Utility Week

UTILITY WEEK | 10TH - 16TH JANUARY 2020 | 23 Finance & Investment "What happens if the shareholders reject the o er? Or if there is disagreement among dif- ferent factions? If nothing else it seems like it will take a while for them to secure agree- ment – and the clock is ticking." Ofwat said: "Thames has failed to come up with a reasoned, evidenced proposition to address water network performance issues in London, and we are concerned about con- sequences for customers. Given this, we have stepped in to further protect them. "It is for Thames to develop and submit its proposals, and to do so in short order. We will assess those plans and the commitment of a substantial contribution from sharehold- ers before deciding whether the plans meet the mark." The spokesperson added: "If Thames can demonstrate a concrete and deliverable proposition we will let them bid to keep up to £480 million to improve resilience and the performance of the London water network." According to Hardman & Co analyst and regular Utility Week contributor Nigel Hawk- ins, this bespoke deal could set a di‹ cult precedent which Ofwat may come to regret. He said: "If companies do go down the route of appealing to the Competition and Markets Authority (CMA), I wouldn't be sur- prised if a few of them used the Thames situation as an example of where the " nal determination could have gone. Why has only one company received a conditional allowance?" Peer pressure Hawkins said the compromises reached with Thames will have made interesting reading for the likes of Anglian and Northumbrian, whose position a• er the " nal determinations is largely unchanged from what it was when the dra• decisions were announced. Look- ing solely at totex, the former still faces a £744— million gap between its business plan and its " nal determination, while the latter has a £126 million di erence. Northumbrian also faces an eye-watering 26 per cent reduc- tion in its bills over the next " ve years. Other companies facing a sizeable totex gap include Yorkshire (£370 million), South- ern (£235 million) and Wessex (£141 million). Hawkins believes all of the above are potential candidates to appeal to the CMA. He tells Utility Week: "These companies have seen very little movement. Northum- brian and Wessex have also made their views clear on cost of capital and will not have been pleased with the " gure Ofwat came out with. There's a sense for some of them that they haven't got the credit for what they have achieved so far." Another observer agreed, saying: "Anglian is leading the industry in so many ways. It was the " rst to enshrine social commitments; it topped a poll this year as the best company to work for; and it has really tried to work with Ofwat. Northumbrian similarly has been doing some great work with its communities and in innovation. These companies are set- ting themselves tough targets and they prob- ably feel it's not being recognised." While Thames has been the biggest talk- ing point, it is important to note that Ofwat has compromised with some others. Welsh Water, for example, saw positive movement on bills and totex since the dra• stage and is now pretty much aligned with the regulator on overall revenue. There was also some surprise at the changes in the " nal determinations for fast- track companies, all of whom saw their bill reduction targets steepen, while Severn Trent and South West also took a hit on their totex allowances. One source observed: "What exactly is the point in being fast track, other than getting to see the dra• determination early? They've still been landed with these last-minute chal- lenges and there doesn't seem to be much in the way of special treatment." For Barclays analyst Dominic Nash, the impact of the " nal determinations has to be seen in the wider context of a suddenly more stable market for utilities following last week's election. Overall, he believes, Ofwat has retreated somewhat from its no-holds- barred position on companies. He said: "Returns are down in line with market expectations. It could have been worse on returns and lower " gures were being suggested. "Broadly the review doesn't appear as di‹ cult for the water companies as Ofwat was threatening earlier in the year. There has been a material compromise on the totex gap and ODIs [outcome delivery incen- tives]. It appears Ofwat has compromised its tough—stance. "All in all, the water sector is worth a lot more than it was [before the election], with the threat of nationalisation li• ed, at least for the next " ve years, and with price cer- tainty from the price review. "The listed sector is trading at a 20 per cent premium to RAB [regulated asset base]. That's towards the higher end of historical averages. However, that's with the caveat that the three listed companies aren't necessarily representative of the industry as a whole." Healthy tension Not all industry voices took the line that the regulator should aim for an intractable stance at all cost. One tells Utility Week: "It was always going to be the case that Ofwat would be toughest at the dra• stage – to act as a stim- ulus to companies to really focus on what fat there was to trim. Thames is a perfect example of that. Getting an agreement with Thames – and we can't guarantee that will happen but it looks likely – should be seen as a success not a failure. "Ultimately the mechanism is sound; there is a healthy tension. Ofwat's position now is likely to be that if companies go to the CMA then so be it, because the process was rigorous and it has faith in that." The big question now, putting CMA refer- rals to one side, is how deliverable the plans are. Ofwat has made much of the environ- mental and societal commitments the water industry will be expected to deliver over the next " ve years. However, Nicci Russell, managing direc- tor of water e‹ ciency champion Waterwise, warned that given the scale of the challenges presented to companies, it is important that these key pledges are not sidelined. She says: "It's good to see Ofwat mak- ing a commitment for the industry on envi- ronmental issues and water e‹ ciency but my concern is whether the companies will be able to deliver. The strategic narrative on water e‹ ciency and the environment is strong but cost models can complicate that. My worry is that companies have so many stretching commitments that this may be an area where they compromise." Water company bosses now face some serious reª ection over the festive break as to how deliverable their targets are within the parameters Ofwat has set. If they stick to the views expressed in response to Ofwat's dra• determinations, that they are "un" nance- able", then it seems 2020 will be yet another year dominated by arguments over PR19. James Wallin, digital editor, Utility Week "The review doesn't appear as diffi cult for the water companies as Ofwat was threatening earlier in the year. There has been a material compromise on the totex gap and ODIs." Dominic Nash, analyst, Barclays companies as Ofwat was threatening earlier in the year. There has been a material compromise on the totex gap and ODIs." Dominic Nash analyst, Barclays

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