Ofwat: PR19 is pro-investment

Following last month’s final determinations (FD), senior Ofwat figures spoke to investors about the major changes that appeared in the plans – the performance commitments, increase in totex allowance and lower allowed return – as well as the curious case of Thames’ conditional package.

The water regulator’s final determinations dispelled the view of it being anti-investment as it set its expectations for greater efficiency from the sector and hopes to bolster public trust.

That was the message from the combined heads of Ofwat, with chairman Jonson Cox keen to highlight the level of investment to protect the environment, improve service and boost resilience.

“I sometimes hear we’re anti-investment,” Cox said. “That’s a myth, and I hope this package will put that to bed.”

This included allowing £1 billion of investment more than was expected by the companies. The additional funding comprised £470 million for inter-company water transfers; £200 million for an innovation fund for the first time and £480 million allowed for Thames Water to invest in infrastructure in London.

The Thames allowance issue raised some questions from analysts that it appeared a U-Turn from the draft determination. Cox said Ofwat was not satisfied with the planned investment Thames set out, so allowed extra funding. The extra cash comes with gateway conditions including co-funding by the company’s owners and adherence to specific performance measures that do not apply to other companies.

The revised plans may bridge the gaps and prevent the company seeking a referral to the Competition and Markets Authority (CMA).

With the review being called the toughest yet, referrals are expected in the coming weeks, but Cox would not comment on how many there may or may not be – or how it would reflect on the regulator if no companies take the route.

Cox added Ofwat is “fully prepared for” making referrals to the CMA. “These determinations are judgments that we make using all the tools available to us. We do our best job. Companies may accept them; they may decide to take a different view. That’s their call. And we will wait and see in January and February what the outcome is.”

Companies have until mid-February to either accept the determination or request a referral.

Total expenditure could be a point of contention, especially for Anglian, which has a £744 million difference between its business plan and the FD. Yorkshire, Northumbrian, Southern and Wessex also each had significant gaps to meet the regulator’s expectations of totex. An industry insider told Utility Week these are tipped to be referred to the CMA.

Ofwat pointed out the gap in totex between draft and final determination “is one of the smallest ever” at 4 per cent across all totex, however for companies with millions of pounds to make up while also reducing bills it may not feel so small.

Ofwat upheld its position that an “efficient company” should be able to finance the business plans but had lowered the underlying efficiency case from 1.5 to 1.1 per cent, which now applies to all base costs and metering enhancement costs.

When questioned on the rationale for lowering the efficiency case David Black, director of finance and governance, said the figure was based on general productivity shift across the economy and gains from the totex and outcomes.

Black said: “the net impact is relatively small attenuation in the efficiency adjustment,” because it applies to the broader base of costs.

Financebility of business plans was referred to by multiple companies in their responses to DDs with Ofwat’s expectations being called unworkable and unachievable.

Director of risk and return Andrew Chesworth said Ofwat has retained its overall approach to the assessment of financebility. “In doing so, we assume each company is able to achieve the benchmarks and performance commitments in our determinations.”

He said companies credit rating is stated at least two notches above the minimum investment grade for the notional capital structure, however S&P and Moodys each warned that credit ratings are likely to fall following these plans. Indeed S&P said 11 of the 14 companies it rates now have a negative outlook.

Chesworth added the credit agency views have been considered and the financial ratios are slightly higher than the previous price review.

None of this will be a shock to the companies involved, they were aware of the transition from RPI to CPIH as an inflation measure and a lower allowed return on capital. The regulator encouraged companies to prepare their structures to improve financial resilience.

Chesworth said some will need to go further to ensure resilience and Ofwat will monitor actions as they are implemented and even challenge companies that are not doing sufficient.

“Our representations also represent an opportunity for companies to become more efficient, harness the power of innovation and to deliver today and tomorrow for customers and the environment. Companies that embrace this opportunity will earn rewards,” he concluded.

On trust and reputation, the sector has made its own efforts to improve with the Public Interest Commitments and a trickle of companies enshrining public interest into their businesses.

Chief executive Rachel Fletcher said the regulator wants the water sector to “lead the way” on adding greater public value therefore Ofwat will push on board leadership, policies on executive performance pay and dividends and the incentives in the price review. She said the incentive mechanisms in the previous price review period showed what companies could do “when they put their mind to it”.