Water 2020 proposals ‘credit negative’ for water sector, analysts warn

Ofwat's proposed changes in its approach to PR19 - Water 2020 - would be "credit negative" for the water sector if implemented, analysts at Moody's have warned.

Individually, the proposals would be unlikely to have a “significant” negative impact over the medium-term.

However, the rating agency’s vice president and senior analyst Stefanie Voelz said they would decrease the stability and predictability of cash flows for the water and sewerage companies over the medium to long-term, “which will be credit negative”.

While the proposed changes are credit negative for the sector overall, companies’ individual exposure varies.

Reforms relating to sludge treatment and disposal, for example, will only affect the larger companies, while the smaller water-only companies are more exposed to the move towards consumer prices indexation (CPI) of revenues and regulatory capital value (RCV), or a new approach to setting the cost of debt allowance.

Smaller companies also have most to lose from the introduction of retail competition.

Moody’s noted that proposals to set tariffs for sludge under a separate price control, and on the basis of a price rather than a revenue cap, from 2020 will expose sewerage companies to volume risk. There is also potential for full competition from 2025 – “a further credit negative”.

The agency added that Ofwat’s proposals to move from retail prices index (RPI) to CPI measure of inflation could “pressure returns” and lead to changes in the timing of cost recovery, if bill increases are to be avoided.

The regulator’s Water 2020 proposals come at a time of “heightened political scrutiny”, it said.

In December last year, the Treasury announced plans to extend retail competition to household customers, subject to a cost/benefit analysis to be carried out by Ofwat by summer this year.

And a recent report by the House of Commons Public Accounts Committee (PAC), published 13 January, suggested that Ofwat had consistently overestimated water companies’ financing and tax costs when setting price limits and called for the regulator ‘to secure a better deal for customers’.

Ofwat will set out its final proposals for PR19 in May 2016.

Based on these, the regulator will consult with companies on licence changes to implement its proposals during the second half of 2016, and before finalising the framework and approach for PR19 in autumn/winter 2017.