SLR 02/05: Financial arrangements for self-lay and requisitioning agreements relating to water mains

SLR 02/05: Financial arrangements for self-lay and requisitioning agreements relating to water mains - offsite reinforcement

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Self-Lay and Requisitioning Letters

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SLR 02/05

7 March 2005

Dear Colleague

Financial Arrangements for Self-Lay and Requisitioning Agreements relating to Water Mains– Offsite reinforcement

We issued our guidance about the financial arrangements for self-lay and requisitioning agreements on 14 May 2004. Since that date we have received a number of enquiries and comments about the particular financial arrangements where off-site reinforcement is required by a water company as a consequence of the provision of a main, either under requisition or by self-lay. I am writing to clarify our guidance on this issue.

Requisitioned Main
Reasonable Costs
When calculating the "relevant deficit", a water company should include in the costs reasonably incurred in providing the requisitioned main:

the costs that are "reasonably incurred in providing such other water mains and such tanks, service reservoirs and pumping stations as it is necessary to provide in consequence of the provision of the new main"(1) (known as network reinforcement), although the water company should not include costs relating to the provision of any additional capacity which allows the main to be used for purposes over and above that needed to comply with the requisition; and

the costs reasonably incurred in providing, or procuring the provision of, the proportion of any additional capacity in an earlier main that will be used as a consequence of the provision of the new main. "Earlier main" refers to a main that has been provided because of a requisition, or has been self-laid and adopted by the water company, in the previous twelve years.

In considering costs reasonably incurred for network reinforcement, water companies should take account of infrastructure charges payable for premises on the relevant development. In considering disputes we will require water companies to explain to us what costs they have incurred in installing infrastructure that they have not recovered through infrastructure charges. This is to ensure that there is no over-recovery of costs.

As an alternative to paying by the relevant deficit mechanism, the requisitioner can choose to pay for the work by the discounted aggregate deficit method (known as the statutory commuted sum). The principles relating to reasonable costs set out above also apply when calculating the statutory commuted sum.(2)

Revenue to be taken into account
The relevant deficit for any year is defined as the amount (if any) by which the annual borrowing costs of a hypothetical loan for the reasonable cost of providing the requisitioned main (see above) exceeds the relevant revenue from that main.(3) Relevant revenue is defined as the charges that have been imposed by the water company in relation to the premises connected with the main and that are reasonably attributable to providing a supply of water to those premises by means of that main.(4) (This applies whether or not the water is supplied for domestic purposes.)

It therefore follows that the revenue that should be taken into account when calculating the relevant deficit is that which is charged to premises connected to the requisitioned main for a supply of water. If a developer requisitions a main to which no premises will be connected, there will be no relevant revenue to take into account.

The statutory commuted sum calculation is based on the relevant deficit methodology. When calculating the statutory commuted sum, the water company has to estimate the relevant revenue from premises expected to be connected with the main. But if no revenue is expected, then no revenue should be taken into account when calculating the statutory commuted sum.

Self-Lay Mains
When a water main is self-laid, the water company can require the person constructing or proposing to construct the main to pay the costs reasonably incurred by the water company in relation to the adopted main. These are calculated in the same way as the costs that are incurred when mains are provided under a requisition agreement (except that the water company will obviously not have incurred the costs of laying the self-laid main).(5)

When it adopts the water main, the water company should pay to the provider of the main a discounted offset amount (known as the asset value). This amount is calculated by adding together the estimated offsets for each of the twelve years following the adoption. Section 51C (7) defines the estimated offset for any year as the lesser of:

a) the revenue (if any) that it is estimated would be received from the premises connected to the self-laid main for a supply of water; and

b) the annual borrowing costs of a hypothetical loan for the amount required for providing that main.

These amounts should be calculated in accordance with the provisions for calculating the statutory commuted sum(6). It therefore follows that the reasonable costs of any work to reinforce the water company's network that is needed because the self-laid main has been installed should be taken into account in calculating what the asset value should be. It also follows that if there are no properties connected to the self-laid main, there should be no estimated revenue to be taken into account in this calculation.

I trust that the above provides further clarification on the financial arrangements for self-lay and requisition agreements. If you have any queries please contact Pauline Amor on 0121 625 1381 (or by email pauline.amor@ofwat.gsi.gov.uk) or Kathryn Frawley on 0121 625 3615 (or by email kathryn.frawley@ofwat.gsi.gov.uk).

Yours sincerely

Tony Smith
Director of Competition and Consumer Affairs Division

(1) See section 43(4) of the Water Industry Act 1991 (WIA91) as amended by the Water Act 2003 ('WA03').
(2) See section 43A(3) of the WIA91.
(3) See section 43(1) of the WIA91.
(4) See section 43(7) of the WIA91.
(5) See section 51C(3) of the WIA91.
(6) See section 51C(8) of the WIA91.

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