Moody’s: CPI move creates risks for water and energy networks

A transition from the retail price index (RPI) to the consumer price index (CPI) creates risks for both water and energy networks, according to analysts at Moody’s.

In a report, the rating agency warned that, although higher current returns could be credit positive, total returns could fall if the regulators – Ofwat and Ofgem – underestimate the CPI-RPI differential.

The RPI has been used to adjust revenues for UK water and energy networks since privatisation 25 years ago, and is deeply entrenched in the Regulated Asset Base (RAB) and in the industry’s capital structure.

However, Ofwat’s initial proposals for Water 2020 published last month included plans to move to a “more legitimate” CPI when setting price controls, to allow for inflation in cost recovery. And Moody’s expects Ofgem to make a similar change from 2021.

The agency suggested that, while CPI is displacing RPI in many regulated sectors, the transition creates “particular challenges” for water and energy networks.

In a note, it said: “Regulators tend to forecast major costs based on nominal prices. However, for costs which are individually trivial or difficult to forecast, regulators may implicitly assume that costs rise with the index.

“In these cases, the use of CPI rather than RPI will yield lower cost allowances, and therefore weaker cash flows, over time.”

Earlier today, the ratings agency warned that Ofwat’s Water 2020 proposals would be “credit negative” for the water sector if implemented.