‘Clear case’ for Ofwat to move away from RPI: Oxera

There is a “clear case” for Ofwat to move away from the retail price index (RPI) as the measure of inflation for setting future price controls, utility consultancy Oxera has insisted.

In an Ofwat-commissioned report, the firm said changing the basis of both the regulatory capital value (RCV) and revenue indexation away from RPI would reduce the reliance of regulation on an inflation statistic that is “gradually falling out of use”.

Amid uncertainty around the final UK Statistics Agency (UKSA) decision regarding the status of CPIH, Oxera said it considers both CPI and CPIH as “potential candidates” to replace RPI.

The consultancy insisted there is “no evidence” that financing costs would go up to the water industry if a switch to a different inflation statistic were implemented in full for both revenues and the RCV.

“All else being equal, changing the way revenues are indexed should have no impact on the forecast revenues – and hence forecast level of customer bills,” it said.

“However, options that involve a change to the indexation of the RCV will have an effect on the forecast profile of revenues and bills, given the mechanics of the regulatory framework.”

But, it added, changing from RPI to the consumer price index (CPI) or CPIH would reduce the reliance of regulation on an inflation statistic that is “statistically flawed” and, in turn, increase the legitimacy of the regulatory framework, reducing volatility of bills.

Ofwat is in the process of reviewing the appropriate inflation statistic to use as part of the Water 2020 programme, which considers the regulatory framework for wholesale markets for the PR19 price review in the water and sewerage sector.

The regulator has said it wants to move to a “more legitimate” CPI when setting price controls to “allow for inflation in cost recovery”.

The UKSA published an independent review of UK consumer prices statistics, led by director of the Institute for Fiscal Studies Paul Johnson, in January 2015.

In place of RPI, the Johnson review recommended that Office for National Statistics should move towards making CPIH its main measure of inflation. In the meantime, the CPI should continue to be the main measure of inflation.

In January this year, Moody’s rating agency warned that although CPI is displacing RPI in many regulated sectors, the transition creates “particular challenges” for water and energy networks.