Regulated water sector rated ‘at risk’ ahead of PR19 ‘challenges’

The UK’s regulated water sector has been classed “at risk” by global credit ratings provider Standard & Poor’s (S&P) which also identified the upcoming price review and subsequent AMP as a key cause for concern.

The finding comes as part of the S&P Industry Top Trends 2018 report for regulated utilities in the EMEA.

Generally, this report suggested regulated companies are likely to “mostly retain their excellent business risk profiles” thanks to regulatory reviews which have put “additional, but manageable, pressure on the sector”.

But in the case of UK water companies, S&P described elements of Ofwat’s final framework for the 2019 price review (PR19), as “challenging”. In particular it raised concerns about the impact of a significant cut in the allowed cost of capital, as well as more rigorous benchmarks on costs efficiency and service performance.

“These elements could lead to pressure on the ratings of UK water utilities,” said the report.

“This said, PR19 is still in an early phase, and water companies maintain some flexibility to mitigate the negative impact by modifying their financial policies and by implementing efficiency measures.

“We expect to be in a better position to determine the credit impact on each company individually from January 2019, once Ofwat provides its initial assessment of the companies’ business plans.”

Looking ahead, S&P predicted that Brexit is unlikely to impact the regulated utilities sector where business operations are “fairly insulated” and access to capital markets stays strong. Yet growing public criticism over affordability and below-average operators remain issues.

Overall, S&P described rating trends as mostly stable, with broadly unchanged regulatory frameworks underpinning cash flow and credit strength. Though, those entities with increasingly leveraged financial structures and stretched credit metrics will face pressure during regulatory reviews it warned.

It observed that a combination of high leverage with average to below-average service quality is particularly likely to draw fire from politicians and regulators.

Under certain circumstances, said the S&P report, these risks may warrant dividend cuts or capital increases to restore balance sheets.

S&P said capital spending across regulated utilities is likely to remain high in 2018 and identified the need to integrate increasing volumes of renewable energy as a key driver for significant investments.

Meanwhile, it noted unregulated utilities also face a range of challenges this year. S&P forecast technological disruption, uncertain energy policies, a burgeoning renewables landscape and conflicting power market design in Europe as high impact issues.

Nevertheless, it concluded: “The sector outlook is broadly stable and improving, supported by a more benign market environment (improving power prices and macroeconomics) as well as effective and fast delivery of strategic plans by companies to adapt their business models and restore their balance sheet.”

The ability of firms to effectively deliver on these strategies will define companies’ capacity to achieve sound operating and financial performance in 2018, said S&P.