Utility Week

22 | 10TH - 16TH JANUARY 2020 | UTILITY WEEK Finance & Investment Analysis A er much debate and public postur- ing on the stance Ofwat should adopt on water company business plans for the next five years, its final determinations landed just before Christmas. It may be a measure of interest in the ver- dict, or simply the sheer volume of informa- tion generated by this sprawling process, but the regulator's website crashed almost as soon as the 200-plus pages of documents were uploaded at 7am on a Monday. Once the details were accessible a stunned silence descended as the industry and observers grappled to get a handle on how much ground Ofwat was willing to con- cede on its challenging dra determinations. For its part, the regulator summed up the process for Utility Week thus: "We have set out fair, challenging determinations for each water company reflecting their plans, evidence provided and benchmarking across the sector. It is now time for all companies to step up and deliver their plans." But, what did the industry think? Three key issues quickly rose to the surface. The first was around the allowed return on capital – the lowest since privatisation at 2.96 per cent for the entire business and just 2.92 per cent for wholesale controls. The verdict seemed to be that this was challenging but perhaps not as ruinous as it could have been. All eyes on Thames Water Lively debate was immediate on the inter- related subjects of the approach taken to Thames Water and how this coloured the perception of the allowances for the rest of the industry. Reaction was mixed to say the least, ranging from one expert, who proclaimed: "Ofwat has blinked. What message does [the Thames decision] send to companies who have really worked to get their house in order?" However, another source said: "It looks like Ofwat has done something really clever here. It has forced Thames to climb down a long way – to do all the compromising. Then it has largely agreed to that proposal but put in quite a few caveats. That has made it very difficult for Thames to appeal because it would essentially be arguing against its own business plan. If that's true, then that's a big headache removed for Ofwat. "The next question is whether other com- panies will be bold enough to appeal without Thames leading the charge." For another industry insider the immi- nent appointment of a new chief executive at Thames, with UK Power Networks boss Basil Scarsella thought to be leading the field, may have been key in the negotiations. "Thames is in a hole and it needs some- one good – really good – to get it out of it, as well as tackling all the significant challenges to come. The threat of a Labour government – and nationalisation – is one possible red line cleared for a new chief executive but it's also difficult to see anyone credible agree- ing to take the job faced with what the dra determinations would have imposed on Thames. "It seems like Ofwat has taken a very prag- matic approach here to recognise that this is the biggest and most high-profile water com- pany and it was going nowhere under what was suggested in its dra determination." Minding the gap Regardless of the stance taken, it is clear that Thames has seen the biggest shi since its dra plan, although as pointed out, this was largely led by the company's willingness to revise down its expectations. Ofwat agreed to a substantial increase in the totex allow- ance (up £796 million), leaving the two sides just £8 million apart. Larger gaps remain for some of Thames' peers. Thames has also won an important reduc- tion on its leakage targets. The gaps between bills and allowed revenue are still significant, however, and it should be noted that Thames has been set a challenging cost-sharing rate for underperformance. It was the extra "conditional" allowance which caught many a commentator's eye. This sets out a £180 million pot specifically for tackling issues in northeast London, as well as £300 million to bolster the water network in the capital. For the latter, there is an expectation of a "significant" contribu- tion from Thames shareholders. There seems to be no further definition on what consti- tutes "significant", although one expert tells Utility Week it is likely to be in the region of £200 million. The source said: "This looks like an 11th hour deal, possibly done since the election result, in which Ofwat has agreed to an extra sweetener and Thames has gauged that there will be enough support from its shareholders to swallow it." However, another observer demurred: PR19 – was Ofwat tough enough? Ofwat's final determinations have received a mixed reaction, with some claiming it has compromised too far while others believe it has boxed clever to head off potential CMA referrals. James Wallin reports.

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