24/07/09
Ofwat's price proposals are tailored to the times and its understanding of customer wishes. But could there be unintended consequences for all interests in the medium term?
Ofwat’s presentation of Draft Determinations yesterday highlighted a proposed cut in water bills over the next five years, emphasising the benefits for customers. The regulator accepts that difficulties facing customers in tough economic times have been a major factor in its considerations, driving a hard-nosed look at company business plans.
But both customer representatives and investors will want to consider whether the proposals are a step too far in this direction. Do they, for instance, pose a threat to the financial stability of an essential industry? And, by so doing, put at risk affordability and the health of the environment in the medium term?
It is true that the sector has successfully financed an £80bn capital programme since privatisation, requiring sustained access to capital markets. Companies have been able to secure finance at highly competitive rates, reflecting investors’ confidence in the transparency and stability of the regulatory regime. Yet this has not been without periods of doubt, for instance following the 1999 periodic review.
For investors assessing the impact of the proposals, the main concern will be whether the balance of risk and return has materially altered with Ofwat’s approach.
This is hard to assess from headline numbers, and particularly so at whole industry level. Each company has received a unique determination – a package deal of prices, investment, and assumptions on cost and efficiencies – that will need careful analysis.
Such analysis must go beyond an admittedly critical single number – the estimated cost of capital – to include all the factors influencing the returns companies can make, including confidence in the risk mitigation measures Ofwat is keen to promote and the strength of the incentives offering an ability to outperform.
At first sight, Ofwat’s proposals clearly strike many in the City and elsewhere as leaving many questions unanswered. If the devil is there, he will be in the detail. It will be to everyone’s benefit to stay on his case in the consultation period until 2 October and longer if necessary.
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For more information please contact:
Water UK Communication
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