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Profits and investment in the water industry

Water UK briefing

May 2012

Water companies are required to meet their customers’ needs and statutory obligations efficiently, within price limits that are set by a regulator.
 
They also have to ensure that they win their investors’ confidence, by delivering a fair return on the investments made – like paying the interest on a mortgage. They do this by paying interest and dividends from their profits.
 
Getting this balance right between performance and returns allows them to access funds at the lowest possible rate. The cost of borrowing directly affects customers’ bills, and it is in all parties’ interests to keep it low.

Water companies and customer water bills are closely regulated

Public water services in England and Wales are provided by private sector companies. These companies deliver levels of service that are carefully agreed with their customers, and are additionally required to meet strong economic, environmental and quality regulation requirements.

The Drinking Water Inspectorate, the Environment Agency and Ofwat, with strategic guidance from the government, set the priorities and the standards the industry is legally obliged to meet. The Consumer Council for Water is the statutory consumer representative body.

To finance the work that water companies undertake, they are allowed to charge their customers according to strict price limits. These are set by Ofwat every five years.

In agreeing how much money companies can charge through water bills, Ofwat undertakes a detailed review of the business case that companies bring forward to deliver the day-to-day service (operating expenditure) and invest in the infrastructure for the future (capital expenditure).

After looking at the water companies’ long term strategies, business plans and investment requirements, Ofwat sets an annual price limit and then a series of performance targets. This price limit includes a declared amount of profit that the independent regulator judges companies will need, to finance all that they do sustainably, whilst keeping bills at levels customers will accept.

At the moment, companies are judged to need a return on their assets of around 5%, meaning that for every £100 that their investors put in, they should expect to get approximately £105 back.

By investment standards, the return is reasonable but not high. The stringent regulation of the water sector, complemented by the record of achievements by the companies, does though mean that, when compared to an uncertain investment climate around the world, it is currently low-risk. With many billions of pounds being borrowed by water companies each year – just like a mortgage – the bondholders, banks, pension funds and wider investors all expect to see the collective sector keep the risk low, and water companies give them a fair return on their money.

To gain further rewards, the system of regulation actively incentivises the companies to keep improving against the Ofwat targets. If water companies manage their business to give even higher levels of performance and efficiency than are agreed, they are able to keep the additional savings in the short term.

Customers benefit from this too, as once prices limits are set again at the next price review, the regulator resets the benchmark, taking into account the higher performance targets and giving the savings straight back to customers. This ongoing pressure to improve, or ‘incentive based regulation’, means that all parties get the benefits. The regulatory system has brought about significant savings over the years.

Where does the investment go?

The water companies play a significant part in almost every aspect of our daily lives, providing household water supply and sanitation, supporting the business infrastructure and playing a major part in the stewardship of our environment.

More than 17 billion litres of water comes out of the environment each day to meet society’s needs.

The high levels of water company investments go into:
 • Giving household and business customers the levels of service and performance that they demand
 • Providing one of the highest quality tap waters in the world
 • Working to keep improving the health of our rivers, streams and beaches
 • Seeking to reduce the impact of the public water and sewerage services on the environment
 • Supporting wildlife and their surroundings
 • Investing in water resources and flooding measures to meet the changing weather patterns.

Outcomes

 • Between 1990 and 2012 the water industry will have invested around £100 billion in England and Wales – around double the rate of investment from when it was in public ownership.

 • This still gives household customers all of their water and sewerage services for an average price of £1 a day. Customers receive premium quality tap water at a price of around one penny for 50 glasses, that is equivalent to two and a half tonnes for the price of one high street coffee.

 • In independent studies by the Consumer Council for Water, customer satisfaction with water and sewerage services remains high.

 • Companies keep working to remove customer complaints, reducing levels by almost a third over the past three years.

 • Water company leakage is among the lowest in the world. Levels of leakage have continued to improve for a number of years and are now almost 40% lower than they were in 2002.

 • Environmental improvements have been significant to date, with further investment and progress ongoing.

 • Achieving the right balance of high performance and low risk with measured returns for investors has allowed companies to access funds at competitive rates. The cost of paying for the money that is borrowed directly affects customers' bills, and it is in all parties' interests to secure a good deal.


© Water UK

Thu 17 Apr 2014, 11:57
http://www.water.org.uk/home/policy/positions/investments