Utility Week

UTILITY WEEK | 18TH - 24TH JANUARY 2019 | 15 Finance & Investment Key points: l Utility CFOs would like to see the debate on profits and returns to be "properly informed" and based on fact not hysteria. l Water CFOs expect a "very challenging price review", especially following the nega- tive credit rating given to some operators. l CFOs are having to make difficult decisions around competing demands for investment, such as upgrading ageing infrastructure, climate change resilience and cyber security – and the quality of this decision-making is the difference between success and failure. l CFOs are far more involved in their busi- nesses than 20 years ago and finance leaders must help drive the CEO's and board's vision for the business, its core operating models and how those can be made better over time. l Brexit is creating uncertainty and "inves- tors generally don't like uncertainty". l But new investment streams are opening up, with pension funds looking to support long-term sustainability projects. l Financial decisions will increasingly need to weigh up social good. For some finance leaders in the sector there's also the pure wild cards. It came as a surprise to many in the industry when the capacity market ground to a halt, leaving European Union officials red-faced and gaping holes in the finances of energy generators. On the retail side, competition is grow- ing, pulling customers away from the big six: SSE lost 460,000 customers in the year to September alone. This unbridled market competition is bringing its own turmoil – ten retailers have gone under in the past 18 months, before the price cap begins to take a seemingly inevitable toll. The tough oper- ating climate is one of the reasons why the City has fallen out of love with listed firms like Centrica, which has announced that the price cap is likely to see profits fall by £70 million in the first quarter of 2019. Martin Beesley, CFO of Morrison Utility Services, sees a new landscape emerging. "There are currently over 70 [suppliers] oper- ating, which is not sustainable in the long term. It's an evolving market with an inter- esting period that lies ahead as lower-cost suppliers, without the big legacy systems and associated costs, may be well positioned to flourish alongside established players." One thing is certain: the steady-as-she- goes regulated sector is looking increasingly bumpy. The CFO has a huge role to play in steering a safe passage through uncharted terrain. Brought to you in association with The impact of PR19 The most pressing and immediate challenge facing the CFO in the highly regulated util- ity sector of water and networks concerns the issue of legitimacy and its regulatory repercussions. CFOs must play with a more constrained financial hand, while still keeping investors keen and credit ratings high. CFOs acknowl- edge the need to rebuild public trust but are concerned that any measures they adopt will alienate investors and investment. Under- standably, they would like to see more open and measured debate of the issues they face. Richard Khaldi, water specialist, PA Con- sulting, explains: "Both PR19 and RIIO2 will set lower costs of capital than utility firms currently enjoy. This will inevitably lead to reduced revenues and a need for increased efficiency as both Ofwat and Ofgem have made it clear their expectations regard- ing customer outcomes/outputs will only increase going forward. It's the CFO that sits at the heart of this challenge." Operations directors and chief execu- tives may be the ones deciding where they can save costs by reducing or closing down operations, but financial modelling will increasingly be part of the finance director's armoury as they weigh up savings versus capital investment, says analyst Nigel Hawk- ins, of Hardman & Co. The tightening control comes in the wake of a backlash from politicians and the public, who have railed against electricity and water companies and questioned their legitimacy. They have been accused of over- profiting from financial engineering, award- ing excessive executive pay and dividends and presiding over questionable operations in tax havens. In March, environment secretary Michael Gove launched an unprecedented attack on the water sector, hitting out at its com- Under the microscope and feeling the financial pressure "It's important to be honest about our performance – good and bad." Liz Barber, Yorkshire Water group director of finance, regulation and markets continued overleaf plex financial arrangements and profits and accusing it of operating in a way that did not serve the public interest. Several months later, the GMB union launched a high-profile campaign criticising the water sector in par- ticular for high salaries, claiming nine execu- tives had earned £58 million in salaries, bonuses, pensions and other benefits over the past five years. The charge of self-enrichment was fur- ther hammered home by shadow chancel- lor John McDonnell during his speech to the Labour party conference in September last year, when he claimed the water industry had paid £18 billion out in dividends since privatisation. Such attacks on water follow a report published in September 2017 by the Energy and Climate Information Unit (ECIU) that claimed distribution network operators (DNOs) had been achieving annual average profit margins of 32 per cent during the first half of this decade. According to that report, six DNOs made a collective final profit of £10.7 billion on total revenues of £33.5 bil- lion between 2010 and 2015, which equates to £27 per home per annum. The margins it cited of the individual DNOs ranged from 25.7 per cent at Electricity North West to 38.9 per cent at Scottish Power. Regardless of whether or not Labour wins at the next general election, the public sen- timent it is currently tapping into is unlikely to dissipate. Firms accept that the dial has been reset and they must rebuild their public reputations and become trusted as forces for public good. Accordingly, water CFOs have been busy winding up their Cayman Islands subsidi- aries as they try to improve transparency. Yorkshire Water announced its intention to close its offshore financial arrangements in October 2017 and transferred the £3 billion of

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