Capital spending during AMP5 2010-15 in England and Wales has focused on networks, capital maintenance and small projects to improve operational expenditure and energy efficiency, with a relative lack of major projects and new builds. Between 2010 and 2015, Thames Water had by far the biggest capital spending programme, with an allowance of £4.9 billion, up by 59% compared to the previous five-year period. This largely reflects major capital investment programmes in London to reduce sewage overflow as part of the London Tideway Improvements Programme, including the construction of the £635 million Lee Tunnel.

Figure 1: UK capital expenditure on water and sewerage services, 2009/102013/14

Source: Ofwat, individual company annual reports and MBD estimates

For AMP6 2015-20 Ofwat has introduced a move towards total expenditure (totex), combining capital and operational expenditure. Ofwat believes this will remove a bias toward capital programmes, as capital expenditure has often been preferred over operational expenditure in delivery solutions due to the design of the regulatory framework. The move towards totex should encourage companies to deliver solutions as efficiently as possible.

Total capital expenditure by water and sewerage companies is projected to reach £23.4 billion over AMP6, equivalent to 58% of the totex allowance. Annual capital expenditure is expected to peak in the middle of the five-year spending cycle at almost £5 billion in 2017/18. Spending is then expected to fall in the following two years to £4.2 billion in 2019/20, a decline of 14% compared with 2017/18.

Thames Water is set to continue to have the largest capital investment programme, with anticipated capex of £4.6 billion during AMP6, equivalent to 20% of the industry total. In January 2015, Thames Water officially signed up two alliances that will deliver a large proportion of its AMP6 work, representing the biggest contracts in water industry history.

Gross capital expenditure by the UK’s electricity distribution network operators (DNOs) increased by a strong 14% in 2011/12, followed by further growth of 7% in 2012/13 and 11% in 2013/14. In the latter year, capital spending reached £3.4 billion. This is in contrast to relatively flat spending levels in previous years, with gross capital expenditure oscillating around £2.5 billion between 2008/09 and 2010/11. The recent upturn was principally driven by increased expenditure on replacing failing and ageing distribution network assets.

During the current price control period RIIO-ED1, which runs from April 2015 to March 2023, network investment by DNOs in Great Britain is expected to be dominated by non-load related capital expenditure due to the country’s ageing asset base. Network investment is anticipated to steadily decline over RIIO-ED1, reducing by a cumulative 15% in real terms between 2015/16 and 2022/23. This is believed to reflect a move away from traditional network asset investment to more flexible solutions offered by smart grid technologies and improved cost efficiencies.

In addition to asset replacement and network reinforcement, DNOs are expected to concentrate on the development of smart grids and new technologies to facilitate the transition to a low-carbon economy. The growth in low-carbon technologies, such as heat pumps, solar photovoltaic for electricity generation and electric vehicles, will also require increased network investment. DNOs have to enable cost effective connection of these low carbon solutions and provide sufficient capacity in the network to accommodate increased loads.

Figure 2: Forecast network investment of the electricity distribution network operators in Great Britain, 2015/16-2022/23

Source: MBD analysis of individual company revised business plans

Total capital expenditure by electricity transmission network operators increased in each year between 2009/10 and 2012/13, culminating in strong growth of 66%. In 2013/14, capital expenditure fell by a moderate 1% to £1,969 million, reflecting a shift towards total expenditure during the current price control period RIIO-T1 2013-21, which is set to reduce the bias towards capital spending. The vast majority of capital investment is accounted for by National Grid Electricity Transmission (NGET). In 2013/14, the operator was responsible for 67% of industry capex, although this is down from 85% in 2009/10.

Over the next two decades, capital expenditure on the electricity transmission network will be driven by the construction of new power stations, network upgrades, and the change in the energy mix and location of centres of supply and demand. The future change in the energy supply largely reflects the phasing out of coal-fired power plants, strong growth in renewables generation and plans for new nuclear and gas-fired power stations.

Total capital expenditure on transmission and distribution in the gas industry has fallen during most years since 2009/10, except for a 4% increase in 2012/13. However, this was more than offset by a considerable 26% decline in 2013/14, as most network operators reported lower capital spending during the first year of the new price controls, RIIO-GD1 and RIIO-T1.

Gas transmission capital expenditure is volatile and since 2009/10 growth in one year has been followed by reduced expenditure in the next. In 2012/13, investment was increased by 6%, although this was more than offset by a significant 27% decline in 2013/14 to £181 million. During the five-year review period, gas transmission capital expenditure peaked at £289 million in 2010/11.

Total capital expenditure in the gas distribution industry has tended to follow a more even development than the transmission sector. Between 2009/10 and 2012/13, spending levels fluctuated at moderate levels, declining by 5% overall. However, this was followed by a strong 25% reduction in 2013/14, taking capital expenditure to £738.8 million. The decline in the latter year largely reflects the start of the new eight-year price control period RIIO-GD1, with network operators focussing on planning, preparation and innovation during 2013/14.

Figure 4: Total gas transmission and distribution capital expenditure, 2009/10-2013/14

Source: MBD analysis of individual company data

All sectors of the utility industry are highly regulated. Ofwat is responsible for regulating the water and sewerage industry in England and Wales, while Ofgem regulates gas and electricity transmission and distribution network operators. The majority of companies operate as monopolies, meaning that consumers have no choice of provider. The priority of regulatory bodies is therefore to protect customers’ interests through the promotion of effectively functioning markets and networks. The industry bodies set limits on the revenue companies can recover from customers and the levels of investment for the forthcoming period, which ranges from five to eight years depending on the sector. This is done through the price control review process.

The regulatory bodies recently introduced a number of changes to the regulatory framework and price review process that will affect the approach to infrastructure investment in the utility industry.

Ofwat has introduced a move towards total expenditure (totex), combining capital and operational expenditure, for the next price control period 2015-2020. Ofwat believes this will remove a bias towards capital programmes, as capital expenditure has often been preferred over operational expenditure in delivery solutions due to the design of the regulatory framework. The move towards totex should encourage companies to deliver solutions as efficiently as possible.

Ofgem has also introduced a new framework for the gas and electricity sectors, known as RIIO. This framework will ensure that the revenue network operators earn is strongly linked to incentives, innovation and outputs. In other words, Ofgem will seek to reward behaviours that customers want, support the use of innovation to consider how networks meet the challenges of tomorrow, and require companies to commit to outputs they will deliver.

The changes in the regulatory frameworks across the utility sectors mean that companies are taking a more long-term approach to infrastructure investment decisions, with an increased focus on active asset management over traditional network investment. There will also be greater focus on innovation and new technologies that facilitate the efficient operation of the infrastructure network and provide operational cost savings.

Government and EU policy have a significant impact on the utility industry and investment levels, with different legislative measures affecting various sectors. As such, EU directives have been the key driver for infrastructure investment in the water and sewerage industry over the past two decades. However, many major projects driven by legislative requirements in the water and sewerage industry have been completed, and there is now increased emphasis on asset and infrastructure maintenance rather than new infrastructure investment.

The energy transportation sectors are predominately affected by legislative measures concerning energy policy and the de-carbonisation of the UK economy. Policy changes can affect the amount and location of investment required in the networks and the way companies operate. Key policies affecting the energy network sectors include the Electricity Market Review (EMR), the Renewables Obligation, and the decarbonisation of the UK economy, as outlined in the 2011 Carbon Plan.

The supply base remains surprisingly concentrated given the size of the market. This is due to the capital investment required and the need for demonstrable experience and expertise, which are prerequisites for market entry. However, the range of equipment supplied is clearly vast and many companies are operating in specific market niches. There are relatively few suppliers who operate across a wide range of sectors (other than water and sewerage, gas and electricity) and the contracting supply base remains concentrated. Indeed, many are major international suppliers of plants, with the UK enjoying a strong reputation for supply, not least due to advanced privatisation in the utilities sector compared to other countries in Europe and further afield.

Individual contracts are often extremely high value and their importance to utility companies tends to place suppliers in a relatively strong bargaining position, although spending levels are highly affected by regulator requirements. There is a general trend across all utility sectors to adopt a more collaborative approach and closer relationships with the supply chain, with companies increasingly opting for long-term alliances and framework agreements.

The wide range of sectors involved means that suppliers include equipment manufacturers, process plant contractors, civil engineers and building companies, among others.

The importance of investments to the customer tend to encourage a high degree of concern over project risk. This favours large companies, who are able to cope with the cash flows of large project. They also have an existing reputation in the market, which is important as specifiers seek to reduce the risk of using unknown or inexperienced suppliers.

The business environment across the utility sectors is in transition, with the industry challenged by a changing regulatory environment, climate change, security of supply and uncertainties regarding future network requirements. These factors also influence the industry’s approach to capital expenditure.

Undoubtedly, infrastructure investment will continue to be a key focus across the utility sectors, largely driven by the need to replace old assets and by new capacity requirements on networks. However, the approach to investment across the sectors is now shifting due to changes in the regulatory environment, including increased pressure to reduce costs for consumers while ensuring security of supply. There is an increased focus on innovation and long-term outcomes in infrastructure management and investment, replacing the short-term outputs and capital expenditure preferred in the past. The scope for traditional infrastructure investment may be limited, but there will be more opportunities for companies that can provide innovative solutions for efficient network and asset management.

Water & Sewerage - With major capital projects driven by legislative requirements now completed, the industry is shifting its focus towards operating, maintaining and managing these assets and ensuring that inefficiencies are minimised during such activities.

Electricity Distribution - the focus is set to move away from traditional network asset investment to more flexible solutions offered by smart grid technologies and improved cost efficiencies. There will be an increased focus on innovation across the industry to accelerate the roll-out of smart grid technologies.

Electricity Transmission - Capital expenditure will be driven by a number of factors, including: new power stations being built, required network upgrades, the change in energy mix and location of centres of electricity supply and demand. However, there are significant uncertainties regarding future requirements on the transmission system, especially with respect to the quantity, type and location of connected generation and the extent and location of new interconnections to other systems.

Gas Transmission & Distribution - System operators in the gas transmission and distribution sector continue to focus investment on the Iron Mains Replacement Programme. This requires companies to replace old metal mains within 30 metres of a property over 30 years.