Karam: Ofwat ‘didn’t follow precedent’ on Bristol’s FD

“Any company which ends up in a disagreement with its regulator twice in a row should look carefully at what it’s done and what it’s doing.”

Bristol Water chief executive Mel Karam admits that this quote in a Utility Week interview from 2017 has been “ringing in my ears” throughout this price control process. It is a measure of how challenging the company found Ofwat’s final determination that it finds itself in 2020 appealing the regulator’s terms for an unprecedented third time.

“It’s important,” Karam says, “because it really is what we tried to do – we tried to learn from every lesson from the last decision the company made and it made it really, really hard for us to decide this time around.”

He explains that Bristol had expected an additional cost allowance, which Ofwat did not include, without which its plan was not financeable.

Karam stresses the company is in agreement with Ofwat on its performance goals but could not finance the plan without a more generous funding allowance.

Ofwat did not follow the precedent to allow additional funding for small water companies, which Karam explains was agreed by the CMA in previous appeals.

“We don’t have any issues with the ambitious targets – we put them forward, but we feel the risk associated with ambitious, challenging targets needs to be recognised in the rewards and in the finances of the company.”

He says the additional cost of financing for a small water company should have been recognised by Ofwat “explicitly”.

“Twice before in 2010 and 2015 the issue of cost of capital adjustment for a small water company was considered and accepted by the CMA but unfortunately the final determination didn’t consider it and allow for it,” Karam explains.

“It wasn’t an easy decision for us to not accept the final determination on that basis, but we ended up in a position that we really didn’t have any option.”

He says the company holds long-term debts it will be paying for decades, which would be negatively affected by the terms of the determination.

“We don’t understand why Ofwat didn’t follow the precedent that was set twice before.”

In previous price reviews, the cost of capital for smaller companies has been higher, to account for the higher cost of debt those companies would incur. However the allowance was only given where Ofwat considered there would be customer benefits.

Karam explains the CMA previously agreed Bristol should have been permitted extra costs and the company argues it should have been granted them once again.

“We couldn’t see how we could agree with a final determination knowing the CMA had already decided on it and secondly knowing that, without that, we can’t finance the company adequately for the longer term.”

Bristol is one of four companies appealing to the CMA, along with Yorkshire, Northumbrian and Anglian. Karam said the issues for each company are likely to be different with specific issues and concerns but having allies in the process did not impact Bristol’s choice.

“Regardless of what other companies’ issues may or may not be, we would have made our own decision on its own merits separately,” Karam notes.

Bristol agrees with Ofwat over much of the business plan and Karam is quick to offer support for the regulator’s wider strategies.

“Our own business plan was devised and designed to be very ambitious in improving service levels, and to be at the forefront of the industry. The final determination reflected pretty much all those challenging objectives and targets and we stand by them. We know they’re challenging. We know they’re difficult, but we stand by them and we’re working on delivering them.”

The company will reduce leakage by 21 per cent by the end of the next AMP cycle and cut supply interruptions by 85 per cent.

The company is working on a transformation programme to increase productivity, efficiency, and to close the gap between improving services and reducing customer bills.

“Obviously, there’s a gap there and we know there’s a need for efficiency,” Karam says. “We also totally agree with Ofwat that innovation drives those efficiencies and needs to be at the heart of an ambitious business plan.”

Reflecting on Bristol’s previous appeals, Karam says the company fully recognises the “big, big burden” the process places on the company in time, effort and cost.

“We have been serving the customers for 174 years and the only way to make sure a local company survives to serve those customers, in our view, was to make sure we have a financial future. And to that effect, we ended up with absolutely no other option, but to go the CMA a third time around.”

In 2015 the CMA redetermined Ofwat’s decision and moved slightly in Bristol’s favour on the wholesale cost of capital and saw household bills fall by 16 per cent compared to Ofwat’s proposed 19 per cent cuts.

During the previous appeal Bristol had said the cost of capital calculated by Ofwat was too low and raised concerns over some aspects of the financial incentives linked to performance and ODIs.

Ofwat declined to comment in response to Karam’s comments.