Karma Ockenden on Ofwat’s pre-qualification decision

“With a lack of prescription for business plans, it is perhaps unsurprising that more water companies didn’t pass prequalification with flying colours.”

At Water UK’s City conference last week, South West Water chief executive and conference chair Chris Loughlin joked with the great and good of the industry that Jonson Cox should have swapped a 7am stock exchange announcement on which companies had prequalified for enhanced status for an Oscars-style live-on-stage envelope opening. He speculated Yorkshire Water chief executive Richard Flint could come up and, with a tear in his eye, reel off his list of people to thank.

In the event, it would have been Loughlin himself making the emotional speech. Of the entire industry, only his company and Affinity Water were deemed to have made the grade on outcomes, costs, affordability, board assurance and 2010-15 performance to prequalify for an enhanced classification. Risk and reward components were not considered given Ofwat’s latest guidance on those matters was published in January, after business plan submission in December.

So for South West and Affinity (see Richard Bienfait interview, page 8), the end is in sight. Subject to accepting Ofwat’s January guidance, making a few specified tweaks and continuing to pass prequalification tests, they can look forward to draft determinations by 30 April and a package of rewards. It won’t be a walk in the park; some of Ofwat’s numbers, especially its weighted average cost of capital (Wacc) figure, will require consideration and action. But the companies are unlikely to relinquish the prospect of enhanced status – particularly as so few of their peers prequalified.

Moreover, both debt and equity representatives at the City conference last week indicated that while the Wacc was tough, it was viewed more as a wake-up call for management than a deal-breaker for investors. Hans Peter Portner, senior investment manager at Pictet Asset Management, quaintly described the outlook for UK water over the coming ten years as “a happy place”.

The other 16 companies Ofwat tested for prequalification must be profoundly disappointed. Perhaps the only silver lining is they now won’t have the ignominy of being sorted into “standard” and “resubmission” categories on 4 April.

In the latest PR14 twist, Ofwat has scrapped that plan, introducing instead a timing-based tier system. The deadline for firms to resubmit revised plan elements is 27 June, for draft determinations on 29 August; however those who submit their new information early – by 2 May – will be considered for early draft determinations on 25 June. Perhaps Ofwat is looking to stagger its workload.

Either way, it is back to the grindstone for the vast majority of the industry. Ofwat published some information on Monday on company performance against its prequalification tests; on 4 April it will flesh this out with detail, and publish further information on wholesale cost assessment and models, outcome delivery incentives, cost drivers for cost allocation, the application of AMP5 adjustments and default tariffs.

It expects back not only additional material supporting plan parts that have been revised, but also: its January risk and reward guidance to have been taken into account; further customer challenge group (CCG) engagement and a supplementary CCG report; and a board assurance statement guaranteeing plan financeability.

So how badly did the industry at large do in the regulator’s prequalification tests? On the plus side, Ofwat acknowledged a strong performance was put in on customer engagement, CCG work and willingness to pay (WTP) research, although it added firms had done less well on demonstrating how WTP estimates had shaped the detail of plans. It commended companies too for putting in solid work on board governance and assurance.

Importantly, Ofwat felt the industry had also responded well to the affordability challenge facing customers in 2015-20. Speaker after speaker at the City conference, including Water UK chief executive Pamela Taylor, Wessex Water executive chairman Colin Skellett, Yorkshire’s Flint, various investors and water minister Dan Rogerson, reiterated that companies had got the message on affordability and were acting on it. Ofwat’s main criticism here was that more attention is needed to future (post-2020) affordability.

It was more of a mixed picture, according to the regulator, on performance commitments on outcomes: some companies had achieved consistently highly; others had been more patchy and mixed more traditional inputs/outputs with the PR14-desired outcomes. Wholesale cost assessment also brought mixed fortunes, with firms spread across the B, C and D categories in Ofwat’s exam-style scores.

In other areas, the regulator simply said more work or information was needed.

With the regulator clearly being “flexible” in this review – learning as it goes along – and with a distinct lack of prescription as to what business plans should have looked like, it is perhaps unsurprising that more companies didn’t pass prequalification with flying colours. It’s hard to win an Oscar if the film you are making hasn’t got a script.