Ofwat signals ‘transformation’ for UK water with lowest-ever returns

Ofwat has issued an allowed return of 2.96 percent for the UK water industry’s next regulatory regime, the lowest since the sector was privatised in the 1980s.

The UK water regulator said the adjustment was a “reasonable return” for both debt and equity investors and was made using market data available up to the end of September. Ofwat said it would allow companies to deliver projects on “reasonable terms” while protecting consumers in the long term.

The regulator added that companies whose performances were better or worse than the benchmarks set would earn higher or lower returns than the allowed rate. Each company will be assessed according to the business plan it submitted to Ofwat this year. In July, Ofwat rejected 14 of the 17 companies’ business plans as it did not feel they met the required standards.

“If it is set too high, customers will pay more for their water bill than they would otherwise have done,” Ofwat stated. “They may also feel that companies are making excessive profits, and lose trust in our regulation. If it is set too low, it could jeopardise the ability of efficiently run companies to raise finance on reasonable terms and so provide a high-quality service to customers.”

The now-approved plans will see combined investment of £51 billion ($68.1 billion; €61.1 billion) to improve services, with £13 billion allocated towards providing resilient services and environmental improvements in the face of a growing population and the risks posed by global warming. Consumers are also expected to see a £50 reduction in their bills from 2020 to 2025.

In a statement, Ofwat chief executive Rachel Fletcher said: “Today we’re firing the starting gun on the transformation of the water industry backed by a major investment programme to deliver new, improved services for customers and the environment and resilience for generations to come.”

Cleaning up

Ofwat’s decisions come after a regulatory period in which it delivered record penalties. In June, it imposed a £126 million penalty on Southern Water. Last year, it levied a £65 million fine on Thames Water.

Both penalties were due to leakage offences by the companies, and Ofwat has said that the new regime is intended to cut leakages by 16 percent. The regulator said that since issuing a draft determination earlier this year it had also made changes following a consultation period with stakeholders.

A note to investors from Ofwat, and seen by Infrastructure Investor, stated: “These revisions include higher cost allowances, a reduction in target levels for some key performance commitments, and revisions to outcome delivery incentives and bespoke cost sharing rates”. The note also stated that the allowed return had been reduced by 23 basis points to reflect market realities.

“Ofwat has moved a reasonable way towards what companies would need in order to deliver their plans,” said Peter Antolik, partner at Arjun Infrastructure Partners, which has owned South Staffs Water since its acquisition from KKR in 2018.

“A lot of companies will be having pause for thought on the outcome delivery incentives. The reality is that whereas in previous years incentives were based on customer service and operational performance, those incentives were not particularly large and it was relatively easy to see how companies could achieve those outcomes.”

Ratings agency Moody’s warned last week that the sector as a whole could experience the largest deterioration in credit quality since privatisation as a result of Ofwat’s decisions.