Water-only companies’ PR19 plans rated poorly by Ofwat

Ofwat chief executive Rachel Fletcher was unimpressed by the business plans of the big water companies – and their water-only counterparts performed equally poorly, writes Nigel Hawkins

Ofwat chief executive Rachel Fletcher was clearly unimpressed by most of the business plans submitted by the ten privatised water companies, judging by the poor grades assigned under the nine test areas. Their smaller water-only brethren did not do any better.

In reaching its conclusions, Ofwat drilled down into every conceivable detail of the business plans – and even queried Affinity’s metaldehyde treatment costs.

With six water-only companies under review (the Severn Trent-owned Hafren Dyfrdwy is now treated along with the privatised ten), 54 A grades were theoretically up for grabs. In the event, not a single A was awarded – no obvious “best of breed” there.

However, there were seven Ds, with Affinity – one of Ofwat’s golden boys at the previous price review – relegated to the unwanted “significant scrutiny” category. The other five companies under review were, as expected, all accorded Ofwat’s “slow-tracker” status.

In analysing Ofwat’s conclusions, three particular themes emerged.
First, considerable concern was expressed under the “Securing long-term resilience” heading. In some cases, Ofwat was not convinced that a sufficiently high priority had been accorded to this issue.

After all, some of these companies’ origins date back to the 19th century, so rapid change, despite population increases, is hardly part of their DNA.

Second, the cost base was a recurring theme.

Ofwat extolled Portsmouth’s costs, saying “its base costs are the most efficient in the industry”. Strangely, it was not enough to warrant an A under the “Securing cost efficiency” head, since Ofwat was less persuaded by Portsmouth’s proposed reservoir development.

The cost outlier was SES – the re-branded Sutton & East Surrey – whose residential retail costs were deemed to be some 50 per cent above Ofwat’s efficiency benchmark: the comparable excess for SES’s company level costs was 22 per cent.

Third, for several companies, Ofwat expected a clearer dividend policy, presumably seeking long-term dividend commitments that few companies are prepared to make.

Having had extensive form with Ofwat and the Competition and Markets Authority’s (CMA’s) predecessor, Bristol’s business plan was better received than previously. Its proposal of a 6 per cent cut to real bills between 2020-25 was welcomed; such a scenario differed markedly from its contentious 2014/15 submissions.

Ofwat also could not resist highlighting the marked improvement, compared with the 2014/15 business plan: the cost inefficiency gap has been more than halved. Less well-received was its application for a “specific cost of debt adjustment”. Ofwat has hinted that an equity raise should be considered instead. Ask your shareholders for more funds, not us, is the underlying message.

However, Bristol’s past was reflected in a D rating under the “Accounting for past delivery” heading.

Portsmouth enjoys almost as lengthy a heritage as Bristol – the companies were founded in 1857 and 1846 respectively. On the cost front, Portsmouth has deservedly taken plaudits. However, under every other head, it was marked with a C. In this case, consistency was less of a virtue. Aside from doubts about its dividend policy, Ofwat also focused – somewhat curiously – on Portsmouth “using financial levers to move money between periods without providing sufficient evidence or explanation…”.

A rising population is central to any analysis of South East’s long-term plans. Ofwat has expressed concern about its resilience and specifically whether its finances are robust enough to ensure the necessary credit rating. Furthermore, Ofwat disputes South East’s enhancement costs, which it concludes are “inefficient”. This element has pushed its wholesale water costs to c23 per cent above Ofwat’s benchmark.

And South East picked up an unwanted D under the “Accounting for past delivery” heading. Various poor performance issues were cited.

South Staffordshire was also given a D as Ofwat lashed into its perceived lack of resilience.

Ofwat’s criticism was strident. “The plan provides little evidence that the company will be financially resilient in the long term”, it said. The regulator also doubted South Staffordshire’s capacity to maintain its targeted credit rating. Overall, though, South Staffordshire somehow avoided the dreaded “significant scrutiny” category.

Ofwat’s conclusions on the business plan submitted by the Japanese-owned SES Water centred on its inflated cost base: it was rated a D in this category. And, under the “Securing confidence and assurance” head it did little better, with another D being recorded. Several financial concerns were highlighted.

Ofwat’s verdict on Affinity was rather unexpected, given how strongly its star had shone previously. But Ofwat is clearly not persuaded by its water supply resilience strategy, although the seemingly never-ending Abingdon reservoir project is led by Thames.

Concerns on this front, which also cover high gearing, and on the “Aligning risk and return” head led to two Ds – and effectively propelling Affinity to an overall “significant scrutiny” rating.

Like Wessex, Affinity also earned a reminder for its efforts to secure a higher weighted average cost of capital (Wacc) – an apparent no-no in today’s regulatory environment, which is very different from the 1990s era of Transco’s bare knuckle fight over the Wacc with Ofgas.

No doubt the resubmitted business plans will have addressed many of the above issues.

Nigel Hawkins is a freelance writer and utilities sector analyst at Hardman & Co.