Ofwat CEO rejects industry fears on cost of capital

Cathryn Ross knocks back water company complaints about projected cost of equity in PR19

Ofwat chief executive Cathryn Ross has rejected industry fears that the projected cost of capital for the next regulatory period will undermine resilience.

Speaking at an Ofwat event in London, Ross said: she is “not desperately sympathetic to some of the noises off” companies are making about the regulator’s proposed level for the cost of capital in PR19, and in particular the reductions it has proposed for the cost of equity.

She said that suggestions these changes might compromise the sector’s financial resilience are wrong.

“The implication is that there is a relationship between our cost of capital, spend on resilience and the delivery of actual resilience,” she continued. “That relationship just does not exist”.

Last week, a KPMG report commissioned by Anglian, Northumbrian and Affinity Water, claimed that Ofwat’s proposed cost of equity was based on flawed assumptions about the total market return (TMR) companies will see.

It warned that if Ofwat pushes ahead with its proposed TMR (of 5.1 per cent to 5.5 per cent) there could be “significant implications for financeability and cash flows of the regulated firms, allocation of capital by investors, perception of the UK utilities sector, and potentially for consumers”.

The report suggested Ofwat should therefore “review in detail” its plans.

But Ross pushed back on such claims. “The best way for us to get the resilience that customers and society need is not to ratchet up the cost of capital,” she insisted. “What matters is that we provide a reasonable return on risk – which we will.”

She added that “what also matters” is that Ofwat allows companies to “recover, through charges, the efficient cost of managing the risks to the outcomes customers want to see”. Ross said this would “primarily be a function of the quality of the business plans that we get. And that, of course, is down to the companies”.

Ofwat’s event yesterday was focused on the approach to resilience in PR19 and its expectations of resilience planning from companies.

For the upcoming price review, Ofwat has imposed a broad definition of what resilience should mean for the water sector. It has called this “resilience in the round” and it includes three main strands: financial resilience; corporate resilience; and operational resilience.

The regulator’s chief executive said that she was aware some company bosses were unhappy with this new definition of resilience, finding it too broad and “that somehow it is too all-encompassing and too challenging”.

Again, Ross was firm that she does “not have a lot of sympathy with that”.

She said Ofwat’s expectation for resilience in the round is “no more or less than a water company’s job. It is also no more or less than customers and society expect.”

Ofwat used its event, which included insights into how leaders in other sectors approach financial, corporate and operational resilience, to launch its new report Resilience in the round: Building resilience for the future as well as its Targeted Review of Asset Health, which examines the contribution that management of asset health can offer to operational resilience.

John Russel, Ofwat’s senior director for strategy and planning said the documents should “inspire” companies and help them to understand what resilience might look like in practice.

Several key themes emerged from the event, relating to areas which water companies will need to improve on in order to deliver resilience in the round. Among these, “systems thinking” and an improved understanding of the risks associated with interdependencies between water companies as well as between the water sector and other infrastructure and utility systems, was the most prominent.