Ofwat, UK water firms compromise, agree on changes

Separation between wholesale and retail price controls will go ahead, but Ofwat’s proposed ability to shift activities accounting for up to 40% of water firms’ total revenues outside of the current price control framework have been nixed.

UK watchdog Ofwat and the private firms that manage the country’s water sector have reached a compromise on some of the regulator’s proposed changes ahead of the 2014 price review.

The agreement removes Ofwat’s most threatening proposal from the equation – the proposed ability to move activities accounting for up to 40 percent of water firms’ total revenues outside of the established price control framework – while still allowing the regulator to introduce more flexibility to set price controls.

The biggest changes agreed between the parties concern the separation of wholesale and retail price controls. In short, wholesale price controls for water and sewerage activities will continue to be determined pretty much the way they are today, using the standard RPI+/-K formula, for five-year periods. RPI stands for Retail Price Index, a common inflation indicator. 

Retail services will, from 2014 onwards, be subject to more flexible, separate price controls. The terms will still be defined by Ofwat and price review periods may last less than five years. Furthermore, water firms have also signed up to a change that “requires them to use all reasonable endeavours to work constructively and co-operatively with us [Ofwat] on developing appropriately targeted price controls in respect of specific wholesale activities in the future”.

Moody’s, the ratings agency, has reacted positively to the agreement, saying it reduces near-term uncertainty. 

Still, it warns “that whilst near-term uncertainty has been reduced, it expects negative credit pressure to build for water companies over the medium to long term due to a shifting regulatory landscape, although the full extent of the consequences will not become clear until the regulator publishes more detailed proposals for its future price limits methodology later this year”. 

The ratings agency is also unsure of how Ofwat’s requirement that water companies work constructively with it to implement government policy will affect the industry.