Utility Week

16 | 18TH - 24TH JANUARY 2019 | UTILITY WEEK Finance & Investment l   "Debate is important, but it has to be a debate based on fact and not outlandish claims." Ian Williams, finance director, WPD l   "The regulator is making it more and more challenging, introducing mechanisms that limit the capacity to pay dividends." Matan Benjamin, lead analyst on UK utilities, S&P Global Ratings bonds and US private placement notes that were held within its Cayman Islands subsidi- aries into a new UK incorporated company during the summer. Liz Barber, Yorkshire Water group director of finance, regulation and markets, recently told Utility Week: "When we announced the plan to remove our Cayman companies, it was pleasing to see that our colleagues in other companies with similar structures decided to follow suit. We also said at the time that removing the companies was far from straightforward and would take some time, with a range of legal and regulatory approvals. Nonetheless, we've moved as quickly as we could." In what it describes as a first of its kind, the company also aims to become an open data business and will publish data sets that underpin its business plan submis- sion, including 12 months of leakage data and reports into pollution incidents. Barber told Utility Week: "It's important to be hon- est about our performance – good and bad." This is surely a reflection of the efforts to build trust and the role CFOs are playing in that rehabilitation process. There will certainly be no let-up in regu- latory pressures on the utilities sector. Con- scious of being widely seen as over-lenient in the past, regulators won't be in a generous mood as they embark on the latest round of price reviews. Ofwat's 2019 price review (PR19) sets the price, service and incentive package that water companies must deliver during the five-year asset management plan period. As part of PR19, each water company in England and Wales has set out a business plan detailing what it intends to deliver and what it proposes to charge customers. Following a consultation launched in April, the regulator has introduced a range of measures that will see customers share the financial gains made by water companies, which have high levels of debt. These debt levels have enabled them to drive up profits because the allowance for the weighted aver- age cost of capital (Wacc) had been set much higher in PR14 than the historically low interest rates. The cost of capital is the allowance Ofwat makes within its price controls for the costs of raising debt or equity to fund improve- ments. It has also set out more details on the transparency expected around shareholder dividends and performance-related executive pay in companies' business plans for PR19. The document includes an initial view of the cost of capital of 2.4 per cent in RPI terms, a record low for a regulated utility. The regu- lator estimates this reduced cost of capital l   "There are currently over 70 [suppliers] operating, which is not sustainable in the long term." Martin Beesley, CFO, Morrison Utility Services could result in an average saving per cus- tomer of £15-£25 per year from 2020 onwards. The 2.4 per cent figure represents a material reduction of 1.3 per cent since PR14, which Ofwat says has been driven by the lower expectation of the cost of debt and equity. Analyst Nigel Hawkins says CFOs will be working hard to push this figure higher for their individual businesses as they make their cases to Ofwat (which is now scruti- nising business plans) – while at the same time calming the nerves of shareholders con- cerned about cuts to dividends. The water regulator is due to publish its initial assessment of each company's plan on 31 January 2019, when it will categorise companies' plans according to the level of quality, ambition and innovation they have demonstrated. The best plans could ben- efit from incentives through the price review process, while those that fall short will face closer scrutiny and interventions and could receive lower returns. Says Hawkins: "It's unbelievably compli- cated because of the fixed costs and healthy operating margins which the regular seeks to curb. But if yields are still at 5-6 per cent, that shouldn't dent investors' appetites." Gearing up for RIIO2 Energy networks, the other heavily regulated arm of the utility sector, have come in for equally harsh criticism and they too are fac- ing greater financial control in the next price review, RIIO2. This is currently being formu- lated – and the first tranche will come into effect in 2021. In July, Ofgem confirmed that the cost of equity range (the amount network compa- nies pay their shareholders) will go down to between 3 per cent and 5 per cent, from 6 per cent to 7 per cent currently and in December confirmed a rate of 4 per cent. According to Ofgem, this is the lowest rate ever proposed for energy network price controls in Britain. The reduced range will also impact the return on regulated equity, which is an esti- mate of a company's return including the cost of equity and earnings across the range of incentives in the price control, for exam- ple to reduce power cuts, reduce losses and improve service. According to the regulator, the average return on regulated equity across the sector is currently 9.45 per cent. However, to some CFOs the measure is misleading and is skew- ing the debate. In the run-up to RIIO2 they will be pushing hard to ensure a fair hearing of their side of the story. "Ofgem looks at the return on regulated equity as being the measure of how we are compared to each other and the level of continued from previous page RETURN ON REGULATORY EQUITY FOR ELECTRICITY DISTRIBUTION NETWORKS (RIIO-ED1) RETURN ON REGULATORY EQUITY FOR GAS DISTRIBUTION NETWORKS (RIIO-GD1) RoRE & (real returns, post-tax) RoRE & (real returns, post-tax) Source: Ofgem 12.5 10.0 7.5 5.0 2.5 0 12.5 10.0 7.5 5.0 2.5 0 ENWL NPG WPD UKPN SPEN SSEN Current eight-year period Current eight-year period Cadent NGN SGN WWU CFO Insight report

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