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The efficacy of the regulatory stick was clear this week, as the majority of water companies fell into line with their revised business plans. Wessex Water, United Utilities, Severn Trent – even the usually recalcitrant Thames Water bowed to the inevitable and accepted Ofwat’s 3.85 per cent vanilla weighted average cost of capital (Wacc). Mind you, Thames is never far from the negotiating table; it says the sums don’t add up and that the only way it can make the lower Wacc work is by holding back £108 million of wholesale cost savings. This latest sally is unlikely to be the last round in the negotiation, but there are at least some horses to trade for the regulator and the UK’s largest water company.
Not so for some of the water-only companies (Wocs) – notably Sutton and East Surrey Water (SESW), which has bid for a 4.75 per cent Wacc. As Yes, Minister’s Sir Humphrey Appleby might say, a brave move indeed. The Woc argues that it has independent research proving it requires this level of investor return to remain financeable. Ofwat will beg to differ – its trump card being the fast-tracked Woc Affinity Water, which, it will say, has proved that a well-run and efficient Woc is perfectly capable of accepting a lower rate of return.
Wocs used to benefit from a financial allowance made for small companies, and SESW will argue that nothing has changed since that allowance was removed. Ofwat itself has said that it will listen to smaller companies who argue for more money – but that there must be evidence of customer benefit, and the bar for that evidence will be set high. With the counter-example of Affinity Water and its recent track record of relentless focus on affordability, Ofwat seems likely to reject SESW’s bid.
If the Wocs say they can’t run at the allowed rate of return because they don’t have the efficiencies of scale, there is an obvious answer. Ofwat opened the door to mergers in the water sector earlier this year, and chief executive Cathryn Ross told analysts in April that changes to the industry structure might be appropriate. Is time running out for the Wocs?
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