Utility Week

14 | 6TH - 12TH SEPTEMBER 2019 | UTILITY WEEK Policy & Regulation Analysis W ith "Final Determination Day" less than four months away, it is salu- tary to consider which water com- panies may use their right to appeal Ofwat's ruling to the Competition and Markets Authority (CMA). A•er all, PR19 is the toughest price con- trol the sector has faced since privatisation in 1989 – with a meagre 2.4 per cent weighted average cost of capital (Wacc) being assumed by Ofwat. Given the very sharp reductions that some water companies will need to absorb – potentially up to a whopping 25 per cent for Northumbrian – it seems likely that some will take the risk of appealing their final determinations. But the record of securing material con- cessions from the CMA is not good. Bristol went down this route for both the 2009/10 and 2014/15 periodic reviews – its pickings were meagre. Wide differences A starting point for how wide the current gap is between Ofwat and some water companies is illustrated by the table below. While accepting that it does not address future investment requirements directly, it does show how Ofwat expects average water prices to fall, in real terms, between now and 2024/25. Remember, too, that with many operating costs fixed most of the revenue lost through Ofwat's tough rulings comes straight off the earnings line. The table records Ofwat's price projec- tions for 2024/25, based both on the recent dra• determinations and on the figures sub- mitted by the water companies as part of their business plans. It shows that several water companies proposed decidedly modest price reductions. In Anglian's case, this was just 1.2 per cent over five years; Ofwat's dra• determina- tion sought a 12 per cent cut. Bridging this gap, without a CMA referral, will require major back-downs by at least one party, if not both. Thames and Wessex are in a similar position. Out of the ten privatised water compa- nies, it is long odds-on that the trio who were fast-tracked – Severn Trent, South West and United Utilities – will accept their final determinations. The other seven may all have strong grounds to appeal, given the size of the price cuts that Ofwat expects them to absorb. Three approaches There are probably three approaches these companies can use where they have a decent chance of getting change from the CMA. First, and at a general level, they may seek to argue that the overall deal they have been given by Ofwat is simply lousy – on several counts. Some of the harsh price cuts being proposed by Ofwat would underpin this viewpoint. This strategy may be suitable for some of the highly indebted private equity-owned water companies, who have a ra• of issues to deal with, such as Thames with its net debt of over £11 billion, controversy over past div- idend payments, the Thames Tideway Tun- nel and excessive leakage inter alia. Second, the issue of Ofwat's 2.4 per cent Wacc assumption may be contested. A•er all, it represents a third off what was used by Ofwat back in 2014. Wessex is believed to feel strongly about the aggressive Wacc. Ofwat would, no doubt, argue that yields on ten-year gilt-edged stock are now near record lows. Furthermore, it will have taken note that United Utilities, in particular, seemed very relaxed about the 2.4 per cent Wacc when it submitted its business plan. Third, the Test Area Assessments made by Ofwat may have opened a veritable can of worms, especially given the regulator's laconic – and blunt – approach in summaris- ing many complex issues. Consequently, some of Ofwat's evidence behind such seemingly dismissive comments may be tested. Given that both Southern and Thames received three D ratings each, these assessments may – unwittingly – provide fertile ground for their lawyers. Thames, for example, may take issue with Ofwat's opinion that its "costs in water… are above our view of efficient costs by around 36 per cent". It's a big number – and presum- ably Ofwat's dra• determination for Thames took full account of this conclusion. Likely appeals Of the seven privatised water companies that were not fast-tracked, which ones are the most likely to appeal their final determinations? Southern, the subject of trenchant criti- cism recently from Ofwat over its concealed sewage leakages – not forgetting its three Ds Bridging the PR19 gap As water companies consider their next move on the toughest price controls since privatisation, Nigel Hawkins considers whether we could see a raft of appeals to the CMA. ANNUAL BILLS (£) FOR AVERAGE HOUSEHOLD – PRE-INFLATION 2019/20 bill 2024/25 company 2024/25 Ofwat % Cut between 2019/20 bill bill and Ofwat bills Anglian 421 416 370 -12.1 Dwr Cymru 439 417 378 -13.9 Northumbrian 429 337 319 -25.6 Severn Trent* 343 325 327 -4.7 Southern 422 392 362 -14.2 South West* 527 454 450 -14.6 Thames (ex TTT) 382 373 344 -9.9 United Utilities* 427 382 378 -11.5 Wessex 457 430 390 -14.7 Yorkshire 380 379 342 -10.0 * Fast-tracked Source: Ofwat, Nigel Hawkins Associates

• Cover