The Ofwat director heading up PR19, David Black, has told Utility Week that companies “could lose as well as gain” from an appeal to the Competition and Markets Authority.
He said chief executives were “very much in a listening mood” when he spoke to them about the final determinations (FD) ahead of the publication today (16 December).
Black said Ofwat expects referrals to the CMA with each review but none have been suggested so far, despite much “chatter”.
“We are very happy that they have the option and we are happy to take any challenges through the CMA process; our focus will be on getting good outcomes for customers. It’s an important safeguard to the process and we expect it only to be used where companies think there are serious issues to be addressed.
“It’s quite a serious step for companies because they could lose as well as gain as the CMA retakes the final determination in full so there’s no guarantee the company will benefit from an appeal. It’s also a big distraction for management in terms of time and energy as well as there being a cost involved.”
There were numerous changes between the draft and final determinations, notably the 0.16 per cent lower wholesale cost of capital. Black said the changes seen in the FD in terms of operational targets came in response to representations made by companies since August. The reduction in wholesale cost of capital will mean lower bills for customers and limit the amount that shareholders can receive in dividend payments.
Black pointed out reduced return on capital does not mean performance related pay or dividends are ruled out.
“Healthy, well-functioning companies ought to be paying a dividend and we have set out a view that for well performing company a base dividend is four per cent. Beyond that level, we expect companies to go above and beyond on service, outcome delivery service, outperforming their cost allowances to be more efficient than the final determinations. We are very comfortable and consistent with the long-term financing in the sector to have water companies paying dividends, but they have to be linked to returns and performance for customers.”
Tough stance to build trust?
Black said the customer-focused price review will be an important contribution to regaining public trust. “This will come both in terms of the substance in the final determinations – the improvement in service performance, reduction in bills and reduction in returns to investors; but also payments of dividends and executive pay and being clear about how that aligns to customers.
“Clearly there’s a wider set of issues and it’s great to see companies embracing things like the Public Interest Commitments and the role of public purpose. I think all of that has a huge role to play as well. Society has changed and expectations will keep changing. It’s up to companies to keep up with that and embrace it.”
He described Ofwat’s stance as “tough and proactive” for outcomes for customers and the environment. “We will use a full range of tools to deliver on that. That includes challenging companies, but we do recognise good performance as well. There are opportunities for well managed well performing companies to earn higher returns and we do think that’s important. We do think it’s really important that companies take the initiative and put public purpose at the hear of the way they operate as well.”
Innovation fund
As part of the FD announcement Ofwat confirmed a £200 million innovation fund that companies could be granted to progress demonstrably innovative ideas. The regulator wants to see collaboration with companies working across geographic borders and embracing technologies.
Black said the innovation fund is intended to encourage companies to examine how they operate. “There’s a lot of potential there and the price review has brought some of that to the surface. The role of the fund is to drive that further on to make sure that when the companies are feeling the pressure from the challenges there is a source of ideas and innovations out there that they can pick up and run with for their company.
“We are not asking companies to do more of the same and patch the holes a bit faster but to rethink their business and how they can look at business from end to end to drive change and improvements to service.
“We’ve seen aspects of that in the previous review period from the better performing companies but there’s still huge scope for companies to think about how to do things. More collaboration, more effective engagement with the supply chain, more innovation coming from within the companies themselves.
“There’s a lot of excitement in the sector around innovation agenda. I get the sense companies are looking at how they can change their operations and how they work.
On Thames Water
Ofwat set aside “conditional funding” for Thames Water to resubmit a revised plan to address resilience in the water network and water treatments in north east London.
“On water networks we weren’t happy with what was addressed by their plans and applied to them to make an intervention on that basis and asked them to come back with changes. We set aside £300 million in the final determination and set up a gated process. If the company comes back with a plan that passes that gated process, they will retain the funds and be able to make investments, but if they don’t then the funds will be returned to customers. We are also asking for shareholders to make a contribution.”
He said the intervention was warranted because Thames had not sufficiently addressed issues that would have serious implications for customers.