CMA narrows gap with Ofwat on cost of capital

The Competition and Markets Authority has set a new cost of capital for the appellant water companies at 3.2 per cent, which is closer to Ofwat’s figure than the provisional findings in September.

The CMA today (17 March) published its redetermination for Anglian, Bristol, Northumbrian and Yorkshire water companies that all rejected their final determination from Ofwat in the PR19 price review.

The return to investors will be 32 per cent lower than the last price control period, 9 per cent lower than the CMA’s provisional findings in September and approximately 12 per cent lower than the rate proposed by the water companies.

In the previous price control period the allowed rate of return was 4.67 per cent and for this review the water companies had proposed approximately 3.6 per cent. In September the CMA published its provisional findings that set the cost of capital at 0.54 per cent higher than the regulator’s decision at just over 3.5 per cent. It based its methodology on aiming up, which attracted criticism for being too generous to investors.

The CMA’s weighted average cost of capital (WACC) is 0.2 per cent higher than Ofwat because the re-determination placed reliance on different information to produce a range of estimates. The CMA landed on an estimate slightly above the mid-point of the range. It is 0.4 to 0.6 per cent lower than requested by the appellants.

Companies have been allowed additional spending on leakage and security of supply. The CMA has increased totex spending by 3 per cent and provided enhancement spending of £75 million for company specific schemes. Leakage reduction targets remain at 15 per cent as set by Ofwat in its final determination.

The CMA said the rate of return was the minimum it considers sufficient to allow the companies to finance their activities and invest in long-term infrastructure.

Average bills for the four companies’ customers will fall but the CMA’s decision will leave consumers paying £10 to £13 more than Ofwat directed.

Consumer bills for Anglian will be £400, the company had proposed £418 and Ofwat had set £386 in its final determination in December 2019. There is no change from the provisional findings by the CMA.

For Bristol customers, bills will average £172, which is a drop of £2 from Bristol’s proposal, £12 greater than Ofwat’s determination and £6 higher than the CMA’s provisional findings.

Northumbrian’s bills were subject to the biggest drop at PR19 with Ofwat proposing a fall of £106 for billpayers. The CMA landed between Northumbrian’s and the regulator’s amounts at £334, which will still be a significant saving for consumers.

Yorkshire’s average bills will be £374, a figure that is £5 lower than the company’s proposition and £10 greater than Ofwat’s final determination.

Through the year-long process, the CMA said the evidence it gathered suggested the companies would need to spend more than Ofwat had calculated to carry out essential operations. Should the four companies spending come in below the amount set, the extra cost allowance will be returned to customers.

Kip Meek, the chair of the group that re-determined the price controls, said: “In coming to our decision, we have sought to balance keeping bills low with the need to maintain a good quality of service and to invest in critical infrastructure for the future. Our decision means that customers of these companies will be paying, on average, £34 less per year for their water than they did in 2019/20.”

Rachel Fletcher, chief executive of Ofwat, said: “I am grateful to the CMA for its engagement with us and the considerable analysis it has conducted.  Overall, the CMA has supported the ambition we have for the industry. Its decisions require the four companies to make a step change in productivity and performance.

“Crucially, the CMA has backed the principle we have been advocating, that investors must work hard for their returns, bringing customers better, more resilient services and a healthier environment for generations to come.

“In the coming years much work is needed to deliver net zero, improve the natural world, provide resilient water services in the face of climate change, and keep up with customers’ changing expectations. Ofwat will continue to hold companies to account for delivering against these goals, while enabling them to innovate and attract the investment they need.”

Yorkshire has said the adjustments will allow it to make essential investments in future proofing its services.

The company said: “We can now draw a line under the last price review and start to work collaboratively with government and regulators to ensure that we restore the balance to the sector and deliver long term resilience whilst protecting customer interests.

“It is also time to look at the regulatory process and see if we can make it simpler and more effective.  We are sure that Ofwat shares this aspiration.”

Anglian’s chief executive Peter Simpson said the CMA had recognised the need for increased investment in resilience in light of climate change and population growth.

He said: “We welcome the CMA’s recognition that a different approach to funding growth is needed, and that looking after customers’ interests must include ensuring water and water recycling networks are resilient to increased demand as well as climate change. This will be important for future price reviews, alongside keeping bills affordable and supporting our vulnerable customers.

“There is much for us to be positive about in planning for a better future and working with Ofwat and our other regulators to achieve shared goals on resilience, water quality, pollution reduction, and support for vulnerable customers. Excellent progress is being made through Ofwat’s RAPID programme, clearing the way for significant strategic water infrastructure projects. Likewise, the acceleration in innovation and collaboration afforded by Ofwat’s Innovation Fund is one of the elements assisting the industry’s journey towards net zero carbon by the end of the decade.”

Mel Karam, chief executive at Bristol, said: “The CMA determination received today aligns much more closely to our proposed 2020-25 business plan. We will be assessing the re-determination as the full details are published in due course. For now, our focus remains on delivering on our promises for our customers. I’d like to thank the CMA and all the teams in Bristol Water and our supporting partners for their hard work over the past 12 months.”

Northumbrian, which had also rejected its final determination on financeability grounds, said its board will now take time to thoroughly review and discuss the CMA’s conclusions and consider what this means for its customers and stakeholders.

Alistair Cromwell, acting chief executive of Citizens Advice, said: “This announcement shows the CMA has listened to the concerns of Citizens Advice, Ofwat and others who said it had initially been far too generous to water companies.

“Today’s announcement is progress and a better deal for consumers than the CMA originally proposed. However, the CMA should have gone further in cutting back the excess profits made by water companies.”

However the Consumer Council for Water, CCW, said the deal did not represent the best value for billpayers and suggested more of a voice should have been given to customers in the process.

Chief executive Emma Clancy said: “Customers want their voices to be heard and their views should have carried much more weight during this inaccessible, expensive and complex process. Many of the contested issues might have been technical but the outcomes have a direct bearing on customers’ bills and the services they receive which is why their input and influence is so important.

“We believe some of the decisions will still benefit shareholders at the expense of customers who could have received even better value from this deal. That risks overshadowing the additional investment in this package which customers will undoubtedly welcome.”