Notice of Ofwat s proposal to impose a penalty on Thames ...

Notice of Ofwat s proposal to impose a financial penalty on Thames Water Utilities Limited 2 1. Introduction The Water Services Regulation Authority ( Ofwat ) is notifying Thames Water.

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June
2018
Notice of Ofwat’s proposal to impose a penalty on
Thames Water Utilities Limited
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

Contents
Introduction
Thames Water’s leakage reduction performance in AMP6
Findings
Financial penalty
Ofwat’s reasons for considering it appropriate to impose penalties
and the
proposed broad levels
How to make representations or objections
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

1.
Introduction
The Water Services Regulation Authority (“
Ofwat
”) is notifying Thames Water
Utilities Limited (“
Thames Water
”) by this document that it proposes to impose
nominal
penalt
upon it under section 22A paragraphs (1) and (2) of the Water
Industry Act 1991 (
WIA91
) for infringing the following provisions
in relation to
its leakage reduction performance within the c
urrent price control period
(2015
20)
and its management of its leakage reduction operations
Section 37 WIA91, in relation to the economic and efficient maintenance,
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

2.
Thames Water’s
leakage
reduction
performance in
AMP6
Importance of leakage management
It is widely recognised that pressures from population growth and climate
change will reduce the per capita availability of water in
England
generally, and
in critical areas, such as the South East of England, in particular. Population
growth is forecast to increase disproportionately in the South East of England,
where there
are
expected to be drought events of increasing frequency,
duration
and severity
Greater understanding of the environmental impact of
excessive water
abstraction
has
also
emphasised the need for
improved
water
efficiency.
Within this context, efficient
leakage management
is an
important means by
which water companies ens
ure continued security of supply efficiently and
economically.
ustomers have repeatedly confirmed that they place a high
value on leakage reduction
Thames Water’s p
erformance
commi
tm
ents
for AMP6
We asked a
ll water companies in England and Wales
to devel
op business
plans for the current price control period
PR14
Under PR14’s Outcome Delivery Incentive
ODI
mechanism, if a company
exceeds the delivery of its agreed performance commitments, it is rewarded; if
it misses them, it is penalised. These ODIs ha
maximum rewards and
penalties

The long
term potential for deep reduction in household water demand
report
by Artesia
Consulting for Ofwat
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

for PR14
that where performance fell below the level of the penalty collar we
would consider enforcement action
see appendix 5
Each water company publishes
an An
nual Performance Report
APR
as part
of its regulatory reporting requirements
. This includes information about:
hil
we required
companies
to include performance commitments for l
eakage
management
in their 2015
2020 business plans
based on comparable metrics
Leakage
, it was their responsibility to
propose
the levels of those
commitments
and any associated
caps and collars for
penalties and rewards, in
accordance with their stat
utory and licence obligations and
in consultation with
their
customers
For its water service,
we determined
the following
performance commitments
and collars
for Thames Water
for
management of
leakage and
security of
supply risk by reference to a
Securit
y of Supply Index (“
”).
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

Table 1
PR14 Performance Commitments
Performance
Commitment
-
1
6

-
17

-
1
8

-
19

-
20

Leakage (Megalitres
per day (Ml/d))

Leakage collar
SoSI (unit)

SoSI collar
Thames Water’s performance against its AMP6
performance
commitments
Thames
Water
19 April
2017
Thames Water
told
Ofwat
Following
this
June 2017
Thames Water
published its
Annual Report
This
included
its
risk and co
mpliance statement
, which w
e expect
all
compan
ies
to produce yearly
which
should
set out how they have complied with their
relevant statutory, licence and regulatory obligations
Thames Water reported it
had missed its leakage performance commitment in
its Annual Report.
n the same day, we announced that we had opened an investigation into
Thames Water to

SI
ndicates the extent to which a company is able to guarantee provision of its levels of service
for restrictions of supply. The maximum is 100 and indicates the company could deliver its level of
service in a
design
rought. If the score is less than 100 it would need to introduce restrictions, such
as hosepipe bans, sooner in a drought than it should.
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

Water
would incur under the ODI mechanism
Later,
in June 2017
Thames
Water
issued its certificate of adequacy under its licence cond
ition F for 2017
18.
On 9 June 2017
Thames Water
sent
us its leakage recovery plan
in which it
forecast that its leakage
reduction
performance would remain below the penalty
collar for
2017
18 and 2018
-
1
6

-
17

-
1
8

-
19

-
20

Leakage performance
commitment
(Megalitres per day
(Ml/d))

Leakage performance
commitment collar
Leakage recovery plan
forecasts

SoSI performance
commitment
SoSI
performance
commitment collar

SI forecasts
Thames Water has continued to update its forecasts since June
2017
to reflect
the delivery of its leakage recovery plan. In May 2018 it forecast that its leakage
performance would be 695Ml/
for 2017
18, 672Ml/
for 2018
19 and 606Ml/
for 2019
20. It forecasts its SoSI performance will be 97 for 2017
and 100
for 2018
19 and 2019
Reasons for Thames Water’s
under performance on
leakage
From the evidence we have obtained
Thames Water
’s
underperformance on
leakage
reduction
result
from
how it
designed,
implemented and managed
its
contracting arrangements for the delivery of its
leakage
activities
through
its
nfrastructure
lliance
the Alliance
ames Water
chose to
move to an innovative alliance model for the
outsourc
ing
of
its leakage reduction and management activities for
the
AMP
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

period (2015
. The Alliance
compris
a number of third party contractors
(most of whom Thames Water had worked with under different contractual
arrangements during the 2010
15 period)
Alliance models have been
successful elsewhere in deliveri
ng efficient and innovative approaches to
akage management.
Under the model it adopted, Thames Water devolved operational decisions to
its Alliance partners. It based the performance incentives in its contract
on
its
PR14 ODIs. Under PR14, ODIs are
underpinned by Ofwat’s ability to take
enforcement action in the event of performance below the penalty collar. By
contrast, under the model it adopted, Thames
Water
did not hold the Alliance
partners to minimum standards of performance but instead relied
primarily on
the contract’s financial incentives to drive performance.
This was
an innovative
structure, but
Thames
Water
only allowed a three
month transition period f
or
testing
the arrangement with its
lliance
partners
, before moving to full
implementat
ion in April 2015
At that point
Thames Water
stepped back from
We have looked into other company supplier arrangements, some of whom
refer to their suppliers as framework partners and some operate as alliances.
We understand
from
ther companies
that it
has taken
several years to
establish ali
In practice,
the break clause
in itself
did not
provide Thames Water with
sufficient control over the Alliance partners’ perform
ance.
Thames Water
states
that
the financial incentives drove perverse
results
and the Alliance
under
performed badly, both
operationally and financially
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

Thames Water’s poor performance
was
further
affected by
Poor management of
the
transition from three main leakage contractors to
two,
which resulted in t
loss of
an important and
experie
nced leakage
From our review of t
he evidence
we identified
deficiencies i
Thames Water’s
oversight and upward reporting of the
lliance’s operational performance.
Board reporting
on the
Alliance
during
2016
largely focussed on financial
performance,
rather than operational matters,
and lacked detail and
consistency on operatio
nal matters
or appropriate read across to any
implications for Thames Water’s general duty under section 37 WIA91
. As a

Source: Thames Water section 203 response to Ofwat (12 February 2018)
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

result,
there was
insufficient
By the middle of 2015, Thames Water was sufficiently concerned about its
Leakage
reduction
Thames Water’s
poor
leakage
performance
mean
that its customers are
exposed to a higher risk of
water
supply restrictions than the level of services
that
their
bills pay for.
On 11 July 2017 Thames Water reported to Ofwat that its
would
be 96 in 2017
18, a
lower
figure
than Thames Water
had
con
sidered
likely
in any
likely
circumstance when it submitted its business plan
for PR14
In
missing
its
leakage and SoSI
performance commitments, Thames Water
still
incurred expenses
, particularly due
to work that did not achieve leakage
benefit
, for exam
ple,
digging
dry holes, trial holes, non
leakage jobs and a
number of re
visits and aborted jobs.

Thames Water brought
forward capital spend
originally planned for later years in AMP6, principally
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

Any removal of water
(abstraction)
from the natural environment will have an
impact on that environment. Water abstraction during low flows can be
particula
In
April
201
7, Thames Water
initially
approached us
to inform us that it had
missed its performance commitment on leakage
and was seeking to address
the root causes of its poor leakage performance. We subsequently learned that
it ha
taken the following steps
From
December 2016
it appointed a
number of key roles, including a
new Managing Director of Wholesale Water and a Head of
Water
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

Thames
Water also continued to develop its leakage recovery plan during
2017.
The leakage management plan it had in place from
March 2017
assumed
average
winter
(a P50 plan)
Thames Water revised
its plan in November
2017 to deliver on the assumption of one colder than average year in
five
(a
P80 plan).
Its Board
committed
to spend an additional
£65
illion
in April 2017
and a further £74
illion
in Novemb
er 2017 to increase
Thames Water’s
Thames Water has also told us that
its
Thames Water has been in discussion with Ofwat since
May
2017 on the steps
it is taking to address its poor
performance
in relation to its management of
leakage
After having provided a range
of information to
inform our investigation,
19
March 2018
Thames Water approached Ofwat to begin discussions on
package of
proposals
to address its underperformance
, including measures to
ensure that customers would not
bear the costs of
its poor performance
on
leakage
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

3.
indings
Section 37 WIA91
Section 37 WIA91
imposes a general duty on water undertakers
“to develop
and maintain an efficient and economical system of water supply within its area
and to ensure that all such arrangements have been made
(a) for providing supplies of water to premise
s in that area and for making
such supplies available to persons who demand them; and
(b) for maintaining, improving and extending the water undertaker's water
mains and other pipes,
as are necessary for securing that the undertaker is and continues to be
able
We find that Thames Water has failed to maintain an efficient and economical
system of water supply within its area in relation to its management of leakag
during AMP6
As described at
paragraph
2.16
above, the
lliance
structure
and contractual arrangements
incentivised inefficient leakage management
which Thames Water
did not
materially address until two years of poor
performance had
elapsed and it had fa
llen
significantly
below the ODI collar
see
able 2
In doing so
it has
spent customers’ (and its shareholders’)
money
inefficiently
and added additional,
unnecessary stress
to its
ability to
continue to
secure water supply to its c
ustomers
as described in section 2
Thames Water estimates
that
it has spent and will spend
£92
million
in AMP6
more
on leakage management and water treatment
than it would have done
absent the
leakage
reduction
performance and
management
issues described
in section 2
We also find that
from
1 April 2015
to date
, Thames Water
failed to ensure
that it had in place all necessary arrangements for continuing to secure its
obligations under Part III WIA91.
As described in paragraphs
to 2.
Thames
Water implemented a
structure which was novel to it without an appropriate transition strategy, and
without adequate arrangements for oversight of its operations, particularly at
Board level. These factors contributed significantly to Thames Water only
int
Notice of Ofwat’s proposal to impose a financial penalty on
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time to begin to reverse its performance.
Thames Water does not anticipate
In the summer of 2016
Thames Water
reduced
resources
for
leakage
management which could have ameliorated its leakage position, without
countervailing mitigations, when its leakage
reduction
performance continued to
Condition
paragraph 6A.1
Condition 6A.1 of
Condition F of
Thames Water’s licence requires it to “at all
times act in the manner best calculated to ensure that it has adequate:
financial resources and facilities;
management resources; and
systems of planning and
internal control
to enable it to secure the carrying out of the Regulated Activities...”
find
that Thames Water
failed to
ensure it had
adequate management
While Thames Water has pointed out that no innovation is
wholly without risk, in this case the reasons for its
underperformance
were
within its control and as discussed above stemmed from
issues in the design,
implementation, management and oversight of its Alliance arrangement,
alongside the problems associated with its abortive efficiency rationalisations
The consequences of
this
are
discussed at
to 2.25
above
Thames Water
did not
adequately plan for and manage implementation of the
lliance
did not
adequately assess
and address
the risks associated with its
incentive structure for the
Alliance
and
the loss of one of its most experienced
leakage contractors as a result of the n
ew contracting arrangements
did not
mitigate those and other transition risks with an adequately planned and
executed transition strategy.
This is despite the fact that Thames Water has
acknowledged that the
lliance was an innovative step for the orga
nisation. We
summarise
the consequences
of these
shortcomings
at 2.
to 2.25
above.
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

s it was originally conceived,
the Alliance structure did not provide
Thames
Water
with
adequate systems of control over
leakage management.
Relying on
incentives in the contractual framework to drive performance, it relinquished too
much direct control of its operations.
It handed responsibility for o
perational
performance management
of a key component of its operational resilience of
critical
importance to its customers
to its contractors
without adequate
safeguards
. It did not reserve
for itself an adequate p
urchaser function
and
did
not
monitor and enforce minimum performance standards.
Thames Water
acknowledge
s that there were f
laws in
accountability
systems
“For the Alliance model to be effective, systems had to be in place to enable
Alliance
members (including Thames Water) to hold one another to account.
This did not happen in all areas, for example:
Alliance partners did not understand sufficiently their roles and the way
the contract worked;
There was limited and inconsistent reporting from
the Alliance members
to the Alliance Board, or from the Alliance Board to Thames Water
Executive; and
There was an insufficient level of governance and change control, which
meant decisions to improve leakage were either not taken or not acted
upon quickl
y enough when the new model did not deliver to plan.”
Thames Water’s poor planning and management was also largely to blame for
the
difficulties Thames Water encountered when introducing
OneDesk initiative
The decision to
reduce the number of
work
gangs
at a time when leakage
Finally,
we are very concerned to have found evidence of
Thames Water
devoting
sufficient man
agement resources to, and imposin
adequate
systems of control over, leakage
reduction
performance at a Board level.
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Thames Water Utilities Limited

Important issues highlighted in the
Alliance’s
Leakage Exec Packs
were not
included in contemporaneous leakage performance reports to Thames Water’s
Board
The
Alliance
’s
Leakage Exec Pack reported as early as April 2016 that
unless the
lliance’s
ind and
ix activity improved it
would
on track to
By
September 2016, the Alliance’s Exec Pack states that
“confidence in achieving the
The risk of failing leakage was reported as ‘almost certain’ and the impa
ct to
the business reported as ‘major’.
This position was not reflected in those terms in the September report to
Thames Water’s Board. The September 2016 Group Management Report to
Thames
Water’s
Board gave a RAG rating of red for current leakage
performa
nce
. It also showed how current leakage performance compared to
In October 2016 the Alliance’s board minutes report
The Wholesale Water Ri
sk Register for October 2016 also reported this level of
confidence.
The Group Management Report for October 2016 to Thames Water’s Board
continued, however, to give a red RAG rating to the
then current
and year to
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

date leakage levels, but
RAG rating
amber rather than red
for the full year’s
performance against its commitment
. As with
the September report, it reported
activities being taken to address the Leakage Event, but
did
not give an
assessment of their likely adequacy to enable the Performance Commitment to
We are particularly concer
ned, however, that
Thames Water’s
Board did not
challenge the reporting on operational matters or impose greater scrutiny or
control over the
lliance
, particularly given the activities it is contracted to
deliver are so fundamental to Thames Water’s statu
tory obligations
We have reviewed both the
relevant
extracts of
reports provided to Thames
Water’s Board regarding its leakage
reduction
performance, and the minutes
Given how important good leakage management is to ensuring an efficient and
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

we have previously investigated Thames
Water
other water companies
for poor leakage
reduction
performance and we made clear in PR14 that we
would consider enforcement action if performance fell below
the penalty collar
Thames Water’s Board’s underestimation of its statutory obligations in relation
to leakage is further evident in its approach to its reporting obligations under
paragraphs 6A.2A and 6A.2B of Condition F of its licence.
aragraph 6A.2A requires
Thames Water
to provide a certificate of adequacy
at the same time that it submits its annual regulatory account
to us. This is
separate regulatory document to the APR
. Under this, it is required to certify
“(1) that in the opin
ion of the Directors, the Appointee will have available to it
sufficient financial resources and facilities to enable it to carry out, for at least
the next 12 months, the Regulated Activities (including the investment
programme necessary to fulfil the App
ointee's obligations under the
Appointment(s));
(2) that in the opinion of the Directors the Appointee will, for at least the next
12 months, have available to it:
(a) management resources; and
(b) systems of planning and internal control
which are suf
ficient to enable it to carry out those functions as required by
sub
paragraph 6A.1 above; and
(3) that in the opinion of the Directors, all contracts entered into with any
Associated Company include all necessary provisions and requirements
concerning th
e standard of service to be supplied to the Appointee, to ensure

In 2006, we investigated Thames Water for
missing
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Thames Water Utilities Limited

Further
paragraph 6A.2B, sub
paragraph (2) states that:
“(2) Without prejudice to sub
paragraph 6A.3 below,
the Directors shall inform
the Water Services Regulation Authority in writing as soon as they become
aware of any circumstance which causes them to believe that the most recent
certificate under sub
paragraph 6A.2A could not be repeated in the light of
at circumstance.”
Thames Water
’s Board
provided
Ofwat with
a certificate of adequacy in June
2016 despite the fact that
it was already becoming apparent to the
lliance that
there were major, unresolved leakage
reduction
performance issues that risked
it m
issing
its
performance commitment
. It acknowledged internally at Board
Thames Water also provided a certificate of adequacy in June 2017 at a time
when it was still undertaking its root cause analysis for its leakage
underperformance
and before it had
implemented the changes that it has told
us are necessary to bring its performance back in line with its minimum
commitments.
It noted in its certificate “additional consideration has been given
However,
t this point Thames Water’s
recovery
plan
only envisaged it first
Both the certificate and the notice only place obligations on companies to the
extent
of their awareness and opinion
. However, we are concerned that
Thames Water’s Board
did not think that the issues it was facing warranted a
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

different certificate or a not
ification under paragraph 6A.2A(2), at least on a
precautionary basis
.
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

4.
Financial penalty
Under section 22A(1)(a) WIA91 Ofwat may impose on an undertaker a penalty
of such amount (not exceeding 10% of the
regulated
company's turnover
in a
relevant year
) as is reasonable in all the circumstances of the case where it is
satisfied that the undertaker has contravened or is contravening any Condition
of its
Licence
Section 22A(9) WIA91 provides that penalties imposed under section 22A
WIA91 are paid into t
he Consolidated Fund
Period for which a penalty may be imposed
Pursuant to section 22
B(2) WIA91,
Ofwat must have regard to
its most recently
published
statement of policy
with respect to penalties (
Statement of Policy
when
Ofwat may not impose a
penalty
nder section 22A
greater than
10% of the
applicable turnover of the company
. The applicable turnover of the company is
its turnover for
its regulated activities
for the year preceding the year of the
penalty notice
ames Water’s last bus
iness year ran from 1 April 2017 to 31 March 2018
Thames Water’s applicable turnover derived from its activities as a water
undertaker
(it
wholesale water business)
in the
business year
was
£819.7 million
Accordingly, the maximum penalty for Thames Water’s

Based on 2016
17 wh
olesale revenue. To be updated once 2017
18 regulatory accounts are
produced.
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

contravention in this case is
10% of this number, i.
e.
£81.97
million
Section
Section 22A(13) WI
A91
provide
that “before making an enforcement order or
confirming a provisional enforcement order, the Authority (Ofwat) shall consider

See above.
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

5.
Ofwat’s reasons for considerin
g it appropriate to
impose penalt
ies
and the proposed broad level
Under section 22A(4) WIA91,
must specify the “other facts” which
we
consider justify imposing a penalty
for a relevant contravention
, and
of
the
amount proposed.
We are
satisfied that Th
ames Water has con
travened section 37 WIA91 and
Paragraph 6A.1 of Condition F of its Licence in
relation to its leakage reduction
performance and its management of its leakage reduction operations during the
2015
The seriousness and duration of the contraventions
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Thames Water Utilities Limited

This is the worst annual
failure of
SoSI by a company since 2011
12.
With one
exception within a planned scheme
o company has had a SOSI below 98
since 2008
09, the year in which the worst performance was by Thames Wate
with a SOSI of 56.
The projected leakage
under
performance
is the largest both
in absolute size or normalised by property or length of mains since Thames
Water’s failure in 2003
If the contravention or failure has damaged
the interests of customers, the
degree of harm caused and also any increased costs incurred by customers
As
well as damaging security of supply,
Thames Water’s poor performance is likely
to have affected consumers in other ways. At a practical level, re
sidents in
Thames Water’s area have experienced unnecessary nuisance and disruption
Thames Water has told us that it will spend much more on leakage in AMP6
than it would have done had it not had shortcomings in its leak
age
management. Thames Water paid the Alliance for inefficient work before it
started to address the root cause of its performance issues. It now has to bear
the additional cost of reducing a higher level of leakage faster than it would
have done had it ma
naged leakage efficiently. And it has also had to process
more water than otherwise to replace the water lost through leakage beyond an
acceptable level.
Thames Water acknowledges that it has spent money inefficiently on leakage
during AMP6. It has estima
ted the efficient cost of a unit of leakage reduction
from its revised plans for 2018
19 and from this estimated the efficient cost of
leakage reduction over the period. Using this approach Thames Water
estimates that, by the end of AMP6 it Water will have
incurred c£88 million
more on leakage management than if it had operated efficiently. This estimate

The company that delivered this performance was acting in line with its 2009 water resource
management plan that was to deliver a SOSI below 100 in 2010 to 2014. T
his was because the
company had a reduction to the amount of water it could report could be taken from the environment
in 2007
08 that had a significant impact on its SOSI
Notice of Ofwat’s proposal to impose a financial penalty on
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is associated with inefficient delivery in the three years up to April 2018 as
Thames Water expects to be managing leakage efficiently in the final two yea
rs
of AMP6. In addition, Thames Water has estimates that by the end of AMP6 it
will have spent c£4 million more on processing water than it would have done
had its leakage performance been within its ODI performance commitments.
Under its PR14 settlement T
hames Water would be allowed to recover roughly
50% of this excess expenditure from its customers through higher prices in
AMP7, with the remaining additional costs borne by Thames Water’s
shareholders. On Thames Water’s estimates, customers would ultimate
ly bear
an additional £46 million of inefficient expenditure because of Thames Water’s
poor management of its leakage reduction, as well as bearing the additional
risk to their water supply and inconvenience of Thames Water’s inefficient
If the application of a
penalty
would be
likely to create an incentive to comply
and deter future contraventi
ons or failures
The incentives in the leakage ODI
ny gains
made by the undertaker
(financial or otherwise) from the
contraventi
ons
Thames Water did not make any gains from the contraventions

Any damage to other market participants:
Thames Water
did not cause damage
to other m
Any damage caused to the environment
Excessive leakage leads to more
water abstraction than necessary, putting greater pressure on water levels and
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

the environment more generally. Thames Water’s area is particularly dry:
all of
the ex
ceptionally low flows that the Environment Agency recorded
n 2017
were at flow indicator sites in east and south
east England. We are concerned
that Thames Water’s poor leakage management may have added unnecessary
stress to an already vulnerable environ
mental situation.
Whether the contraventions or failure was or is of a trivial nature
We have
outlined at paragraphs 5.3 and 5.4 the serious nature of these contraventions
and their duration
Whether the contravention or possibility of a contravention would have been
apparent to a diligent undertaker
: As we find in section 3, Thames Water’s poor
performance results from the shortcomings in Thames Water’s operational
planning, management and ope
rational oversight of its leakage performance.
Innovation invariably carries risk. What is striking about Thames Water’s case
is that it did not build in basic mitigations such as a lengthy test phase before
the Alliance’s full implementation or
In PR14 Final Determinations we clearly signaled the possibility of Ofwat taking
enfo
rcement action where a water company’s performance goes below its
agreed ODI collar. We have also previously taken enforcement action against
Thames Water and other water companies for not adequately managing
leakage.
We
are not aware
of any precedent decisions by other regulators in respect of provisions directly
equivalent to
sections 37 WIA91 and Condition F.
The Office of Rail and Road
ORR
Notwithstanding
5.10
and 5.
e consider the reasons
mentioned
above
justify the imposition of penalties.

10
https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/666527/Water_situati
on_report_November_2017.pdf
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

Broad level of the penalty
Sect
ion 22A(10) limits a financial penalty imposed by Ofwat to a maximum of
10% of the
relevant
turnover of the
regulated
company. For these purposes
Ofwat considers relevant turnover to be that related to the
provision of
wholesale water
Having regard to ea
ch of the relevant facts and matters and to all
of the
factors
statement of policy
, Ofwat judges that the level of
the
penalty
shou
ld be
calculated by reference to a starting point
of
the relevant
turnover
based on 2016
17 wholesale water revenue and
assuming customers
are adequately recompensed
. This represents the broad level of the penalty
and would equate to c
24.6
million
This starting point is consistent with
a serious and prolonged failure
to
adequately deliver a core operational function
for a water undertaker
. It is
slightly lower than the penalties imposed on Southern Water (3.5%) and Severn
Trent (3.1%) for deliberate
misreporting to take account of the fact that the
breaches were not deliberate. It is
however
higher than the broad level for
previous fine against Thames Water for misreporting
(0.7%)
, in recognition of
the
additional harm to consumers and the environmen
t and the failures at
Board level
We have found that Thames Water has contravened both section 37 WIA91
and Condition F of its licence
in relation to its management of leakage
However, given the similarity of the findings for each,
in this case
we are
inded only to issue a single penalty.
These may include, but would no
t necessarily be
limited to:
repeated contraventions or failures;
the continuation of a contravention or failure;
any involvement of senior management;
the level of cooperation with any investigation carried out
any attempts to conceal the contravention or
failure;
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

the proactive reporting of the contravention or failure to the enforcement
authority;
taking appropriate action to acknowledge and rectify the contravention or
failure; and
activities to provide restitution and compensation.
Aggravating
factors
Repeated contraventions or failures
Thames Water
n 2006 Ofwat took action as Thames
Water
had
issed
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

“The…368km of additional mains replacement has been fully delivered at the
company’s own cost”
Thames Water has also had other
delivery issues
that resulted from
failures in
its
systems of planning and internal control
In
April 2008 Ofwat imposed financial penalties
on Thames Water for
not
providing guaranteed
service standard (GSS) payments
to customers and
misreporting informat
ion for the period up to March 2006. As part of this Ofwat
noted
“The evidence shows that the systems and processes which Thames
Water had in place to identify GSS events and monitor performance against
those standards were inadequate and as a result Thame
s Water
did not
meet
its
obligations under the GSS Regulations.
Any involvement of senior management
Senior management
at Thames Water
had information to understand the
seri
ous risk of
missing
its leakage performance commitments and falling
It is not clear how senior management concluded that the risk could be averted
beyond September 2016 without a clea
r step change in performance.
From
September 2016
senior
anagement took no action
that
could be realistically
expected to deliver such a step change within the 2016
17 year
t was
evident to senior management from June 2015 that Thames Water was
not find
ing and fixing sufficient leaks
By
acknowledging
the seriousness of the situation or
take adequate, timely
action
Thames
Water
did no

11
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

security of supply
performance commitments
to customers for at least two
years.
Any attempts to conceal the contravention or failure
By September 2016 there was a very high risk that Thames Water would
miss
its 2016
17 leakage
perfor
mance commitment
. This risk steadily increased
, but
was not adequately reported to
Board
until January 2017.
Thames Water
did
clearly inform Ofwat until
April
2017,
three
months after it had accepted
internally it would
miss
its leakage
performance
commitment
We discuss at
section
the fact that throughout this period, Thames Water’s Board ha
certified the adequacy of its operations under Condition F paragraph 6A.2 and
not provided any notice to Ofwat of issues arising in relation to systems
nd governance adequacy under paragraph 6A.2B
While there is no evidence of Thames Water deliberately making efforts to
conceal the failure,
it was, until recently, less open
than we would expect a
public utility
to be
Mitigating factors
The level of
operation with any investigation carried out
Thames Water has complied in full with
Ofwat’s
investigation providing a full
response to Ofwat’s requests for information within the times specified.
The proactive reporting of the contravention or failure t
o the enforcement
authority
Thames Water proactively reported
that it has significantly missed its
leakage
and security of supply
performance commitments
to Ofwat, but not until May
2017, four months after it had accepted internally it would
miss them
While there is no evidence of Thames Water deliberately making efforts to
conceal the failure, the openness of the company was
, until recently,
less
open
than we would expect a public utility
to be
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

Activities to provide restitution and compensation
We w
elcome the fact that Thames Water has proposed measures as part of its
Thames Water has
also
highlighted that it has paid the automatic penalties that
it will occur under the P
R14 ODI regime for its 2016
17 performance as an
attenuation of customers’ bills in 2018
19, rather than wait for these to be
reconciled at PR19.
However, t
A key assumption underlying the calibration of the automatic ODI penalties was
that under
investment would be the main cause of under
performance. Under
investment would also mean l
ower bills for customers (under PR14, customers
share in any savings a company makes) and so ODI penalties were reduced to
take account of the benefit customers would have also received through lower
bills.
However, Thames Water has not saved money, but i
nstead incurred additional
expense inefficiently. In the absence of the package of proposals put forward
by Thames Water, customers will not receive the expected share of lower
costs, but instead, stand to pay more because of inefficient spending caused by
the contraventions.
Thames Water told us that it has
made
improvement
its governance
arrangements
. In its response to our section 203 request
for information
Thames Water state
that it
had undertaken
a substantial restructuring of th
Alliance
It reported
that “b
y 1 December 2017, as part of this restructuring
exercise, around 700 staff have been in
sourced, enabling the performance of
the field force to be much more closely controlled by Thames Water
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

management, rather than relying
on contractual incentives applying to 'rainbow
teams' of Thames Water and contractor operatives
It states that g
reater
control of
its
repair and maintenance performance has provided improved
visibility of performance, and
that
there is now
very strong e
ngagement
On transparency, Thames Water
reports
it has taken positive steps to improve
this around the performance of its water network, for example by providing in
depth
regular
update
of its leakage
reduction
performance to its Customer
Challenge Group
CCG
states that it
is also engaged with
its CCG on the
development of its external reporting pack which it intends to share with all its
customers. Further, Thames Water
has told us that
it is substantially investing
in social media as a means to share with its customers the challenges it faces
and the approach it is taking to addressing them.
On performance, Thames Water
now
has more resources available to provide it
with data to find and fix leaks
, allowing it to improve
the efficiency and
productivity of
its leakage
operations.
Thames Wate
also reports that
it has reviewed and improved
the commercial
model
for the Alliance
, while maintaining the core principle of collaboration with
its
partners. In particular
it
changed
the risk and reward mechanism, which
aligns the contract with
only
those activities that the a
lliance members can
influence.
Thames Water states it
has
sharpened
its
focus on managing risks

12
Source: Thames Water
Section 203 response of 18 February 2018
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

Thames Water has
put forward
the following measures, which we a
re minded
to accept:
To ensure that Thames Water’s customers do not bear the costs of its
failings, a reduction in its total revenue allowance for
MP7 of the
greater of £46
illion
and its total excess expenditure on leakage
management in AMP6 (
as calcula
ted in accordance with the

13
£10.8m is in 2012
13 prices
in 2018
19 prices this equates to £12.6m
We will check at PR19 that
this was applied in line with Ofwat’s Reconciliation Rulebook.
14
£19.85m is in 2012
13 prices
in 2018
19
prices this equates to £23.0
. This
will be applied in
line with Ofwat’s Reconciliation Rulebook.
15
£16.65m is in 2012
13 prices
in 2018
19 prices this equates to £19.33m
. This will be
applied in
line with Ofwat’s Reconciliation Rulebook.
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

A further
rebate on custome
rs’ bills
in 2019
20
to reflect an ex
gratia
payment of
£7 million in recognition of
its
governance failings (“ex gratia
bill reduction”).

16
£10.4m is in
2012
3 prices
in 2018
19 prices this equates to £12
. This
will be applied in line
with Ofwat’s Reconciliation Rulebook.
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

An undertaking that for
the remaining two years of AMP6, no
Executive
or
senior
management
incentives will be paid for
leakage
performance
belo
its
performance commitment
An undertaking to
appoint an independent monitor to certify that
information in its monthly leakage reports is prepared in way that is
consistent with its AMP6 performance commitments
An undertaking, that in providing
certificates under Condition F, Thames
Water’s Directors will do so on the basis of their reasonable belief,
formed on the basis of reasonably diligent enquiry
. The Directors will
provide us evidence of that enquiry
, a statement of the main factors they
ve taken into account
in providing the certificate
and procure a report
addressed to us from
(an)
external auditor
on the adequacy of their
enquiry process.
The report will include the auditor
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

Water staff), that it is able to address any issues which risk the delivery of
its performance commitments in a timely manner.
The proposed penalty
considering
the amount of the penalty to be imposed, Ofwat has taken
account of the
seriousness, duration and impact of the
contravention
s. We are
particularly concerned about
the insufficiency of
Thames Water’s
Board’s
oversight
of leakage performance
, particularly its
apparent
lack of challenge
operational
aspects of i
ts leakage management within the Alliance
before
performance
On the evidence, however,
Thames Water’s
actions
are
more negligent
rather
than deliberate.
We also take
account of the mitigating factors i
n this case,
including
the
seriousness with which
Thames Water
is now addressing its leakage
reduction
performance issues and the steps it has already taken,
the package of measures it is now offering to provide confidence that it
will
fully
remedy its
performance and provide adequate compensation to
customers, and
its
level of cooperation with the investigation.
In the absence of these measures Ofwat would have been minded to impose a
penalty of 3%
of Thames Water's applicable turnover (for
2016
). T
his
amounts to
million
We think the
package of measures
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

e note that some of
the consequences of Thames Wate
r’s poor leakage
reduction
performance issues are not addressed by this package, particularly
impacts on customers
if they
experience water restrictions or interruptions from
reduced water levels
during the remainder of this price review period
. We
expect
Thames Water to take efficient and effective measures to avoid such
restrictions and adequately to compensate customers
should
they occur.
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

6.
How to make representations or objections
Pursuant to section 22A(4) WIA91, Ofwat, in publishing a notice of a propo
sal
to impose a penalty under section 22A(1) WIA91, is required to specify a
period, of no less than 21 days from the date of publication of the notice, within
which representations or objections with respect to the proposed penalty may
be made. Accordingl
y, any such representations
or objections
should be made
so as to be received by Ofwat by 5pm
June
018. Representations
should be sent to Brigitte Gaylor at the following address:
Email:
Brigi
[email protected]
OR by post to:
Ofwat
Centre City Tower
7 Hill Street
Birmingham
B5 4UA
We will publish copies of representations and objections we receive in
response to this notice on our website, unless the person making them
indicates that
they would like their response to remain unpublished.
Information provided in response to this notice, including personal information,
may be published or disclosed in accordance with access to information
legislation
primarily the Freedom of Informatio
n Act 2000 (FoIA), the Data
Protection Act 1998 and from May 2018 the General Data Protection
Regulations (GDPR), and the Environmental Information Regulations 2004.
If persons making representations or objections to this notice would like the
information
they provide to be treated as confidential, please be aware that,
under the FoIA, there is a statutory ‘Code of Practice’ which deals, among other
things, with obligations of confidence. In view of this, it would be helpful if in
making representations or
obligations it is explained why you regard the
information provided as confidential. If we receive a request for disclosure of
the information we will take full account of this explanation, but we cannot give
an assurance that we can maintain confidentiali
ty in all circumstances. An
automatic confidentiality disclaimer generated by your IT system will not, of
itself, be regarded as binding on Ofwat.
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

Glossary of Terms
Aborted job
because no leak is
found where it has been marked up
on
the ground.
coustic loggers
Leaks
ake a
oise and are often located by pinpointing
the source of the sound. This can be undertaken manually
with a listening stick or electronically
with an acoustic
logger
. Acoustic
loggers are electronic r
emote listening
devices
which send an alarm to a central server when they
leak
Appointee
Water company
with an Instrument of Appointment under
the Water Industry
Act 1991
Back to B
ack
Contract t
erm when a sub
contract contains the same terms
and conditions as parent contract. Creates the same
incentives across the supply chain but can also be used to
pass risk through to sub
contractors.
CaLM
Climate and Leakage Model
Thames
Water’s
model of
water demand and supply which includes a predictive tool
to assess performance against weather.
Certificate of
ompliance
certificate of
adequacy
As part of the licence condition companies are required to
confirm and certify annually that their systems and
process’
are compliant with their licence conditions
Consolidated Fund
The Consolidated Fund is the Government's general bank
account at the Ban
k of England. Payments from this
account must be authorised in advance by the House of
Commons. The Government presents its 'requests' to use
this money in the form of Consolidated Fund Bills.
Customer Challenge Groups (CCGs) are independent local
gro
ups of customer representatives and other stakeholders.
They
were
established
PR14 to provide challenge to
water companies
business plans. CCG
ensure that local
and regional issues are properly considered and that the
views of the company
s entire cus
tomer base are taken into
account.
More information about CCG can be found at
https://www.ofwat.gov.uk/regulated
compan
ies/price
review/2019
price
review
final
challenge
groups/
istribution main
ater supply main smaller than 300mm (12inch)
and
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

DMA
District Meter Area
by
average demands should be understood in the area
Dry H
ole
n attempt to repair a leak
where
no leak is found at the
point highlighted for excavation.

Environment Agency
Eight2
Unincorporated
Joint venture of seven companies who,
replacement and pressure management
vent
Thames terminology for a business process outside of
Busine
ss as Usual
Find and fi
The process for leakage detection and repair of all active
and visible leaks.
FTE
Full T
ime Equivalent
typically
when
referring to head count
Up until 2011, water companies sent Ofwat information
about their
performance each year. This an
nual data
Annual Performance Report.
Work g
angs
Site based t
eam
s (could be 1 or more person) undertaking
L3 leakage event
Level three event
one of T
hames four
levels of response
to circumsta
nces outside business as usual.
eakage
Water that cannot be account
ed for in the Water balance.
is a mixture of Real and Apparent Losses.
Apparent losses
are also known as Unaccounted for Water.
Leakage D
tivity to locate leaks
effort
where leaks are
suspected from inspection of data
(DMA nightlin
es)
or
customer reports
of leakage.
Leakage
xec
(utive)
The senior team reporting to the Head of Wholesale Water
Leakage Recovery
lan
Leakage R
epair
Site operation to repair a leaking water mains
Mains R
eplacement
rogramme of
replacement of water mains at the end of
their asset life
Mains replacement is targe
ted
in areas
on a
number of drivers including water quality, pressure, burst
frequency and l
eakage
Ml/d
Mega litre (1,000,000 litres) per day
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

Obligations
Statutory and licence commitments
that the Appointee must
esk
Thames
Water’s
programme to improve efficiency
of
scheduling site operations
Opex
Operating Expenditure
expenditure that cannot be
capitalised in the company accounts
ODI
Outcome Delivery Incentives. Mechanism established by
Ofwat at PR14 to allow companies to agree outcomes with
their customers and to incentivise out performance against
those outcomes
(and to penalise under performance).
Outcomes
Benefits delivered to customer, environment or wider
society
Penalty C
ollar
Limit of
the pain
mechanism associated with
failure to
perform against agreed
utcome
elivery
ncentive
Performance
ommitment
ndertaking by the company to deliver a level of service
e.g
a leakage level.
PR14/PR19
Price review in 2014 or 2019 respectively
Pressure
anagement
The process by which water companies moderate flow (i.e.
of water lost though leaks.
Price C
ontrol
Limit set by O
fwat on the level of revenue that companies
can recover from customers
urchaser
The term referred to in the infrastructure allia
nce contract
for Thames W
ater as the client
egulated Activities
The activities that companies are licensed to undertake
under the water industry act 1991 and their conditions of
licence
. Companies are at liberty to undertake un
regulated
activities.
Relevant
ndertaker
The company licensed to undertake
regulated activities
under WIA
R&M
Repair and M
aintenance
Typically the non
capital works to
replacement
ROI
Risk Opportunity and Innovation Fund. The difference
The profit/loss to be shared by the IA parties.
Schedule of R
ates
Prices submitted by contractor to undertake individual
A schedule of rates (as opposed to the IA
Notice of Ofwat’s proposal to impose a financial penalty on
Thames Water Utilities Limited

‘cost
plus’ contracts) would pass
the risk for variabil
ity in
cost to the contractor. A schedule of rates also
incentivises
the contractor to in
crease work rate
working harder not
smarter.
SoSI
Security of Supply Index
an index of the ability of the
company to supply water
to planned service levels during a
drought
. 100%
is
100%.
otex
Total Expenditure (capital and operational expenditure) a
financial tool introduced by Ofwat in PR14 (AMP6)
Trial H
ole
n excavation to investigate ahead of
planned
works.
Trial
holes can be used to investigate ground
conditions,
presence of other utilities or to survey the main to be
Trunk Mains
arger mains
feeding
from the
Water Treatment Works and
Service R
eservoirs. Typically customers are not supplied
directly from
trunk mains. T
runk mains often operate at
higher pressures than the downstream (distribution) mains.
UFW
Unaccounted for Water
The industry uses this term to
mean real and apparent losses of water. Thames uses the
term for apparent losses (water deliver
ed to customers but
not accounted for).
pparent losses
are water that has
be
reported as leakage but is
actually consumption
These
may be properties with higher than average occupancy
Water B
alance
Equation to account for the
water leaving the treat
ment
rks to enter the distribution sy
stem
sometimes called
Water Into Supply (WIS) or Distribution Input (DI)
and
Ofwat
Centre City Tower
This document is also available from our website at
www.ofwat.gov.uk.
Any enquiries regarding this publication should be sent to us at
[email protected]

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