30/10/09
Regulators must at least ensure that foreseeable problems do not return to haunt investors and consumers.
By the end of the year, the water regulators for England and Wales, Scotland, and Northern Ireland will have published final determinations of price limits for their regulated water companies for the next five
years (three years in Northern Ireland).
In all parts of the UK, the challenge facing the companies is essentially the same. They must deliver an efficient, affordable and sustainable service for customers, in times that have become increasingly difficult because of the slump, the pressure on water resources and the need to address climate change.
All companies have been aware of the need to constrain investment to essential priorities. In England and Wales this can be seen in companies' own 'self-censorship' of their business plans between draft and final submissions, guided by detailed consultation with customers. But cutting back too far could threaten the service now and in the future.
A strong water infrastructure is essential to a healthy economy and society. While there is rightly a debate about limits on the role of economic regulators, and the division of responsibilities between government and regulators, at present it falls to regulators to find a sustainable balance in setting price limits.
It is rational for regulators to wish to keep down prices in difficult economic times and to be seen as "tough" when regulation has suffered reputational damage. However, it is here that regulators can demonstrate the value of their independence. Reaching determinations that avoid short-termism and whose credibility is secured by robust and transparent analysis will provide much-needed confidence
in the face of the many downside risks in today’s uncertain economic climate.
Of particular concern is the ability of companies to raise finance efficiently to secure the investment required. The challenge facing the private companies in England and Wales is different from that of Scottish Water and Northern Ireland Water, which depend on public finance.
Ofwat, for the companies in England and Wales, should note the results of the independent survey of investors it recently supported, which found considerable unease among investors regarding the draft determinations. The survey concluded that "regulatory action is causing investors to reappraise the virtues of UK infrastructure as a home for their funds".
Despite recent 'green shoots' in financial markets, there is still significant volatility, the possibility of a double dip recession, a wide range of expectations around inflation, and a real risk that the cost of debt will rise as the full impact of quantitative easing unwinds. Investors need reassurance that Ofwat has not
set all parameters so tight that there is no room to absorb such risks – and, for equity investors, who are the backbone of an incentive-based regime, that there remains scope for outperformance.
In Scotland and Northern Ireland, economic circumstances are again challenging the public finances. For customers this could mean the sustainability of their services is held to ransom by the politics of public spending. To secure the necessary investment, Scottish Water’s and Northern Ireland Water’s regulators and government owners need to make sure sufficient finance is provided through water charges and government loans (and subsidy in the case of Northern Ireland) – and that appropriate risk buffer mechanisms are put in place. Without this, and with no equity buffer, service will suffer.
Across the UK, the economic climate has made the present price review processes a bumpy ride. In their final determinations, regulators can at least make sure that foreseeable problems do not come back to haunt investors and customers. Whether or not there is further scrutiny in Competition Commission referrals, there is an urgent need to rethink regulation in all areas, in terms of its institutional framework, processes and methodologies and their application. More competition may be a part of this, as proposed by Cave, but it will not be a panacea.
In reviewing regulation, there are two central questions: how to marry a public service ethos with private incentives and how to elicit the behaviours that will secure financial, environmental and social sustainability.
Contact: Water UK Communication
This article appeared in Utility Week 30 October 2009.
