Warnings on PR19 squeeze

Ofwat’s plans for the next price control risk unintended consequences, say experts

Ofwat has been warned that its proposals to squeeze water utilities’ prices will damage the credit worthiness of the sector and potentially undermine investment.

The concerns were expressed at a conference held last week in London, which examined the impact of PR19, under which Ofwat is planning to reduce the cap on annual price rises from 3.5 per cent to less than 3 per cent.              

In his keynote presentation at the conference, David Black, senior director, Water 2020 at Ofwat said low interest rates meant that the sector has enjoyed headroom in its borrowing costs.

He told the conference that water companies should not regard efforts to improve resilience as a “license to spend”.

But Stefanie Voelz, senior credit officer at the infrastructure finance Group, Moody’s Investors Service said that the reduction in water companies’ financial flexibility could lead to a one notch downgrade in their ratings.

She said that the introduction of greater competition into the water market could knock another notch off existing companies’ ratings.

“If businesses are increasing their risk at the same time as reducing financial flexibility that creates pressure on the credit portfolio.

“At the moment, the sector enjoys a very very low cost of debt but that might not always be the case.”

Andrew Beaver, director of the infrastructure advisory group at KPMG, expressed concern that the regulator’s proposals would give water companies insufficient leeway to tackle long-term challenges to their businesses, such as supply shortages.

“If we really think there are long term challenges around water scarcity and floods, perhaps this is the opportunity to use the headroom identified to help address some of those challenges and make investments. There is a question about whether we are pushing too hard to the long term detriment.”

Beaver, who is a former regulator at Ofwat, said that the direction of travel sketched out by the regulator had already had a “chilling effect” on the water market.

“Transaction activity has been happening in the sector but some of the levels of competition for equity stakes have been less than previous periods. Multiples being paid but the world feels different to before.”

Andy Pymer, managing director, Wessex Water, warned that past attempts to curb price increases had created long-term problems for the sector. He pointed to an attempt by the Labour government to do so in the late 1990s, which he said ad resulted in an unsustainable 12 per cent drop in average bills. 

“Companies weren’t trading at a premium but at a 60 per cent discount. Bills had to go back up again in the following decade.

“We must make sure we don’t cut back on essential investment. We must be careful about damaging the things that are fundamental to making this sector successful.”

Tony Smith, chief executive of the Consumer Council for Water, said that Ofwat’s cap on price rises still gave scope for around £25bn worth of investment in the water sector over the five year business planning period covered by PR19.