by dividing the required reduction by an assumed flow rate. The fixed and variable unit costs are derived from the steady state costs at the annual target level of leakage at that time.

The transitional cost also assumes that there is a reducing leak flow rate as leakage is lowered towards the MAbL value. The leak flow rates used in the model have been adjusted to calibrate the overall repair cost of a 1 Ml/d reduction in leakage to approximately

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£800,000; the transitional cost of leakage reduction presented in the Atkin’s report on their MAbL investigation7.

4.3 Unit costs for base year

4.3.1 Active leakage control costs

Direct unit costs for the base year were extracted from the company’s financial records by examining specific cost codes for each of the following areas:

• Monitoring

• Location

• Repairs.

The costs have been taken as an average of the last 5 year and split into fixed and variable costs, i.e. those costs which are variable with respect to leakage.

All costs also include the include environment and social impact. The social and environmental impacts from active leakage control and repair activity have been calculated using the methods and assumptions contained in the SMC report on SELL8. These costs have been used to calculate a social and environmental cost per leak, which has then been allocated to the costs of variable repairs. The carbon impact from pumping water which escapes through leaks has been calculated from the carbon dioxide equivalent per Ml of water produced, which is then converted to a monetary value through a traded cost of carbon. This has then been added to the marginal direct cost of water.

The fixed, variable, direct and indirect costs are shown in Table 3.

Table 3 Fixed and variable costs - with and without environmental and social impacts

Cost heading

Fixed or variable

Total direct cost Total cost including E & S

costs

Monitoring costs Fixed £344,109 £344,109

Leakage detection Fixed £26,732 £26,732

Leakage detection Variable £425,860 £425,860

Total repairs Fixed £285,079 £285,079

Total repairs Variable £1,707,609 £2,025,311

Totals £2,789,389 £3,107,091

7 “Minimum Achievable Leakage Derivation, Atkins, 18th November 2016.

8 Review of the calculation of sustainable economic level of leakage and its integration with water resource management planning. SMC, 2012

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4.3.2 Cost of water

The marginal cost of water (direct costs) is 20.19 p/m3 or £201.9/Ml.

With the inclusion of carbon costs this increases to 21.22 p/m3 or £212.2/Ml.

5 Economic analysis

5.1 Marginal cost of water SELL

The SELL is the level of leakage that minimises the cost of managing the supply-demand balance. The ELL is the point at which the additional cost of reducing leakage is equal to the benefit gained from further leakage reductions. The approach used to determine the SELL within this study uses the Marginal Cost of Water methodology as set out in the Tripartite Best Practice Report.

5.1.1 Base year analysis

The basis behind the steady state and transitional analysis has been explained in this report. A spreadsheet was prepared and used to carry out the steady state and transitional analysis to produce the cost curves explained in 0 and 0. The spreadsheet contains data on:

• Leakage levels in the base year.

• Minimum achievable background leakage.

• Active leakage control costs (including environmental and social costs).

• Repair numbers in the base year.

• Steady state number of repairs.

• Detection hours.

• Property numbers.

• Mains lengths.

• Marginal cost of water (including carbon costs).

The result of the analysis is shown in Figure 4. This graph depicts each of the cost curves and how the costs would change when maintaining leakage at different levels (leakage varies along the x axis, and costs along the y axis). The cost curves for monitoring are fixed, as explained earlier in the report. The location costs and repair costs vary (red line), the combined active leakage control costs are shown in purple. The cost of water (light blue line) is added, and the combined cost curve is shown in orange, the minimum point on this line is the SELL (89.0 l/prop/day or 23.45 Ml/d, shown by the red dotted line). The red star represents the current level of leakage for SES Water (91.7 l/prop/day or 24.17 Ml/d).

The dotted lines on the graph show the SELL range for costs that are ± 1% of the total cost at the SELL. t is recommended that leakage levels which result in a cost within 1% of the absolute minimum should be considered least cost solutions. Using this approach it is concluded that, based on steady state analysis, the SELL lies within the range of 76.5 to 103.5 l/prop/day or 20.2 to 27.3 Ml/d. The current level of leakage (91.7 l/prop/day or 24.17 Ml/d) lies within this economic range.

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At WRMP14 SES Water considered that they were below the SELL, and this was determined using a policy minimum value of 49.73 (see section 0). However, since that time the industry best practice has changed to recommending the use of the MAbL value, which for SES Water has been determined as 29 l/prop/day (which is used for this current SELL).

Figure 4 Leakage cost curves for current leakage control policy and updated MAbL

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Figure 5 Leakage cost curves with the policy minimum set to 49.73

If the MAbL value of 29 l/prop/day is replaced with the policy minimum value of 49.73 l/prop/day, and all other variables are held constant, then the SELL value is 101.5 l/prop/day or 26.74 Ml/d, as shown in Figure 5. SES Water’s current level of leakage is therefore below this value.

5.2 The costs of achieving planned leakage reduction

The current water resource management plan suggests that leakage will be reduced by 0.1 Ml/d per year over the AMP6, yielding a 0.5 Ml/d reduction in this AMP. The SELL model has been used to estimate the cost of achieving this. The figures in Table 4 indicate the costs of meeting this leakage target with the same assumptions included as for section 0, the current SELL assessment.

Table 4 Costs for achieving a 0.5 Ml/d reduction in leakage in AMP6

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The cost estimates from the modelling in Table 4 suggest that reducing leakage by 0.5 Ml/d over the remainder of AMP6 and then maintaining leakage at 23.67 Ml/d is marginally more costly than maintaining leakage at the current level over the next 10 years.

6 Conclusions

The economic analysis has been carried out using the ‘Marginal Cost of Water’ (MCW) approach defined in the Tripartite Report9. This produces an ‘Sustainable Economic Level of Leakage’ or SELL which is defined as the point at which the marginal cost of active leakage control equals the marginal cost of water. The Tripartite Report describes the best practice approaches for determining the ELL in England and Wales.

The SELL has been modelled using data collected from SES Water’s management and reporting systems for the year 2015/16. The average level of leakage during 2015/16 was 24.17 Ml/d or 91.7 l/prop/day based on 263,451 property connections.

Using data on leakage levels, leakage repair rates, active leakage control costs and the cost of water, a series of cost curves are created showing the leakage control costs and the costs of water lost at different levels of leakage. The total cost curve (including social and environmental impacts) indicates the cost to SES Water of operating at different leakage levels. The sustainable economic level of leakage (SELL) is level of leakage where the overall costs are minimised.

The SELL for SES Water has been calculated as 23.45 Ml/d or 89.0 l/prop/day, and lies within a range of 20.2 to 27.3 Ml/d (defined as being within 1% of the total cost of the SELL point). Hence the leakage level for SES Water in 2015/16 is considered to be economically efficient.

At the previous WRMP the company was considered to be below the ELL, however, the best practice relating to the background level of leakage has changed since then. Using the minimum achievable background leakage (MAbL) is now best practice. If the MAbL value is


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adjusted to the background level of leakage used for the last WRMP, then the SELL increases to 26.47 Ml/d; above SES Water’s current leakage level (in 2015/16).

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