Assessing capital efficiency in the water and sewerage industry in England and Wales: Ofwat's approach

The Water Services Regulation Authority (Ofwat) is the economic regulator of the water and sewerage companies in England and Wales. Ofwat carries out regular annual reviews of relative capital efficiency and periodic reviews of prices charged by the companies to determine maximum price limits. In reaching these determinations, the most recent of which was in December 2004 (PR04), Ofwat assumed that the companies can, going forward, make some capital efficiencies. Ofwat assessed the scope for such efficiencies in each company by analysing their capital and operating expenditure and outputs, comparing their unit capital costs, making econometric comparisons of their capital maintenance costs and assessing the scope for continuing capital productivity improvement in the water and comparator sectors. Three separate tools used by Ofwat for assessing capital efficiency are described; the cost base (for capital unit costs), capital maintenance econometric models and 'continuing efficiency'. The paper notes how these three tools were used in combination for price limit assumptions in 2004.