Challenging PR19: Where CMA appeals can be won or lost

With a record number of appellants requesting referrals from Ofwat to the Competition and Markets Authority (CMA) for their PR19 business plans, Utility Week gathers expert views on the areas most likely to feature in the appeals.

Companies were urged to engage with more customers than ever before when writing business plans for the next five years and that focus looks set to shape appeal requests.

Even companies that reluctantly accepted their final determination – such as Wessex, Portsmouth and SES – each flagged the challenges Ofwat’s terms posed and that the regulator’s stance went against the expressed wishes of customers.

Anglian’s director of regulation Alex Plant told Utility Week that after the level of customer engagement the group carried out, the company felt “duty-bound to honour what our customers want us to do”.

The appeal process is set to take at least six months and will re-examine the entire business plan, not just the areas of contention.

One industry source pointed out the volume of work involved in the process suggested companies must feel they have a very solid case to go to the CMA, adding that reaching the decision to appeal can be very “finely balanced”.

“It’s not a contest, it’s an adjudication based on evidence rather than a fight. Ofwat is not trying to beat the companies but both sides will present what they think is reasonable,” they said.

Nigel Hawkins, analyst from Hardman & Co, told Utility Week that if he were a barrister for any of the appellant water companies, he would look at three main areas.

“Firstly, if the overall package was unfair, whilst acceding an a la carte appeal is not an option. Secondly, the weighted average cost of capital (WACC) is unreasonably tight, especially over a five-year period,” he explained.

Compared to PR14 five years ago, Ofwat’s WACC is as much as a third lower than it was, and interest rates have changed in that time, so companies must now improve their earnings against the more generous allowance at the previous price review.

“Thirdly, I would go through Ofwat’s Test Area Assessment for the appellant company with a fine-tooth comb. Many of Ofwat’s comments at the time on company efficiencies read like a fun editorial piece.”

The test area assessments gave scores on efficiency metrics to each company, which Hawkins said a legal team could use to argue whether the basis for efficiency was valid.

He also suggested that companies that base their appeal on the WACC, which Northumbrian with its significant bill hit may do, could impact the wider sector. The WACC reduction was a tough pill to swallow across the sector therefore if the CMA rules that it had been set too low, could other companies argue it is too unfair for their own business plan also?

As well as taking up management time and company resources, the appeal process will leave companies in a state of limbo. They will have to follow the final determination as it stands for the first year of the business plan, while awaiting ruling from the CMA.

Matan Benjamin, director of infrastructure ratings for utilities at S&P Global Ratings, told Utility Week that choosing to appeal prolongs the uncertainty for companies, investors and stakeholders, but could provide an upside.

“It’s important that stakeholders see that this process is stable and provides certainty,” Benjamin said. “Of course, this means that utilities can focus on their operations, while for investors it gives assurance that companies are governed by a predictable and stable regulatory framework.”

He said despite the uncertainty the appeal process brought, the stability of regulation in the UK still made utilities an attractive prospect.

“Regulatory frameworks for utilities in other countries are not necessarily as progressive and evolved compared to the UK. This system, in our view, is strong and reliable – and this is partly thanks to the CMA’s involvement in the process.”