Moody’s is warning that under Ofwat’s Direct Procurement for Customers (DPC) framework for large infrastructure projects, construction risk will weigh on project credit quality.

Under the DPC framework a single asset project, closely linked to a regulated water company, will be delivered by a special purpose entity, known as a Competitively Appointed Provider (CAP), which will fund and procure construction of the asset and be remunerated once it is operational. The CAP itself will not be licenced or directly regulated by Ofwat.

United Utilities Haweswater Aqueduct Resilience Programme, designated by Ofwat as a DPC project in December 2021, is the first and most advanced DPC project.

Going forward, at the forthcoming 2024 Price Review Ofwat will expect all companies to use DPC for all new investments with a whole-life totex of £200 million or more, subject to the assets being sufficiently distinct.

Earlier this month water sector regulator Ofwat published an investor pack flagging up upcoming potential private sector investment opportunities worth up to £14 billion.

The investor pack highlights opportunities for interested parties to get involved and learn more about the sector, together with showcases the significant investment required over the coming years. It also sets out the opportunities for investors, both for the imminent pipeline of projects and future opportunities, specifically focusing on the Direct Procurement for Customers (DPC) framework.

Large projects are expected to be taken forward through DPC, whereby water companies put major projects out to competitive tender for delivery by third parties.

Government support is not envisaged for any of the planned and potential future DPC projects - unlike the Thames Tideway Tunnel which benefits from an extensive government support package.

Moody’s was commenting in its newly-published in-depth sector assessment on regulated water utilities in the UK.

According to the ratings agency, construction risks for DPC projects will be a function of the following:

• asset complexity
• contractor’s strength, track record and experience
• the extent of risk transfer under the construction contract

In Moody’s view the construction risk associated with the asset will constrain DPC credit quality, but could be mitigated by the strength and experience of the contractor, as well as a risk-sharing approach. Complex DPC projects could also benefit from additional regulatory protections that allow significant cost overruns to be shared with customers, which could also be credit-enhancing.

Moody’s comments in the assessment:

“The DPC's revenue stream will be contractually underpinned by the regional (waste-)water company that is the core off-taker and, therefore, closely linked to a regulatory regime that we consider to be amongst the most transparent and predictable, a credit positive.”

However, Moody’s is cautioning that the framework is new, its detailed features are still being developed and contractual arrangements will vary between projects.

Liquidity to withstand cost overruns or delays is also seen as a key mitigant to construction risk by Moody’s which could determine the difference between investment-grade and sub investment-grade projects.

Ofwat believes that outsourcing large projects to a Competitively Appointed Provider (CAP), will attract a wider range of investors, thereby supporting innovation and ultimately lowering project-life costs for the benefit of customers.

In assessing construction risk for DPC projects, Moody’s says it will mirror the approach set out in its rating methodology for Construction Risk in Privately Financed Public Infrastructure (PFI/PPP/P3) Projects, last published in July 2019.

Moody’s credit assessment will also reflect the strong linkage with the regulatory regime for regulated water utilities. Its rating methodology for Regulated Water Utilities, last published in June 2018, will remain the core rating methodology in assessing credit risk for (waste-)water-related infrastructure.

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