Investor concerns remain over regulation of water

The level of regulatory intervention in the water industry compared to other UK sectors remains a concern to international investors, a House of Lord’s select committee has heard.

Despite this, their appetite remains sufficient to fund the mounting infrastructure needs of water companies without dipping into the public purse, the Industry and Regulators Committee was told.

As part of its inquiry into Ofwat’s powers, the committee questioned Lawrence Slade, head of Global Investors Association (GIA), and senior figures at Water UK about the role of investors in the sector.

Drawing comparisons with the energy industry, Slade explained the relationship between investors and Ofgem over past few years has been “slightly more positive and engaging than with Ofwat”.

But he said the “troubling relationship” between Ofwat and the water sector in recent years has given way to more positive engagement that “bodes well for the future”.

There was, Slade said, “a sense heading into PR24 of a greater willingness” for engagement between the investor community and the regulator to understand where problems are and have an active dialogue.

The mounting costs of building the infrastructure required in the coming decades and complying with additional environmental requirements warrant a flexible approach to regulation that is joined up with other nationally significant infrastructure investments, said Slade. He said it should be possible to plan infrastructure nationally and with timeframes that offer the best value for money, whilst also providing the flexibility to scale up or down as the situation demands: “If we get that long term planning right the companies, and therefore investors will have confidence in direction of travel, and the regulatory approach in place then the impact on bills should be minimal.”

Slade said uncertainty over the exposure and resilience of different parts of the country to climate change means the required levels of investment remain unknown:

“Things can change quickly right now – a dry summer could have an impact very quickly,” he explained. “Unlike electricity and gas, there is no integrated water grid so different parts of the country may suffer flooding or droughts. There are not insubstantial issues just around the corner that could require massive investment that isn’t booked in at the moment so we need to continually engage with all stakeholders in these conversations and ensure that we are allowing a certain level of flexibility in any funding settlements to allow water companies to react to any challenges.”

On the often contentious issue of the cost of capital, which was one of the grounds on which four companies sought the re-determination PR19 business plans by the Competition and Markets Authority (CMA), Slade highlighted the multiple methodologies used across different regulators.

He called for a consistent approach to determining the cost of capital and suggested the CMA’s methodology should be adopted, perhaps with more statutory input from the UK Regulators Network “as a body to bring regulators together more formally”.

His confidence that the appetite to invest in the water sector remains sufficient was echoed by the chief executive of Water UK, Christine McGourty, who said despite the significant sums needed in the long term for infrastructure and resilience, she saw “no need to call on the public purse”.

Water UK policy director Stuart Colville, together with McGourty, defended returns paid to sector investors, saying they are essential to attract necessary finance in the coming decades. McGourty told the committee that average dividends are currently in line with Ofwat’s baseline returns, with three companies paying out no dividends last year. Colville said they do not match with “the picture you see in the media of hefty high returns” .

Colville underlined the need for collaboration between water companies and other sectors including farming and agriculture to tackle river water quality issues and minimise the risk of harm from combined sewer overflows. He said it would take innovative thinking to achieve desired improvements at the fastest and lowest cost, but this was something water companies alone could not manage.

The hearing was the inquiry’s final session before the summer recess. The committee will resume its inquiry in the autumn.