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10 | 10TH - 16TH JUNE 2016 | UTILITY WEEK Policy & Regulation Analysis O fwat has a tough task regulating the water sector in a period of major change in, and around, it. At the end of May, the regulator published its Water 2020 document, setting out its decisions on the design of its regulatory framework. The water sector is facing its biggest period of change since privatisation, trig- gered by increasing challenges such as higher customer expectations, scarcity of resources and the effects of climate change. To "play its part" in the solution, Ofwat is changing the way it regulates the sector, and insists it is all about fostering a culture of change – not just during the business plan- ning process, but also as part of the day-to- day running of the company. David Black, senior director of Water 2020 at Ofwat, tells Utility Week the main aim of the reforms is to encourage a deeper focus on the customer. The RPI/CPI question A great deal of attention has fallen on the switch from the retail price index (RPI) to the consumer price index (CPI) – or more accu- rately its derivative CPIH (including costs of owner-occupied housing) – which Ofwat has now confirmed will be going ahead. In its Water 2020 document, Ofwat explains how it is going to regulate the sector during a period of major change, with its main aim being a deeper focus on the customer. Lois Vallely reports. because it should be revenue-neutral for an efficient company. "And as we move from a forward fixation, which has a higher expected level of inflation, to one which has a lower, we will make an offsetting adjust- ment to the weighted average cost of capital that we allow in the review," he adds. He argues that the move could even prove beneficial for companies, because RPI is the more volatile index. "[We recognise] that the sector does attract long-term financing and we think it's important that it continues to attract long-term financing, and therefore we will take that into account in our transition." Promoting markets Following comments by chief executive Cathryn Ross at Utility Week Live last month that Ofwat is becoming "a fundamentally more pro-market" regulator, Ofwat has laid out steps to inform, enable and encourage the development of two new markets: sludge and water resources. This includes setting separate price controls, which Ofwat estimates will cost between £6 million and £11 million. How- ever, this cost looks "very small" when com- pared with the "significant benefits" on offer. Ofwat is also encouraging a greater use Ofwat says credible and legitimate index- ation of customer bills is "central to trust and confidence in the sector". Until now, its price controls have been linked to RPI, meaning customer bills have also been linked to RPI. Black says the regulator has had discus- sions with investors and companies and other stakeholders, and has decided to con- tinue with its proposal, as set out in Decem- ber, to shi the indexation of revenues from RPI to CPI, and "also that indexation of the regulatory capital value [RCV] would transi- tion so that 50 per cent would move on to CPI and any new additions would also be indexed to CPI for the RCV". "RPI is no longer an official statistic," the document says. "Its robustness has been called into question and its use by govern- ment and regulators is diminishing." Investors, in particular, have voiced con- cern that a switch from RPI could drag down companies' revenues and make them a less attractive investment proposition. In March, analysts at Water UK's City Conference warned that there is a "real risk" that if water companies are "forced into a CPI market", they could lose out financially. However, Black insists that the changes will not affect the revenues companies get, WILL WASTE COMPANIES ENTER THE TREATMENT MARKET IN THE NEXT FIVE YEARS? Source: Ofwat analysis of responses to survey of potential sludge market entrants 21% 7% 14% 7% 22% 29% Definitely not Very unlikely May consider Very likely Definitely will Already provide sludge treatment services CPI AND RPI INFLATION 12 10 8 6 4 2 0 -2 -4 CPI, RPI annual % saving Jan 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Nov 2014 Source: www.economincshelp.org - ONS D7G7, CZBH CPI RPI