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Upstream reform could result in a “significant deterioration” of the credit quality of the UK water companies, Moody’s has warned.
The credit rating agency stated in a report that reform to upstream activities, such as water resourcing and sludge treatment, could significantly damage the financial standing of the incumbent water companies.
It states that if full functional unbundling of the value chain is implemented, it would introduce volatility into the cash flows of the incumbents because of the potential influx of new entrants in various sectors of the industry.
However, it stated that the introduction of competition and markets to that extent is unlikely in the short to medium term, although increased trading and the entry of third parties to provide new assets is possible for PR19.
This “may have material implications” as incumbents may be competing to develop new assets out of region for lower costs, or as other parties come in to develop assets within their area, reducing the regulated capital value in the longer term.
Moody’s vice president and senior analyst Stefanie Voelz said: “We expect regulation to adapt to changing circumstances and reform could lead to little change in the credit quality of the water companies, but competition could also result in a significant deterioration – even if we consider this less likely.”
The report says that while business and financial risk implications of upstream reform could be small depending on the scenario, existing financing arrangement might constrain reform.
Voelz added that any “adverse changes might trigger covenant breaches in the sector’s financing arrangements”.
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