Wacc crashes to 2.4 per cent

Ofwat has signalled a record low cost of capital as part of its PR19 methodology, published today (13 December).

The document includes an initial view of the cost of capital of 2.4 per cent in RPI terms, which would be a record low for a regulated utility. Ofwat said it estimates this reduced cost of capital could result in an average saving per customer of £15-£25 per year from 2020 onwards.

The cost of capital is the allowance Ofwat makes within its price controls for the costs of raising debt or equity to fund improvements. The 2.4 per cent figure represents a material reduction of 1.3 per cent since PR14, driven by lower expectations of the market cost of debt and equity, Ofwat said.

Ofwat insisted the reduction should not come as too much of a shock to the industry. When it published its draft PR19 methodology, the regulator warned water companies to expect a “significant” reduction in the weight average cost of capital (Wacc).

However, industry participants which spoke to Utility Week had been expecting the Wacc to be confirmed at 2.6 per cent.

In its methodology document, Ofwat said that having considered the range of evidence available to it, it considers a more tightly-bounded plausible range for the Wacc is 2.2 per cent to 2.6 per cent.

Table: Ofwat’s early view of the cost of capital

David Black, senior director, Water 2020 told Utility Week this shouldn’t be of significant surprise for the industry, as the regulator had signalled this was the direction of travel in July. “Obviously it is much lower than it was previously, but this does reflect the fact that they [water companies] can borrow for lower cost in the market, so we think there should be an appreciation that this is the world that we live in.”

Ofwat will review the cost of capital at the draft and final determinations. Utilities analyst Nigel Hawkins told Utility Week the initial headline figure is “tougher than most forecasts”, but whether it will endure at the final determination “remains to be seen”.

The PR19 methodology is centred on four themes – great customer service, long-term resilience, affordability, and innovation. It challenges water companies to “step up”, and excepts significant increases in customer service.

Commenting on the publication of the document, Ofwat chief executive Cathryn Ross said the next decade will see “profound changes” in customers’ expectations and the regulator is pushing the water sector to be at the forefront of that.

“The methodology we’ve published today outlines how we will use our price review to get the very best for customers, through higher quality of service and support for those who need it most, all with scope for lower bills.

“We’ve said many times already that this will be a tough price review for companies. We will cut the financing costs they can recover from customers and, with this lower guaranteed return, they will need to be more efficient and innovative than ever before. I’ve no doubt that the sector can step up and meet the challenges we’ve laid before them today.”

Water companies must submit their business plans by 3 September 2018, with Ofwat due to make its initial assessment and categorisation of plans in late January 2019.

Early draft determinations will then be made by March or April 2019, and other draft determinations by July 2019. Final determinations will be set out in December 2019.