On 3 September water companies in England and Wales submitted their business plans to regulator, Ofwat who are now in an intense period of assessing and ranking those plans. For the first time, Ofwat is challenging companies in England and Wales to think differently about how they procure major infrastructure.
Some of the issues facing companies in stepping up to the Ofwat challenge have been experienced first hand in Scotland. Lessons can be learned from those early projects, helping to ensure that Ofwat’s proposals for direct procurement in England and Wales deliver successfully for customers.
Looking beyond the “hard” issues usually addressed in contract drafting, there is real scope for bringing new ideas to concepts of contract change, contract management and dispute prevention.
Ofwat’s methodology for the 2019 price review sets out a clear ambition to use competitive pressures and market forces more extensively than has been the case to date. For enhancement projects with a whole life value of £100M or more and that are regarded as “discrete”, companies must very actively and openly weigh up the benefits of introducing competition into their design, construction, financing and/or operation.
Badged as “Direct Procurement for Customers” Ofwat’s approach both reflects and builds on the experience of the Thames Tideway model and of other sectors such as electricity both in the UK and further afield.
In Scotland, Scottish Water inherited nine Private Finance Initiative (PFI) projects on its establishment in 2002, consisting of twenty wastewater treatment works and one dedicated sludge treatment centre. Approximately 50% of waste treated by volume is treated through a third party PFI scheme in Scotland at present. Many of these will come to the end of their operational (or contractual) life over the next ten years.
The experiences in Scotland, of operating a single water and wastewater network with multiple providers, must be of value to companies in England and Wales as they consider how to tackle direct procurement contracts.
Many different factors can alter over the 20 year plus life of a large water or waste water asset. Socio economic changes in the geographical area can impact the scale and type of services needed and changes in law can have a dramatic effect on the underlying costs of the third party provider.
Whilst careful attention needs to be taken to setting the specification for any works and services at the outset, it is the inevitability of change that often presents the real challenges over time.
Water companies and third party providers need to consider contract change processes and behaviours from day one. How will the water company, the third party provider and the operator of the works (and funders) collectively work to deliver the best outcomes for customers? What processes and behaviours can be fostered that ensure everyone is incentivised to bring imaginative and customer-centric solutions into reality?
Typical PPP style change mechanisms have improved greatly since these early projects in Scotland were let but challenges remain. As the water sector in England and Wales moves towards the introduction of greater competition, there is an opportunity here to think differently. For example, could the contract allow for some change management “headroom” from day one to allow urgent changes to be implemented via a streamlined process?
Ofwat are rightly concerned to ensure that risks are allocated to the party best placed to manage those risks. Passing down regulatory risk is always a difficult topic. It is often difficult or unrealistic to pass down risks relating to business plan commitments made by the water company. An incident on the wider network may adversely impact the third party provider and lead to a pollution incident, but to what extent can that risk be seen as lying fully with the third party?
Allocating risk backed up with liquidated damages or other forms of compensation can also drive the wrong behaviours – risking a willingness to pay the cost rather than avoid the breach. Again, time and thought will be needed for each particular project team to identify those risks that are realistically third party risks, and those than can only be managed by the water company.
Managing performance can also present challenges as a result of differing cultures. Third party companies may be successful due to very legitimate but different employment policies and terms – this can make driving an efficiency change through an entire water company network problematic.
For example, employees of the water company may be required to work certain hours or shift patterns but employees of the operator may not be on similar terms. Water companies will want to consider the skill sets they need to work actively with third party providers to understand where service improvements and efficiencies can be made over time. This is a task that should be given due prominence as water companies consider the skills needed to manage direct procurement arrangements.
When preparing and signing up any direct procurement contract, disputes and (more importantly) dispute prevention also need to be addressed. Parties often shy away from this topic, thinking it will never happen.
The chances are, however, that it will.
No matter how much time and thought is spent seeking to predict the future, parties signing up contracts (and their lawyers) are fallible. Differences of view regarding contract interpretation will arise and incidents may happen on the network that were wholly unanticipated and that impact the project assets adversely.
Being willing, therefore, to anticipate this in the contract itself and build in the right mechanisms is key. The type of disputes that might arise during construction could need a short sharp adjudication style procedure to resolve, whereas longer term processes may need to focus far more on escalation and mediation, with a view to delivering the best result for customers.
As companies in England and Wales work with Ofwat to deliver the first direct procurement projects, it will be great to see innovation and thought in all of these areas. Contracts needs to provide flexibility and encourage positive behaviours – this can only be delivered by strong collaboration between technical, commercial and legal teams.