The “unduly harsh” plans for the next price review would undermine confidence in the water sector and could lead to a spike in customer bills in later regulatory cycles, according to Northumbrian Water.
In its response to Ofwat’s consultation on its framework for PR19, Northumbrian has warned that it “simply shifts the dial too far, introducing an associated level of overall risk that threatens to undermine confidence in the sector and will ultimately impact on the outcomes the sector is able to deliver to customers”.
Northumbrian has joined forces with Anglian Water and Affinity Water to commission a report from consultant KPMG, challenging the financial assumptions underlying Ofwat’s proposed total market return, a key element of the cost of equity.
The company warned: “We recognise that this review offers the prospect of a reduction in customer bills, driven by lower returns and the sharing of past outperformance. We believe, however, that a sharp reduction in bills that is caused by an unduly harsh reduction in returns would ultimately act against customers’ interests by undermining investor confidence – risking a sharp increase in prices at the end of the PR19 control. This would be similar to the situation that arose following the PR99 review where a sharp reduction in prices was followed by financial distress in the sector and a significant increase in prices at the next review in 2004.
“Such a rollercoaster ride for prices is not in the interests of customers nor does it facilitate confidence and efficient financing of the sector.”
Northumbrian has also challenged the calibration of outcome delivery incentives (ODIs) in the proposed framework, saying: “We find it surprising that Ofwat’s expectation is that more companies will face performance penalties than rewards and in particular that average performance should attract a penalty. This implies that an average company will earn less than the cost of capital, which would represent a significant change in risk profile for individual companies and for the sector as a whole.”
It addsed: “In our view the package that is being proposed is unbalanced and fails to incentivise the exceptional performance that Ofwat, our customers, and we as a leading company wish to see.
“This is particularly concerning at a time when the UK economy is facing unprecedented uncertainty given a volatile global outlook compounded by the prospect of Brexit.”
The company has lent its support to the overall structure and form of the price control, and the plan to create greater differentiation between companies based on performance. It has also backed the four key themes of the price review: customer service, affordability, innovation and resilience.
Ofwat has received more than 60 responses to its consultation and will publish its response alongside its final methodology in December.