Two fast-tracked for PR14

Affinity Water and South West Water have had their business plans put forward by Ofwat to be fast-tracked through PR14, and the rewards and prestige are considerable, says Conor McGlone.

South West Water and Affinity Water have pre-qualified for “enhanced” status, meaning they can take a fast track through the current price review, PR14, as long as they accept some of Ofwat’s conditions, the most significant of which is a weighted average cost of capital (Wacc) of 3.85 per cent. The upside for playing ball is huge: as well as the stability and speed provided by fast-tracking, the companies would receive financial benefits totalling up to £24 million. But the Consumer Council for Water (CCWater) has questioned the wisdom of offering companies these financial incentives, because ultimately it will be the customer paying for them.
So what have South West and Affinity got that the rest don’t? The documents Ofwat published on Monday set out where the companies scored high. Speaking to Utility Week, Ofwat director of economics David Black singles out South West’s customer engagement. It was the only water company to receive an A-grade in this category, which considers the quality and breadth of engagement, dialogue with other regulators, and whether robust evidence has been developed and used throughout the plan
Getting its Customer Challenge Group (CCG) to agree to and endorse its business plan, which received a customer approval rating of at least 84 per cent, was another tick in the box for Ofwat
Affinity Water scored points for agreeing with the Environment Agency to reduce the amount it abstracts by 42 million litres a day by 2020 – nearly 5 per cent. It is also proposing to reduce demand through metering and water efficiency. It has proposed a target of cutting leakage by 14 per cent by 2020.
According to Ofwat, it also acknowledged the impact the Thames Tideway Tunnel would have on the bills of those of its customers served by Thames Water for sewerage. It therefore went to work with its CCG to devise a programme to inform customers of potential price changes and has taken steps to mitigate the impact on vulnerable and low-income customers. Affinity Water has also committed to introducing a social tariff in April 2014, which it expects will attract up to 30,000 more vulnerable households.
For the two companies that received the golden ticket, the next step is to deliberate about whether to accept Ofwat’s January guidance on risk and reward and so take the fast track. They have until Monday to decide.
Given the financial incentives on offer, it probably will not be a difficult decision. On top of “initial awards” of £11 million and £4 million, respectively, the two companies will benefit from a package of outperformance incentives which could be worth an additional £6 million for South West and £3 million for Affinity Water.
South West says it will “work closely” with the regulator to be in a position to respond by Monday, while Affinity Water says it will “consider carefully” Ofwat’s risk and reward guidance.
But this raises questions. The companies choose how to fund the financial incentives, but ultimately customers pay. Does it make sense to reward companies for customer-friendly business plans by allowing them to charge more? Black thinks so. He tells Utility Week: “We felt that there was significant value to customers in terms of the development of a high quality plan and that we should recognise this.”
However, CCWater sounds a note of caution. Chief executive Tony Smith says: “We know that most customers are not in favour of incentives and don’t want to pay more to encourage water companies to provide a good service. We will be pushing the companies and regulator to take account of this.”
Black argues that the impact on bills could be minimised by how the companies choose to take up their incentives. For example, adding their reward to their regulatory capital value at the beginning of the period and recovering it over time would be easier on bills, he says. “We have been clear that a high quality business plan will see an appropriate sharing of risk and reward. We are determined that customers should share in that efficiency saving.”
Smith is also surprised that South West was picked out, since it has the highest bills in the UK, and this is “the subject of ongoing customer concern”.
However, Black says South West, which has to look after more coastline than any other company, has committed to reducing bills in real terms by 2019/20, while it has frozen bills until April 2015.
Meanwhile, the rest of the industry has until 27 June to submit adjusted business plans. Those who can submit early, by 2 May, will receive their draft determinations early. As the other companies knuckle down to the work of redrafting, South West and Affinity will be the only ones celebrating this week.