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Letters to Regulatory Directors
RD 17/06 27 October 2006 Dear Regulatory Director Review and development of the cost base tool for use in setting price limits in 2009 We have used the cost base at each price review to assess relative efficiency in the delivery of capital programmes. We have reviewed and modified the cost base following each periodic review to improve the accuracy and consistency of our capital expenditure efficiency challenge. It is crucial that we keep our methodologies under review to ensure they continue to provide a fair and robust efficiency challenge. The independent steering group chaired by John Baker also recommended that we review the cost base methodology in their report on the 2004 periodic review. Although the cost base is broadly accepted and understood by the industry, the feedback we received following the 2004 price review (PR04) has provided a valuable starting point for assessing areas for improvement in preparation for the 2009 price review (PR09). The purpose of this letter is to: 1. Set out the issues raised following the PR04 process (annex 1). 2. Outline the main focus of our review. 3. Provide an indication of how and when you will be invited to contribute to this process. 1. Key issues raised following the 2004 price review Since the conception of the cost base many interested parties have reviewed and commented on the approach. Annex 1 contains a summary of the issues and concerns raised following the PR04 process. If you feel there are any significant omissions from this summary please send us your comments. The annex does not include a discussion of each point, but the key themes of our review are outlined below. We will review the detailed points about the technicalities of the approach later in the development process. 2. Key themes for the review and development of the cost base 2.1 Estimating methods In assessing relative efficiency, the cost base approach relies on companies using the same data source to derive both standard project costings and the business plan project costings. It is important that this data reflects actual project costs. We are also considering how to assess the robustness of the capital costing process used by companies in developing their business plans. Therefore a key area of development will focus on our approach to understanding and challenging business plan estimating methods and the quality of cost information used in both business plan and cost base estimates. In developing our approach to this we will be examining:
2.2 Improved consistency for compliance with the standard cost descriptions The cost base aims to identify differences in efficiency through the use of standard costs. It is important for us to understand if other factors contribute to the variance in estimates. We will therefore investigate and attempt to minimise the variance that we can attribute to issues such as:
3. Industry involvement We are grateful to the companies who have already contributed to our review work and helped us to better understand how the cost base submissions are produced. We will continue to meet with companies throughout the development of the cost base. We intend to hold a workshop for all stakeholders in early 2007 to review the progress made with the issues outlined in this letter. We also intend that there will be a further opportunity to comment on our developing thinking and any proposed changes prior to the formal PR09 consultation process. We are also grateful for the work that the industry is doing to improve understanding of some of the issues raised in section 2.2 above. We propose to convene a working group to expand on the work that has already been completed and to facilitate technical dialogue and identify priorities for further work. We do not expect this to require representation from all companies. We will keep all companies informed throughout the development process. Please confirm email contact details for future communication on this work, and indicate if you want to contribute to the working group, by email to Kay Webb (kay.webb@ofwat.gsi.gov.uk) by 20th November 2006. Please contact Kay Webb on 0121 625 1370, or myself on 0121 625 1454 if you wish to discuss these issues. Yours sincerely GEORGE DAY Head of Capital Maintenance  |
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