The return to a stable outlook in 2021 for UK regulated water utilities reflects certainty around allowed returns and cost allowances over the five-year period from April 2020 (AMP7), according to a new research report published by Moody's Investors Service today.
“While the unprecedented cut in allowed returns has significantly weakened interest cover ratios across the sector, there is now certainty on allowed returns until March 2025 and we expect companies’ credit ratios to stabilise at a weaker level,” said Stefanie Voelz, a Moody's Vice President - Senior Credit Officer and the report's author.
Last September, the Competition and Markets Authority (CMA) published its provisional findings on appeals by Anglian Water Services Ltd., Northumbrian Water Ltd., Yorkshire Water Services Limited and Bristol Water plc relating to their AMP7 revenue allowances. The provisional findings could have improved the four companies' financial metrics markedly compared with Ofwat’s determination.
However, a consultation on the cost of capital determination, published on 8 January 2021, indicates that the CMA may ultimately allow a return that is 30 basis points below its provisional findings.
The ratings agency said while this would still be above the level set in Ofwat's determination, the potential for metrics improvement would be more muted.
According to Moody's, for the sector as a whole, revenue has fallen as businesses use less water during the pandemic. While the regulator allows this lost revenue to be recovered with a lag, it could be more than offset by penalties for underperforming regulatory targets. COVID-19 could also make meeting already demanding targets harder.
Over the longer-term, climate change will increase the risk of water stress. Near-term investment will be required to avoid much larger costs in future. Such investments will need to be supported by the regulatory tariff framework to avoid negative credit implications, but they create affordability concerns.
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