Ofwat’s long-awaited draft determination announcement was overshadowed in the national business press by a second Tesco profit-warning but, in truth, there were few real surprises in its reams of published documents.
Based on a move to ‘upper quartile’ rather than ‘average efficiency’ benchmarking and an assumed weighted average cost of capital (Wacc) of 3.7 per cent, retail water bills are expected to fall on average by 1 per cent in real terms per year until 2020, although the average 2.1 per cent cut for Anglian does look challenging.
Nonetheless, much sector focus will be directed towards the three largest companies.
In Severn Trent’s case, the draft determinations were overall positive, especially with its submitted wastewater costs being markedly lower than Ofwat’s figures.
Severn Trent’s average bill should fall from £315 currently to £297 by 2019/20 (before inflation). Despite its wafer thin dividend cover, these numbers may enable Severn Trent to avoid a dividend cut – and even re-invigorate last year’s bid interest.
By contrast, United Utilities still has considerable unfinished business with Ofwat, especially on its wastewater operations. There is a massive £773 million of projected wastewater expenditure which has not been accepted by the regulator.
Closing this formidable gap will not be easy. Investors will be anxiously assessing the robustness of its future dividend projections and the underlying 2013/14 dividend cover ratio was just 1.2x.
Thames, while satisfying Ofwat on its clean water operations, still faces many uncertainties on the wastewater front as Ofwat’s exhaustive company-specific 203-page appendix confirmed.
In particular, the financing details of its controversial £4.2 billion Tideway Tunnel scheme still have to be resolved. Ofwat has consistently argued that this scheme is outwith its regulatory asset value (RAV)-based financial model.
Elsewhere in the proposals the benefits for the two original fast-trackers – South West and Affinity – were re-affirmed, along with some minor concessions for Dwr Cymru and Northumbrian. These companies were given their draft determinations in May.
United Utilities was alone in receiving financial compensation for its high bad debt level – other water companies may wonder why they failed to meet Ofwat’s materiality test.
At last, too, Ofwat has imposed a more rigorous obligation to reduce leakage levels, which – in many areas – remain excessive after twenty five years of privatisation.
Amongst the water-only companies, Bristol’s water supply cost submission was way above Ofwat’s projections, whilst Portsmouth was unique in being permitted to retain its average £92 water cost charge in real terms until March 2020. Two water-only companies also received a 0.15 per cent WACC premium.
Importantly, Ofwat has confirmed that its assumed WACC could be adjusted prior to December’s final determination.
Ofwat has also proposed a ‘cap and collar’ regime to prevent excessive or inadequate returns on regulatory equity between 2015 and 2020.
The water companies now have until 3 October to respond to these draft determinations. Many will broadly accept what is on offer, with minor tweaking. But for United Utilities and Thames, earnest discussions will continue – whether Ofwat will be moved sufficiently remains to be seen.