The credit ratings of the four gas distribution networks (GDN) in Great Britain are likely to come under pressure as Ofgem clamps down on profits as part of the RIIO2 settlement, Moody’s has warned.

In a consultation published in December, the regulator proposed to the lower the baseline profit allowance to 2.64 per cent for the RIIO GD2 price control starting in 2021. For comparison, the equivalent figure for 2018/19 is 4.59 per cent.

On this basis, Moody’s said GDNs could expect to see their nominal returns fall by 30 per cent and their real returns by 25 per cent.

The ratings agency also drew attention to Ofgem’s proposals to limit returns if they exceed the baseline profit allowance by more than 3 percentage points. It noted that GDNs are currently projected to outperform the baseline by an average of 4.5 percentage points over RIIO GD1.

“Gas distribution companies will face an unprecedented cut in allowed returns and much less scope for outperformance in RIIO-GD2, putting increasing pressure on cash flows and interest coverage,” said Graham Taylor, senior credit officer for infrastructure and utilities at Moody’s.

Moody’s said Wales & West Utilities (WWU) is likely to be hit hardest by Ofgem’s efforts to rein in profits due to its high borrowing costs which are forecast to average 4 per cent on a real basis over the RIIO GD2 period compared to an expected regulatory allowance of less than 2 per cent.

Accordingly, the company has already downgraded a tranche of WWU loans set to mature in 2021 from Baa1 to Baa2.

Ofgem has additionally floated the idea of introducing a new mechanism whereby operating companies struggling to service their debts would have a share of the costs picked up by customers. Moody’s said the mechanism is likely to have “significant practical limitations” and provide no support to leveraged holding companies.

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