Utility Week

UTILITY WEEK | 5TH - 11TH APRIL 2019 | 13 Policy & Regulation Wessex will have been disappointed not to have secured "fast-track" status; instead, it picked up a D under the "Aligning Risk and Return" head. Ofwat's marking of Dwr Cymru was some- thing of a curate's egg. Under the "Securing Con€ dence and Assurance" head, it did win Ofwat's con€ dence. But it fell well short on the cost eƒ ciency front, with its wholesale clean water costs being 26 per cent above Ofwat's benchmark. And its retail clean water costs were even more of an outlier – at 40 per cent above Ofwat's benchmark. Bad though some of these marks were, it was Thames and Southern who fared worse, coming in the "Signi€ cant Scrutiny" catego- risation – which also included Aƒ nity Water and Hafren Dyfrdwy. Ofwat did not hold back in its trenchant criticism. For years, Thames has faced many brick- bats for its £11.3 billion net debt, its massive dividend payments, its poor leakage record and its minimal corporation tax payments, notwithstanding the e' ective contracting out of its Tideway Tunnel project. Now, Ofwat has awarded the company three Ds and six Cs – with neither an A nor a B in sight. And the phrase "…its plan falls (signi€ cantly) short…" appears under all nine heads. Ofwat focused on the lack of resilience of its operations, for which it was marked with a D. It noted, too, that Thames does not seem to have "a good understanding of the condi- tion of its assets…" Cost e ciency The cost eƒ ciency € gures were also dire – and yielded a second D. Ofwat reckons that Thames' clean water costs, despite the vast Ring Main investment made in previ- ous decades, are about 36 per cent above its eƒ ciency benchmark – a formidable gap tošclose. Unsurprisingly, the third D arose under the "Accounting for Past Delivery" head. Ofwat is not persuaded that Thames can meet its leakage targets, especially given well-publicised past failures. In its analysis, Ofwat has expressed con- cern about Thames' € nances and the very high debt it has accumulated as a private equity-owned company. Southern received an equally caustic review, and was allocated three Ds. The € rst D covered long-term resilience. Ofwat listed many shortcomings in South- ern's business plan in this area and even cast doubt on its plans for a capital injection. On the cost eƒ ciency front, the 21 per cent clean water and 26 per cent wastewater premiums over Ofwat's eƒ ciency benchmark were pivotal in the second D that was given. The third D was allocated under the "Accounting for Past Delivery" head, partly because Ofwat has underlying doubts about Southern's ability to deliver its plans – and various environment-related prosecutions have not helped. Although Ofwat is undoubtedly talking tough, the gap between some water company costs and its eƒ ciency benchmarks is vast. How Ofwat addresses this issue is unclear. On the € nancial front, some water com- panies, led by Thames, have vast debts. Tough regulation raises the issue, especially for private equity-owned water companies, as to whether their owners will be required to inject more share capital? But the water companies have a crucial backstop against tough regulation, like Brit- ish Telecom and its pension fund a' ord- ability "joker", which it plays when tough regulation is threatened. In the water companies' case, retaining investment-grade credit ratings is paramount – something that ultra-tough price reviews do not permit. AŸ er all, Ofwat's indicative Weighted Average Cost of Capital (WACC) of 2.4 per cent – roughly a third o' its 2014/15 prede- cessor – is not being aggressively challenged. Certainly, United Utilities will have earned brownie points from Ofwat by submitting its business plan based on "adopting an RPI- stripped appointee cost of capital of 2.4 per cent consistent with Ofwat's early view". In contrast, Wessex was criticised by Ofwat for "limited and unconvincing evi- dence in support of the company's proposed upliŸ to the early view cost of capital". Clearly, Ofwat is not anticipating a Transco-like regulatory battle over its pro- posed WACC. The fact that the three quoted water com- panies were the only ones to secure "fast- track" status is signi€ cant. The chances of this quoted trio out of all 11 companies doing so are very long. Coincidence – as Ofwat is reputed to have implied – it was not. The other seven companies had to re-submit their business plans to Ofwat by 1 April – their chance to rebut Ofwat's coruscating judgements. But, having savaged so many of its regulated companies, is Ofwat's bark far worse than its bite? Almost certainly so. Maintaining invest- ment grade credit ratings is the pivotal backstop. Nigel Hawkins, utilities sector analyst, Hardman & Co "Ofwat reckons Thames' clean water costs, despite the vast Ring Main investment of previous decades, are about 36 per cent above its effi ciency benchmark" Ofwat's verdict on water company plans Severn Trent South West United Utilities Plans ready to implement. Receive nancial bene t, early decisions and early certainty Further work to do on plans FAST TRACK SLOW TRACK SIGNIFICANT SCRUTINY Anglian Bristol Dwr Cymru Portsmouth Northumbrian South East Wessex South Sta‡ s Yorkshire SES Substantially rework and resubmit plans. Increased regulatory scrutiny Aˆ nity Hafren Dyfrdwy Southern Thames

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