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Ofwat has proposed changes to how allowed returns are calculated in the financial model for the next price review period.
At present the PR24 approach calculates the return on regulated capital value (RCV) by multiplying the real wholesale weighted average cost of capital (WACC) by the average RCV balance during the year.
Ofwat suggested this model may over reward companies and said there was a “clear case” for amending the approach.
This could be done by adjusting the WACC or amending the return on RCV calculation, Ofwat said, and proposed the latter as “more transparent and addresses the issue in a clearer way”.
An external review of the PR24 methodology raised concerns with how returns are calculated. It suggested the current formula was not present value (PV) neutral.
It proposed formulae that would ensure exact PV neutrality and is consistent with the common convention of midyear cashflows.
The proposed approach uses the formula:
Ofwat said: “We have considered how the new formulae work when inflation is factored into he calculations. We conclude that no further adjustment is needed to account for inflation.”
The consultation will run to 16 May.
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