Final methodology for tough new water price control contains few concessions

Ofwat released the final version of its methodology for the 2019 price review (PR19) on 13 December, having published the draft for consultation in July. The water regulator has repeatedly touted each successive price control as being its toughest one yet, but they have usually turned out to be fairly lenient. However, the way PR19 is shaping up, Ofwat’s claims may be borne out.

The final methodology showed that Ofwat is indeed planning an unprecedentedly-low cost of capital for the price control, its initial view being 2.4% in RPI terms (the wholesale-only figure being 2.3%). This is 1.3 percentage points – roughly a third – below the level for PR14. The low allowance for cost of capital will be a driving factor behind the regulator’s projected bill reductions for customers of £15-25 per household per year from 2020.

Generally, Ofwat’s central ethos has been that investors should not be able to reap the substantial rewards which they have in the past from companies which are just doing business as usual. A greater amount of company revenue will be put at risk by outcome delivery incentives (ODIs), and these will be reconfigured so that a company only achieving average performance will actually receive a penalty rather than a neutral or positive result.

One concession to water companies in the final methodology is that they will only need to achieve forecast upper quartile performance each year on a rolling basis, rather than having to achieve projected 2024-25 performance from the beginning of the control, as had originally been proposed.

Similarly, the Service Incentive Mechanism is to be replaced with new Customer and Developer Measures of Experience (C-MeX and D-MeX). It is hoped that these will support innovation and remove perverse incentives not to engage with customers. Companies are also challenged to save 170bn litres a year through reducing leakage, and helping vulnerable customers will be an explicit part of the price control for the first time.

With companies and investors having got over the initial shock of the PR19 proposals, they are now looking fairly confident again. The water companies have demonstrated that they know how to handle risk and improve efficiency, so they likely remain a safe bet for investment. PR19 should bring real benefits to consumers too: in price, in service, and in innovation.

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