What’s in this report?
Utility Week’s new CEO Insight research series will provide regular access to the sentiment of industry chief executive on key themes and developments impacting the sector, and their businesses individually.
Our analysis of the findings from the first iteration of this research will be published in easy to digest instalments for Utility Week members. A complete research report will also be made available to members in hard copy or PDF format
Each instalment of the research analysis published online will focus on a particular theme or set of findings emanating from the research including:
- The macro environment
- Business model transformation
- Access to finance and investor confidence
In addition however, Utility Week has developed a special research analysis focusing exclusively on findings relating to the water sector, since water company leaders returned some of the most forthright and robust views on the questions put to them by our survey.
This subsector focus summarises these findings, splitting out issues relating to wholesale and non-domestic retail operations for separate consideration. It is available to all Utility Week readers, members and non-members.
As utilities grapple with the transformational change sweeping the sector, company chief executives face challenges on many fronts. In the first of a new, regular series of research reports – CEO Insight – Utility Week surveyed the leaders of the UK’s major utilities, to understand their views on the political and economic climate their organisations are operating in, the regulatory and policy landscape surrounding them and what the future holds in terms of change and challenge.
The results paint a picture of chief executives poised for sector disruption. They expect radical changes to business models, even in the short term; are dissatisfied with or lukewarm to the regulatory regimes they operate under and express concern in relation to wider economic and political factors impacting their businesses.
Utility Week’s first CEO Insight research, conducted by Utility Week’s independent market research partner Insight Advantage, shows:
- Policy and regulatory instability are the highest rated factors impacting businesses today, receiving scores of 7.9 and 7.5 out of ten for impact respectively. The third highest rated impact factor was change and uncertainty relating to new technologies and commercial models (7.2).
- Brexit is currently relatively low on CEOs’ agendas, with respondents scoring its impact at just 4.5 out of a possible 10. However, this varies considerably by sector, with vertically integrated energy companies scoring it much higher than average (7 out of 10) and water retailers much lower (1.5 out of 10).
- More than half (57 per cent) of CEOs believe the regulatory regime under which they currently operate is not fit for purpose, with water retailers and challenger energy supply brands most likely to take this view, and power and gas networks least likely to. Even with water retailers and challenger suppliers taken out of the equation however, nearly half of CEOs say their current regulatory regime is not fit for purpose.
- Even in the next five years, CEOs expect considerable change in their business models, with respondents rating the expected scale of change at 6.7 out of ten in the next five years. This rises to 8.7 out of ten in the next ten years, and a transformational 9.3 out of 10 in the next 15 years.
- Respondents expressed a strong appetite for M&A, with 81 per cent of CEOs saying their organisation would be a “buyer” in an M&A scenario. At the same time though, there was little expectation of significant M&A activity in the next 12 months, with 67 per cent of CEOs saying they expect “very little” M&A and a further 19 per cent expecting “moderate” levels of M&A.
While responses to some questions show significant variation in opinion between different utilities subsectors, qualitative commentary on the survey findings, provided by sector leaders, showed the findings generally resonate with chief executives across the board.
Even in areas where a single subsector stands out from the crowd – for example with regards to networks’ support for their regulatory regime – qualified comments shows that there are significant and growing concerns about the direction of travel for the future, and the influence that political interventions are having on this.
In this first iteration of our CEO research, respondents from the water sector – spanning wholesale and water retail – provided especially robust responses to questions about satisfaction levels with the regulatory and market structures which envelope company operations and profitability.
To acknowledge this, as well as including observations on water responses in our general commentary, we have broken them out in a special subsector focus chapter.
The next iteration of our CEO Insight series will gather evidence over spring 2018, with a second report appearing in the summer.
Subsector focus: water
Some of the most robust CEO survey responses came from the water wholesale and retail sectors where CEO outlook was generally gloomier than in other subsectors.
CEOs in water businesses generally express a lower level of confidence in the ability of the UK government and economy to provide a stable environment for their businesses. Wholesalers in particular expressed negativity around customer perceptions of the utilities sector, with all subsector responses saying perceptions are deteriorating.
This negativity may in part be attributable to the recent and sudden exposure of water companies in political debate over the legitimacy of UK utilities and the value they provide to customers. While companies in the energy sector – especially energy retail – have long been subject to such scrutiny, water companies have been used to relative anonymity of in public debates over utility costs, profits and service quality.
Water chief executives also expressed the highest levels of negativity regarding their regulatory regimes, with 100 per cent of retailers and 50 per cent of wholesalers saying it is not fit for purpose.
In wholesale, divided opinion on the suitability of the regulatory regime was matched with slow progress in embracing some of its newer elements, such as totex accounting. Meanwhile, water retailers were forthright in expressing dissatisfaction with the margin allowed by the regulator at market opening and the level playing field provided in the market for new entrants compared to incumbents.
On a more positive note, it appears there is significant scope for M&A activity in the water retail market. An equal number of CEOs classed themselves as buyers and sellers in an M&A scenario, suggesting that the market is ripe for deals to be struck.
Key water findings
- Water wholesalers and retailers expressed lower than average confidence in the UK government and economy to provide a stable environment for their business when compared to other utilities. Wholesaler CEOs were also unanimous in saying customer perceptions of the utilities sector are on the decline.
- Wholesaler confidence in their access to debt and equity was lower than that of other regulated utilities. Wholesalers rated ease of access to debt at 7 out of 10 and ease of access to equity at 5.6 out of ten. This compares to rating of 9 and 7.3 out of ten for power networks.
- Wholesalers are lagging behind their peers in gas and power networks in terms of realising the benefits of a move to totex accounting
- Satisfaction with the currently regulatory regime is low across the water sector, especially among water retailers where all CEO respondents said the current regime is not fit for purpose.
- Wholesaler sentiment around the framework for PR19 is lukewarm, with significant dissatisfaction expressed with regards to: the approach to setting the cost of capital and the introduction of new performance targets.
The most notable findings from water wholesale survey response relate to sentiment about the current regulator regime under which companies operate, and the direction of travel this regime is taking.
Half of water wholesale chief executives said they believe their current regulatory framework is not fit for purpose and there was clear dissatisfaction around some of the elements of the framework for the next price control – PR19.
With regards to the current environment, one commentator said they believed “considerable evolution” in the regulatory structure for water companies had led to a more “hands-on” approach from Ofwat with the introduction of more targets and prescriptive guidance.
It’s notable too however, that the relatively high levels of dissatisfaction with the current wholesale regulatory regime – compared to other regulated utilities – were also accompanied by an apparently laggardly approach to embracing some of its newer elements.
For example, asked to what extent their organisations had embraced benefits as a result of the move to totex accounting in PR14 – with the intention of creating longer-term thinking in asset planning and supporting the creation of smart, non-asset-centric solutions water network challenges – CEOs responded with an uninspiring 5.1 out of ten. This compares to 8 out of ten for gas networks and 7.7 out of ten for power networks, which were both required to shift to totex reporting under RIIO in 2013 and 2015 respectively.
Interestingly, this finding resonates with previous research conducted by Utility Week in 2016 which found that less than half of water companies saw totex as being intrinsically linked to innovation in terms of finding new ways of working.
It should be acknowledged however, that while half of wholesaler respondents said their current regulatory regime is not fit for purpose, the other half were more positive.
Taking responses in the round, Wessex Water chief executive Colin Skellett suggested the industry is not so much dissatisfied, as keen to work with the regulator to find areas where the regime can be improved.
“I don think we can find a different model,” he said. “It’s a question of what can we do better’ – and I think there are areas where we can.”
This said, wholesaler CEO sentiment around the final methodology for PR19 indicated little satisfaction with the direction of travel for the regulatory framework, especially around Ofwat’s approach to setting the cost of capital – a major determining factor in shareholder returns – and its immediate introduction of stretching new performance targets at the beginning of the next price control period.
With regards to the former, 43 per cent of CEOs rated their satisfaction with Ofwat’s approach as “low” or “very low” with the remainder merely rating the approach as “adequate”.
This scepticism over the regulator’s economic modelling methods is reflected in the public challenges several water companies have made to Ofwat’s plans for the weighted average cost of capital over the next regulatory period. For example, Anglian, Northumbrian and Affinity Water commissioned KPMG to review Ofwat’s methodology. The resulting publication claimed the regulator’s assumptions in calculating total market return, a key element in the cost of equity, were flawed.
The most popular element of PR19 was, unsurprisingly, the least controversial. Almost half (43 per cent of wholesaler CEOs expressed very high satisfaction Ofwat’s plans for an enhanced focus on resilience in the upcoming price review. A further 14 per cent expressed high satisfaction with the new importance given to this long term issue.
Just under a year after the opening of the non-domestic water market to competition, chief executives at water retail companies are apparently less than enthusiastic about the way in which the new market is operating.
All water retail respondents to Utility Week’s survey said they believe the current regulatory regime for water retail is not fit for purpose. Delving further into the sources of this dissatisfaction found that CEOs are only adequately satisfied at best with the structures put in place to enable non-domestic competition.
Many of the areas of the market deemed most inadequate by respondents will come as no surprise to retailers or market commentators.
Issues around the quality of data available for non-domestic supply points, for example, have been well trailed in Utility Week and its sister title Water.Retail. Likewise, concerns over the level of the retail margin set by Ofwat have been aired since well before market opening, with many commentators saying the level is too low to incentivise real competition.
Dissatisfaction with the service levels provided by wholesalers to the retailer community is more of an emerging issue, with commentators referencing a troublesome lack of standardisation in service levels.
John Parsonage, utilities and regulatory expert at PA Consulting group said this is a key issue which is “holding the industry back” and blocking the delivery of value to customers.
“The lack of standardisation in operational processes creates a need for bespoke interfaces for each wholesaler, increases transaction costs for retailers, tightens margins and reduces the scope for innovative solutions for customers,” he observed.
“The idea that the market would sort out an optimum solution to this problem has proved to be wishful thinking. There’s just no incentive for anyone to develop a solution and it’s time for Ofwat to take the lead role in making this happen.”
Adding to qualitative commentary on wholesale service issues, Neil Pendle, chief executive water retail company Waterscan, observed that performance is wide ranging and “inconsistent”.
While acknowledging that some wholesalers have a been “very engaged” in developing their services and are “brilliant to work with” he admitted several company are considerably less capable.
As a generalisation, he suggested wholesaler services from water and sewerage companies are better than those provided by their water only contemporaries, which tend to “have invested less in systems and relationships with retailers”.
More broadly however, Pendle was keen to soften the negative picture drawn by survey findings, of retailer satisfaction with market structure and regulation of non-domestic competition.
He said he would generally rate the regulatory environment as “good” with Ofwat providing “clear leadership and guidance to the market on what it expects the market changes to deliver”.
Pendle added that since market opening, the regulator has remained engaged with market participants, exploring their contributions to ambition programme for the future development of water markets, including Water 2020 and Road to Resilience.
“Where market issues have occurred, Ofwat have been able to provide assistance but allowed trading parties to resolve these together rather than intervene at every opportunity,” he concluded.
Other qualitative input from water retail CEOs seemed to corroborate this view, with most saying that the market’s first year had been a useful, and largely positive testing ground for the regulatory framework and market mechanisms. There is now a period of opportunity, they said, to learn from the issues that have been exposed and work collaboratively to resolve them.
Some CEO commentators were more robust in challenging Ofwat however. Johanna Dow, chief executive of Business Stream – which was the incumbent retailer at market opening in Scotland in 2008, but a new entrant in the English market – reiterated previously aired opinions that the English market does not offer a level playing field for new entrants and incumbents.
She once again urged the regulator to apply similar restrictions on market incumbents in England as were applied to Business Stream as the Scottish market incumbent.
Jacob Tompkins, chief executive of The Water Retail Company seconded this idea and called for Ofwat to rethink the license application process for new market entrants. He described this as “laborious” and “written for the incumbents”.
Extending a competitive market to domestic water retail has been a long-cherished ambition of free market proponents, and one that was brought forward by then Chancellor George Osborne in 2015, when his autumn statement laid out plans to give water customer choice of supplier, possibly as soon as 2020.
Brexit has kicked this issue into the political long grass however, with the current government seeming to have no plans to act.
This seems to sit fairly comfortably with water sector leaders responding to Utility Week’s survey. CEOs were lukewarm at best about the prospect of extended competition some speaking of the “significant cost versus an ambiguous opportunity” involved and others simply saying it would have little impact.
Interestingly, this sentiment contrasts with anecdotal evidence that many CEOs, especially in water retail firms but also at wholesale companies, believe domestic water competition to be “inevitable” if not imminent.
It may be that this evidence, gathered via industry events, debates and interviews over the course of 2017, has been knocked off course by the overwhelming impact of Brexit negotiations on the ability of government departments to progress non-Brexit related issues, and the surge in Labour’s popularity, with an associated implication that there is little public support for extending competitive market in utilities.
Further installments from Utility Week’s first CEO Insight report are available to Utility Week members via the following links: