Investor confidence remains high under tough regulation

The firm approach by Ofwat at the price review continues to give confidence to investors, according to S&P Global Ratings, which told Utility Week the challenges reflect growing public demand for the sector to shape up.

S&P said the final determinations were tough even if Ofwat has adjusted some elements that enhance the credit worthiness of some of the companies after July’s draft determinations.

Matan Benjamin, the director responsible for UK utilities at S&P, said: “We were expecting a decline in the weighted average cost of capital (WACC) after the draft determination. Up until December there was intense interactions between Ofwat and the companies and eventually Ofwat has offset the reduction of the WACC by allowing some flexibility in other elements such as pay-as-you-go (PAYG), higher allowances and narrowing the range for penalties and rewards. The final determination is more balanced than the draft, though overall it remains tough. We are waiting now to see whether companies will choose to appeal.”

He said: “There could be some appeals but I think the moves that Ofwat made could make it sufficient for them to accept this tough determination. But it will take effort for the companies to operate with that over the next five years.”

Despite the tough stance, S&P said the long-term investment prospects for water companies remain adequate.

“This remains a strong industry. On the one hand, things are becoming more challenging for companies because the regulator aims to make them work more efficiently but that efficiency is good for society. There is a balance between what companies are doing and how efficient they are and what value they provide to society and customers.”

He went on to stress that a good regulatory framework needs to ensure companies service their debts while reaching the tougher targets for customers and the environment.

“Overall our view is that regulations in the UK are credit supportive. We recognise the industry needs to change to adapt to the changes in the environment,” Benjamin said.

The greater emphasis in the price review to meet customer service and environmental targets reflects the focus from the public on greater accountability and responsibility from companies.

“The regulator’s targets reflect that, compared to five years ago there’s greater focus on environmental, social and governance (ESG) considerations today. For example, 20-25 per cent of water is lost through leakage. This is no longer acceptable, so the regulator is imposing tougher targets. There is also pressure to reduce supply interruptions and improve customer service,” he said.

“It is hard to find the balance, maybe sometimes that’s too strict but overall it reflects the noise, sounds and requests of society.”