Bristol to CMA: Ofwat got it wrong

The four water companies appealing to the Competition & Markets Authority have submitted their grounds for referring Ofwat's final determinations on their business plans for the next five years. Utility Week is exploring each of their Statements of Case and the central arguments of the appeals. In this piece, we look at why Bristol Water thinks Ofwat has made mistakes..

Bristol Water has cited “specific erroneous decisions by Ofwat” for requesting a redetermination as it expressed “reluctance” at its third appeal to the Competition and Markets Authority (CMA).

The company laid out its grievances with the final determination made by Ofwat in December for its business plan for AMP7. It requested a referral to the CMA in February this year saying the plan was not financeable.

It said “errors” relating to cost of capital, cost allowance and balance of risk meant it had to reject the business plan, but fully supported Ofwat’s ruling on performance commitments, outcome delivery incentives (ODIs) and resilience investment.

Following the appeal request, chief executive Mel Karam told Utility Week that the decision had not been taken lightly but the company was left with no choice.

“Twice before in 2010 and 2015 the issue of cost of capital adjustment for a small water company was considered and accepted by the CMA but unfortunately the final determination didn’t consider it and allow for it,” Karam explained in a Utility Week interview in February.

In its Statement of Case the company said the “most concerning and by far the most fundamental issue” was the cost of capital being set too low to support a company the size of Bristol. Previous redeterminations by the CMA recognised this and Bristol said the precedent should have been followed by the regulator.

It said Ofwat’s failure to apply a Company Specific Adjustment uplift on the cost of debt, together with “other errors”, meant the company could not earn a reasonable rate of return during 2020-25.

Bristol said evidence for the necessity of the uplift had been provided in its business plan and it had expected precedent to be followed.

This, Bristol argued, extended also to the cost of equity, which for a small company is more highly geared compared to the regulator’s benchmark of a notional company.

The statement questioned Ofwat’s cost of capital – which many companies had also queried – as unjustified.

On cost allowance, the company highlighted an adjustment of £30 million that would reduce its cost base further and pose a risk to the quality of what could be carried out in the AMP plan.

Bristol called Ofwat’s assumptions about the level of industry-wide productivity improvements “unjustified” because of “incorrect adjustments” to specific cost items.

The company also pointed to errors in the balance of risk including the imposition of extra financial incentive measures without supporting analysis. It said this would expose Bristol to material downside financial risk, compromise the return on capital and underminine financebility.

Bristol said Ofwat was wrong to set the penalty rate too high on certain ODIs and for imposing a gearing outperformance mechanism that, together with other burdens, impacted Bristol’s ability to fund its plan.

The company described itself as having “changed significantly” from the company it was five years ago. Ownership, management and board structure are all different, and it pointed to a clearly defined social purpose.

Karam, who joined in 2017, previously said he did not want to see the company in a position it disagreed with the regulator again, which made the PR19 decision even more tough.

The final determination included 14.8 per cent reduction in bills, compared to the 5.4 per cent reduction proposed by the company. The company was allowed £553.3 million in revenue compared to £603.5 million requested.

The company’s key performance commitments in the final determination included a 21.2 per cent leakage reduction on a three-year average basis, a 6.3 per cent drop in per capita consumption and a 59 per cent reduction in water supply interruptions to five minutes.