Ofwat tipped to relax water company performance metrics

Ofwat is expected to relax its outcome delivery incentive (ODI) benchmarks for the next asset management period (AMP8) to maintain investor confidence in the sector.

That is according to ratings agency Fitch, which has predicted that Ofwat will “opt for a measured approach” when setting performance targets in the upcoming PR24 draft determinations.

It said that the regulator is expected to rule that the current ODI benchmarks are beyond what is achievable during the next asset management period (AMP8).

Fitch said the change of approach is a direct result of performance during AMP7 where the majority of companies incurred ODI penalties. Severn Trent and United Utilities were the highest ODI performers, while Thames and Southern were rated as “below-average”.

Specifically, Fitch said that Ofwat may increase the revenue-at-risk in the ODI framework due to the challenging AMP8 targets, which could temper investor confidence.

“We expect that Ofwat may ultimately opt for a less-challenging stance in setting these ODI benchmarks,” Fitch said.

“Ofwat may suggest that the standards could exceed what is reasonably achievable for water networks if a significant portion of the industry experience net penalties, given their operational realities.”

The agency also stated that companies with low rating headroom would likely require equity injections to stay within Ofwat’s licence conditions.

Last year, Ofwat updated water company licences to state they must maintain minimum BBB/Negative, with effect from April 2025. These have been factored into “most” company submissions, Fitch noted and added these will be dependent on the outcome of companies’ price reviews.

The ratings agency added: “We anticipate that investment committees will be weighing the draft determination’s risk-return balance in their funding decisions, despite a willingness from shareholders to support their respective water companies.

“This consideration is crucial to ensuring that credit ratings maintain adequate headroom in the face of higher totex.”

Fitch highlighted Southern and Thames’ parent company Kemble as “negative outliers” in terms of inadequate headroom. It also pointed to United Utilities’ limited headroom and said it anticipates “significant” investment above its baseline allowance to provide headroom.

Its own forecasts for AMP8 ratings will be based upon the weighted average cost of capital specified in Ofwat’s draft determinations, due 11 July. However it said “in most cases” it will wait for the final determinations to be published before taking rating actions.

Fitch outlined that it anticipates a higher WACC in the draft determinations by Ofwat than in its 2022 methodology.

It outlined that the sector is set to double its total expenditure (totex) over the five years to 2030, which will be driven by the need to meet new statutory targets.

“The increase in totex will be largely driven by higher investments in combined sewer overflow (CSO), pollution reduction, and nutrient mitigation, as water and wastewater companies attempt to meet tougher statutory requirements,” it added.

In total, water companies are asking for more than £100 billion to fund their work during the next asset management period.

However, senior figures within the water sector have told Utility Week that they expect spending asks to be watered down which could lead to a record number of formal appeals lodged with the Competition and Markets Authority (CMA).

Concerns have also been raised with the revised timetable for PR24, with senior figures describing it as “very problematic” and “borderline ridiculous”.

After being forced to move the publication of the draft determinations from 12 June to 11 July because of the general election, Ofwat has also shunted the timeline for the rest of the process.

Final determinations are now earmarked for 19 December, however Ofwat has also set a “backstop” date which gives the regulator until 31 January 2025 to publish its final rulings.