Ofwat has expressed concern that the allowed rate of return by the Competition and Markets Authority (CMA) is higher than requested by the companies whose preliminary redeterminations were published today (29 September).
The allowed rate of return is 0.54 per cent higher than the final determinations but the CMA pointed out that this is still “significantly lower” than previous price control periods.
“Our concern is that if the allowed returns are too high that’s just a transfer from customers to investors,” David Black senior director at Ofwat told Utility Week. “The allowed returns appear to be higher than requested by companies in their business plans, which is quite unusual for regulators to allow a return higher than the companies asked for.”
He said the regulator was concerned that the higher rate means customers are paying too much but the CMA said the rate would ensure continued investment in the sector.
Black added that Ofwat was “really pleased with some aspects of the decisions particularly outcome cost allowances,” but admitted to being surprised at some of the methods.
The approach taken by the CMA on allowed returns was, Black said, “fundamentally different” from its decision on Civil Aviation Authority (CAA)’s price review earlier in the year when the CMA’s decision was largely aligned with the CAA.
He said Ofwat would examine how the CMA reached its decisions and consider challenging whether the amount is above what investors require as part of the consultation process, which runs until the end of October.
The weighted average cost of capital (WACC) was adjusted to 3.5 per cent, which Black called “quite a significant change” that came from a shift in approach in how data points and WACC parameters were calculated by the CMA. This equates to a roughly 20 per cent increase in investor returns and impacts bills.
The reduction in bills using the CMA’s WACC calculation will be around 9.3 per cent compared to PR14, while the Ofwat’s calculations would have resulted in a 12.6 per cent cut.
“It has a significant impact on bills – rightly the CMA has to be careful in getting that amount calibrated right,” Black said.
Black said the CMA has “taken quite a different approach from previous decisions” on a number of areas including adding weight to the corporate debt as an indicator of risk-free rate and incorporating the effects on the Beta – the measure of systematic risk compared to the wider market – in previous determinations dating back to 2005, which had not been considered in previous appeals.
Another point of surprise for Ofwat was that the cost of equity was at the upper end of a range of potential returns and, again differing from other price reviews the CMA took the view that company outperformance should not be accounted for in debt allowance.
The CMA permitted additional funding for Anglian, Northumbrian and Yorkshire for resilience projects – something that had strong customer support within business plans. On resilience, Black said Ofwat would agree that investment for the long term was important. He noted some company claims for increased funding around climate change had been rejected and challenged, adding “there is certainly no blank cheque for resilience or climate change”.
On costs and outcomes, Black said the CMA has “effectively endorsed Ofwat’s decisions” and added there is a lot that the regulator supports and other areas that it will take time to assess the detail in the decisions.
Company reactions
Peter Simpson, chief executive, Anglian: “This is a complex process, where competing interests and perspectives have to be balanced, and where it is always expected that the CMA panel will challenge or reject some arguments put to them. We never expect to prevail on all points, but we do believe that robust and independent regulation is a profound strength of the system. We will continue to focus on providing the CMA with evidence about what matters most to customers and the environment, now and in the future.”
Liz Barber, chief executive, Yorkshire Water: “Our challenge was about protecting the long-term resilience of Yorkshire and ensuring that the cost of vital infrastructure investment was not pushed on to future generations. We wanted to ensure that the next price review in 2024 struck the right balance between investment and price and did not make the mistakes of PR19.
“The CMA has recognised that the needs of current and future customers are best served by encouraging investment in infrastructure to mitigate the impact of climate change.
“This decision signals a significant move in regulatory approach which is to be welcomed. We are seeing some promising early signs that Ofwat recognises that PR24 needs to be very different and we look forward to working with both government and regulators to create a more sustainable system.”
Heidi Mottram, chief executive, Northumbrian Water: “Our customers’ key priorities were efficient costs and assurance that water and wastewater services would be robust, deliverable and resilient for the future.
“We will be studying the detail in the CMA’s provisional findings over the coming weeks and will prepare a full response in due course. We appreciate the thorough and diligent approach the CMA has taken to make the process to this point fair and comprehensive given the difficult circumstances of Covid-19.”
Mel Karam, chief executive, Bristol Water: “There are a lot of pages to read and a lot of discussions to be had before this process is concluded. This is just part of the journey. Everyone involved so far, the CMA, Ofwat, have done a great job in simply running this process during Covid times. There is more to be done and we look forward to December.”
Stakeholder reactions
Gillian Guy, chief executive, Citizens Advice: “We’re disappointed the CMA’s initial findings are not recommending a better deal for customers – particularly at a time when so many people are struggling financially.
“Supplying an essential service shouldn’t be a one way street. The profits of these monopoly companies must be balanced by a fair deal for the general public.
“When the expected cost of maintaining industry infrastructure is set unrealistically high, bills are inflated unnecessarily.
“We call on the CMA to look again at all the evidence before it makes a final decision.”
Emma Clancy, chief executive, CCW: “While customers will welcome the additional investment to safeguard the reliability of future services, any bill rise – no matter how small – would be a body blow to households already reeling from the financial impact of coronavirus. Companies need to be clear about what customers are getting for this money, while increasing the support available to those who might struggle to afford the proposed increase. The industry also needs to work together to end the postcode lottery impacting the range of help available to customers in different regions. We will be responding to the CMA’s provisional findings and will expect customer views to be heard and listened to.”
Lawrence Slade, chief executive, Global Infrastructure Investors Association: “It is important that regulation ensures that consumers across the country pay a fair price for their utilities, whilst at the same time making sure that the UK is able to attract the level of investment required to address resilience to climate change impacts and meet the UK’s legally binding commitment to achieve Net Zero carbon emissions by 2050. These issues will require extensive investment in the UK’s infrastructure over the coming decades and the associated costs must be fairly allocated to provide inter-generational equity between current and future consumers.
“The CMA’s provisional findings indicate that some adjustments are needed to Ofwat’s price determinations in order to achieve the right balance, and we agree. GIIA will be submitting further evidence in response to the CMA’s provisional findings and we will continue to encourage the Government, Regulators and Investors to create the necessary environment to meet the UK’s future water and energy needs at the same time as achieving a fair deal for all consumers.”
Utility Week will diver deeper into the company outcomes and reactions in the coverage in the coming days.