On the 13th day, Ofwat spoke – and the seemingly interminable PR19 has moved a significant notch forward.
Whilst Ofwat’s latest 259-page tome was wide-ranging, for most water company executives, leading shareholders and utility analysts, it will be the chapter on the sector’s finances that will be the most scrutinised.
In particular, details of Ofwat’s latest thinking on its assumed weighted average cost of capital (Wacc) – a pivotal figure – were set out.
Following much speculation about Ofwat’s initial Wacc assumption, it has now been confirmed that – “In RPI-terms, it is 2.4 per cent, which is a reduction of 1.3 per cent from the 2014 price review.”
This initial headline figure was tougher than most forecasts, but whether it will endure at the final determination remains to be seen.
Furthermore, there are strong Wacc-based premium incentives to secure Ofwat’s coveted “exceptional” or “fast-track” status.
With a much tighter Wacc already discounted by the market, shares in the three quoted water stocks – Severn Trent, United Utilities and Pennon – were down marginally earlier today: Severn Trent’s shares have fallen by 17 per cent since their May 2017 peak.
With Ofwat’s latest Wacc assumptions now in the public domain, the focus of the water companies will move increasingly to their long-term business plans.
Outside the water sector, other utilities – including the regulated electricity companies – will take careful note of Ofwat’s aggressive Wacc stance as will their respective regulatory bodies, including Ofgem.
Furthermore, the Treasury will closely monitor the response of the credit rating agencies to Ofwat’s tough Wacc announcement given that the water companies need to preserve their treasured investment grade status.
It may be that the sector is being used a “stalking horse” by the Treasury to ascertain whether regulated companies can absorb a much more aggressive Wacc – down by a third in just five years after what will have been over 30 years since privatisation.
Undoubtedly, over the next few months, considerable debate will ensue about Ofwat’s Wacc range – and the extent, if any, to which its financial analysis is flawed.
Aside from financial issues, it should be added that the sector will not exactly welcome Ofwat’s more aggressive leakage stance – reductions of “at least 15 per cent” are being sought; this will be a seriously “big ask” for some of the urban-based water companies.
Overall, not a good morning for water sector shareholders, although customers will welcome the projected £15 to £25 annual price cuts.