Information Letters

DWI Information Letter 5/2003

16 May 2003

To: Board Level Contacts of Water and Sewerage Companies in England and Wales

Dear Sir or Madam

The 2004 Periodic Review of Prices and AMP4 – Appraisal Methodology for Water Company Proposals for Drinking Water Quality Improvement Schemes

Purpose

1. The purpose of this Information Letter is to advise water companies and other stakeholders of the DWI methodology for appraising proposals for drinking water quality improvement schemes for PR04. The cost-effectiveness approach is an integral part of the DWI appraisal methodology and is applicable to all schemes that have statutory drivers. Cost benefit appraisal, as determined through consumer surveys and reductions in the level of complaints, is proposed for schemes aimed at delivering enhanced drinking water quality, as perceived by consumers. .

   Introduction

2. The role of DWI in determining the drinking water quality programme for the Periodic Review of Prices 2004 (PR04) should be seen in the context of the respective roles of other participants, including Ministers, Ofwat and water companies. These roles are summarised in Table 1.

   Roles in determining the drinking water quality programme for PR04

   Main participants	Role
   Ministers	Confirmation of statutory requirements Confirmation of discretionary requirements Confirmation of timing and pace
   DWI	Guidance to Ministers Transposition of Ministerial requirements to programmes of work Process and methodology Assessment of proposals Confirmation of requirements to companies and Ofwat Monitoring delivery of supported requirements and report on progress to Ofwat
   Ofwat	Financial provision for requirements within the overall periodic review process Monitoring of outputs delivered and associated costs Monitoring serviceability Appraisal of companies' (draft) business plans Setting price limits to enable prudent and well managed companies to finance their functions
   Water Companies	Determination of status in respect of existing, revised, and new requirements Preparation of proposals Provision for supported requirements in business plans Delivery of supported requirements

3. In addition, DWI participates actively in debating strategic industry issues that impact on drinking water quality.

4. In previous Periodic Reviews, programmes of work for drinking water quality improvements have been assessed by DWI on technical grounds, incorporating cost-effectiveness as an important consideration and an integral part of the process. The Water Supply (Water Quality) Regulations 2000 (the 2000 Regulations) for water companies whose area of supply is wholly or mainly in England, and the Water Supply (Water Quality) Regulations 2001 (the 2001 Regulations) for water companies whose area of supply is wholly or mainly in Wales require DWI to have regard to the water company view of the costs of steps when supporting or accepting the steps that a water company is proposing to take in order to secure the requirements of Part III (wholesomeness) for the purposes of Section 21 ( authorised departures).

5. DWI also recognises the Initial Guidance from Ministers that looks to regulators to encourage approaches that integrate and trade off the possibilities of new investment, maintenance and operations to deliver what is overall the most cost-effective solution. DWI is not proposing to recommend specific capital and operational projects under maintenance but to review and comment on water companies’ Distribution Operation and Maintenance Strategies (DOMS) proposed by companies to meet drinking water quality requirements.

6. This Information Letter describes the appraisal methodology that DWI intends to follow in assessing whether to support water company proposals for drinking water quality schemes for inclusion in PR04 Business Plans, consistent with its statutory duties and guidance from Ministers. The use of cost-effectiveness and cost-benefit approaches is described in the context of the overall methodology.

   Types of Appraisal

7. There are two approaches used by water companies and regulators for determining the appropriate level of investment to meet future environmental and drinking water quality requirements.

8. The cost-effectiveness approach is used to determine the work needed to achieve the statutory requirements and maintain levels of service at least cost, and is the default method for all scheme appraisals. The way in which this is embedded in the DWI appraisal process is described below.

9. The cost-benefit approach is used to determine the work needed to achieve statutory requirements and to improve the service where it can be shown that the benefits to consumers outweigh the cost of any improvements. The scope of the service valuation analysis depends on the merits of including wider social and environmental costs and benefits within the analysis, in addition to the costs and benefits of the service improvements identified by the water companies and their consumers. Given that the wider issues are taken into account in the framing of legislation on drinking water quality, DWI’s appraisal of benefits, where appropriate, will be confined to an assessment of the benefits of any proposed drinking water quality improvements, as perceived by consumers.

   Cost-effectiveness appraisal

10. Cost-effectiveness is implicit in all aspects of DWI’s dealings with water companies on PR04 proposals, starting with identification of need through to final delivery and sign–off of programmes of work. This is achieved by:
    • Providing detailed guidance on expectations for meeting drinking water requirements;

    • Professional assessment of options in the development of a strategy to deal with quality issues (e.g. lead);

    • Defining criteria to trigger programmes of work, taking account of triviality and risk;

    • Taking account of costs in water companies’ proposals and justification of preferred options;

    • Encouraging sustainable solutions to maintain compliance in the long term (e.g. Nitrates);

    • Seeking integrated solutions within an overall programme for the AMP period;

    • Working with Ofwat and its Reporters in assessing the cost-effectiveness of solutions;

    • A staged approach to programme delivery to achieve least cost solutions;

    • Monitoring delivery of programmes by requiring companies to carry out detailed investigations on the appropriateness of solutions, in the light of detailed design and planning considerations;

    • Confirming that target completion dates and profiling of delivery is consistent with providing the most cost-effective solution and is consistent with Ministerial guidance;

    • Confirming the integrity of the overall process by audits at various stages.

    Categorising schemes for cost-effectiveness or cost-benefit appraisal

    Statutory schemes

11. Programmes of work for drinking water quality are usually driven by statutory requirements, and are triggered by either:
    • actual compliance failures which are non-trivial and likely to recur, or

    • schemes at material risk of non-compliance with statutory requirements, where there may be borderline failures, supported by data from operational failures, predictive modelling (e.g. nitrate schemes) or consumer complaints (e.g. discoloration due to iron). Cost-benefit analysis is inappropriate in this context as failure to meet a statutory requirement is the principal driver. Cost-effectiveness appraisal is, therefore, the most suitable approach.

    Drinking water quality enhancement schemes

12. These are schemes which have no specific statutory driver but which would lead to an improvement in the quality of water perceived by consumers. Such schemes will need to be justified in cost-benefit terms by identifying the improvement in water quality, the cost, and the benefit to consumers of such an improvement. Examples are schemes to deal with consumer complaints caused by taste and odour issues, or to address hardness of water. Such schemes will need to have measurable outputs deliverable by a due date supported by DWI.

    Methodology

13. Following receipt of water companies’ individual scheme submissions, DWI will follow the process and methodology set out in Table 2, and described in recent Information Letters to companies (principally IL 14/2002 and IL 4/2003). The appraisal will be informed by the Preliminary Submissions made by water companies in October 2002, and the subsequent DWI/water company meetings between November 2002 to date.

    Table 2. DWI Appraisal methodology for PR04

    Step	Description	Date by
    1	Individual scheme submissions	May/June 2003
    2	Justification of need confirm statutory basis Establish scheme satisfies programme criteria Identify service enhancement (cost-benefit schemes)
    3	Option selection check Identify all available options Examine capital and operating costs of each option Investigate sustainability of proposed solution Note degree of integration with other drivers
    4	Determination of timing and pace Check alignment with Ministerial guidance Ensure cost-effective delivery profile
    5	Cost effectiveness appraisal Assess companies' preferred technical solution Review cost of favoured option(s) Liaise with Ofwat on company cost estimates
    6	Cost-benefit appraisal Assess companies' customer survey results (where appropriate) Examine level and distribution of consumer complaints Identify target level of improvement Assess effectiveness of proposed solution to deliver target improvement in service Normalise results across companies
    7	Preliminary Opinion Letters Identify issues to be resolved / jusified before a letter of support can be provided	June/July 2003
    8	Integrity audit on data Carry out checks on companies' data and process which support proposals
    9	Letters of Support Confirm statutory basis, or Confirm support on cost-benefit grounds (service enhancement)	Nov 2003
    10	Programme confirmation Convert individual schemes into regulatory programmes of work Confirm scope, timing and pace set milestones for delivery Confirm company's overall drinking water quality programme	March 2004
    11	Programme Delivery Detailed investigations and design confirm justification monitor progress against milestones, and share information with Ofwat	AMP4 period
    12	Demonstration of benefit confirm target completion dates achieved confirm drinking water quality improvements achieved ensuring target improvements in service levels achieved perform audits, as necessary	AMP4 period
    13	Completion and sign off	AMP4 period

     

14. The approach taken in respect of each of the main drinking water quality drivers for PR04 is further discussed below and specific actions by DWI or requirements placed on companies to ensure cost-effective or cost-beneficial solutions for each driver are summarised in Annex A.

    Programmes of work

    Distribution System Renovation

15. Since 1990, water companies have carried out extensive programmes of work to renovate their distribution systems under Distribution (Section19) Undertakings. For some water companies, this work will continue into the AMP4 period. A process of pre- and post-renovation assessment (PPRA) has been developed by DWI, and used to ensure that the work is carried out in the most cost-effective manner and to demonstrate that the benefits associated with improvements in drinking water quality are achieved.

16. Furthermore, the Undertakings include a requirement for companies to submit to the Secretary of State a strategy for strategic operation and maintenance of the system to prevent a recurrence of the contravention(s). This requirement has recently been broadened to include all companies’ distribution systems and is discussed further below.

    Water Treatment Improvements

17. Programmes of work at treatment works are assessed on a scheme basis using information provided by water companies, and checked by DWI by audit. The information includes water company estimates of the capital costs and the net additional operating costs of the options considered. As for the other drivers, DWI’s principal role is to assess the justification for the proposal and the adequacy of the solution proposed. As appropriate, opportunity is provided to consult with other stakeholders on the scheme DWI is minded to support. When DWI support is given for a particular scheme, the basis for the costs put forward for the proposed solution may be challenged by the water company’s Reporter, and in due course by Ofwat. However, it is expected that provision for the scheme will be made in Business Plans.

    Strategic Lead Communications Pipe Replacement

18. PR99 made financial provision for the work needed to meet the interim standard for lead of 25µg/l and to make a start to meet the final standard for lead of 10µg/l. Initial work on the optimisation of plumbosolvency measures has demonstrated that treatment can be very effective in reducing lead concentrations in drinking water at a fraction of the cost of lead pipe replacement. It will also reduce lead uptake from consumers’ lead pipework. DWI will examine water companies’ plans to ensure the potential benefits of plumbosolvency measures are established before strategic replacement of water company lead pipes commences. Trials carried out with a number of water companies have also assisted in developing criteria for shaping strategic programmes of work and the experience gained will be made available to all water companies.

19. This guidance also reflects Ministers’ views that water companies are expected to take advantage of any cost-effective opportunities to bring forward replacement of lead pipe during other work, such as refurbishment of mains.

    Acceptability of Drinking Water to Consumers

20. Dissatisfaction with the aesthetic quality of water supplies has been highlighted in the recent Ministerial Guidance. Water companies have been challenged to adopt a more proactive and long-term strategic approach to managing water supply systems with a view to reducing substantially the number of consumer complaints. DWI has outlined its approach, which includes the setting of targets for a rapid reduction in consumer complaints, in Information Letters 14/2002 and 4/2003. The measures described, when taken alongside the companies’ strategy for capital maintenance, will deliver the necessary improvements to water quality in the most efficient manner.

    Distribution Operation and Maintenance Strategies (DOMS)

21. DWI has set out its expectations for water companies to prepare and implement strategies for the proactive management of drinking water distribution systems over the long term. These expectations align with the guidance from Ministers that the strategy documents should be considered as an integral part of the Common Framework methodology and that improvements made to drinking water quality in recent years should be consolidated by effective and efficient operation and maintenance of assets.

    Enquiries

22. Enquiries about this letter should be addressed to Milo Purcell (020 7944 5993), or milo.purcell@defra.gsi.gov.uk. This letter is being sent electronically to Board Level and Day-to-Day contacts. Please acknowledge receipt by e-mail to dwi.enquiries@defra.gsi.gov.uk. Hard copies are not being sent. This letter may be freely copied.

23. Copies of this letter are being sent to Pamela Taylor, Chief Executive, Water UK; Rodney Anderson, Water Supply and Regulation Division, Department of the Environment, Food & Rural Affairs; Bob Macey, Environment Division, The National Assembly for Wales; Tim Hooton, Drinking Water Quality Regulator for Scotland; Randal Scott, Drinking Water Inspector for Northern Ireland; Rowena Tye, Office of Water Services.

Yours sincerely

Prof. Jeni Colbourne MBE
Chief Inspector
Drinking Water Inspectorate

Annex A

Summary of DWI Actions or Requirements Placed on Companies to Ensure Cost-Effective of Cost-Beneficial Solutions for Each Drinking Water Driver

Department for Enviroment,
Food & Rural Affairs (DEFRA)

The National Assembly for Wales /
Cynulliad Cenedlaethol Cymru

Last updated April 2003

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