Four UK water companies have been declared provisionally successful in their appeal against regulator Ofwat’s price controls following a review by the country’s Competition and Markets Authority.
In February, Anglian Water, Bristol Water, Northumbrian Water and Yorkshire Water appealed against Ofwat’s determination for the 2020-25 period. The companies argued that the proposed 2.96 percent cost of capital would not provide investors with a reasonable rate of return or incentivise them to invest in making the sector resilient over the long term.
The CMA has provisionally agreed with this view and has raised the cost of capital to 3.5 percent. This measure will only apply to the four companies that appealed against the controls and will not be applicable to the other 13 water monopolies.
“The allowed rate of return in the CMA’s provisional findings is lower than in previous recent water price controls,” the authority said in a statement. “This largely reflects market movements and means that customers will still receive lower bills in the CMA’s provisional findings for the 2020-2025 price review, although they will be higher than those under Ofwat’s price control. This reflects the judgements the CMA has made about financing investments that are needed in the sector both now and in the future.”
According to the CMA, more funding has been provided to the companies for projects to address leakages and challenges associated with climate change, while the incentive regime has been rebalanced to better promote efficiency.
The decision, which will be open to consultation for four weeks, was hailed as “a significant move in regulatory approach” in a statement by Liz Barber, chief executive of Yorkshire Water, which is owned by GIC (33.6 percent), Corsair Capital (30.3 percent) and DWS (23.4 percent).
“We are seeing some promising early signs that Ofwat recognises that PR24 needs to be very different,” she added.
Anglian Water, which is 32.9 percent owned by the Canada Pension Plan Investment Board, also praised the move. CPPIB declined to comment beyond the company’s statement. However, its managing director Neil King told us in an interview recently that “there have been trends in regulation which have reduced returns – to some extent, I think reasonably, but sometimes unreasonably”.
A warning sign for Ofgem
The decision by the CMA to boost the cost of capital as much as it did was an unexpected development for some in the sector.
“I was surprised by the provisional cost of capital being so high, given the relative perception of risk for investors in the two industries,” said Colm Gibson, head of economic regulation at the Berkeley Research Group. He was referring to a decision earlier this year by the CMA on air traffic control charges, which were lower than those for the water industry.
However, Gibson said the decision would have a significant impact on the price controls currently proposed by Ofgem. The UK energy regulator has initially set allowed returns for its next price control period of between 3.9 percent and 4.2 percent.
“Ofgem and Ofwat were in a very similar position on cost of capital,” explained Gibson. “I envisage Ofgem will be forced to rethink its approach to cost of capital. I don’t believe it’s got any choice other than to rethink it. If any of the companies refer it to the CMA, you have a strong indication of what the answer is going to be. The regulator is very tied.”
In a statement, Ofwat’s chief executive Rachel Fletcher said: “Our final determinations demanded a step change from the sector, so it is unsurprising that four companies considered the challenge uncomfortable. We respect the CMA and will look closely at their analysis before submitting further evidence to inform their final decision in December.”