The new direct procurement for customers (DPC) framework introduced by U.K. water regulator Ofwat offers a good opportunity for U.K. water utilities to share risks with project companies, contractors, and customers, according to S&P Global Ratings.
The credit ratings agency has set out its thinking on Ofwat’s DPC model in a new paper published on 16th May last week - U.K. Water Utilities And Projects: The New DPC Investment Model In Focus.
The paper assesses the implications of the DPC framework for S&P’s ratings on English and Welsh water utilities, together with describing the approach S&P expects to take to rating DPC projects.
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.
In October 2022 Ofwat published an investor pack flagging up upcoming potential private sector investment opportunities worth up to £14 billion.
The information pack sets out the upcoming opportunities in the sector for investors, both for the imminent pipeline of projects and future opportunities, with a predominant focus on the development of major new infrastructure and strategic water resource solutions and on the Direct Procurement for Customers (DPC) framework.
United Utilities Haweswater Aqueduct Resilience Programme, designated by Ofwat as a DPC project in December 2021, is the first and most advanced DPC project.
In the pack Ofwat flags up the investor opportunity - describing the water sector as “a low-risk growth sector with long-term stable returns and a guaranteed revenue stream underpinned by commitment from the regulator.”
S&P "DPC projects - predictable availability-based operating revenue could represent a clear rating strength"
Commenting on DPC in the paper, S&P Global Ratings said:
“We would likely treat DPC project-level debt as a contingent liability for the utility--if we view the contingent risks as sufficiently remote and limited, we would exclude it from our calculation of the utility's adjusted debt.
“Projects that use the DPC model could be eligible to be rated using our project finance criteria, if they have the relevant attributes, including the covenant package, security interest, and bankruptcy remoteness.
“For DPC projects, predictable availability-based operating revenue could represent a clear rating strength, but key risks could emerge if the committed funding does not fully cover construction costs, including the cost overruns we assume in our downside scenarios.”
An article published separately in the Financial Times on Friday said that the UK’s “debt-laden water utilities” were being encouraged by the water sector regulator to set up new “privately financed companies to deliver billions of pounds worth of critical infrastructure” to be paid for via customer bills.
The FT quotes Professor Dieter Helm of Oxford University as saying that the use of DPC schemes was partly a result of “Ofwat’s failure to stop the balance sheets of the utilities being misused for financial engineering.”
Ofwat CEO - “At privatisation, it was always intended that investment required to upgrade water networks would be, at least in part, financed by debt"
Commenting on debt and water sector finance in July 2023, David Black, Chief Executive of Ofwat said:
“At privatisation, it was always intended that the investment required to upgrade water networks would be, at least in part, financed by debt. Just as you borrow to buy a house or a car: so companies borrow to invest in pipes or treatment plants….
“Looking ahead, the sector faces big challenges that need significant investment – to finance new reservoirs and water transfers, and to cut sewage discharges and nutrient pollution.
Companies will need to borrow to make this investment. As they do so, they need to learn the lessons of the past and consider the role of equity as well as debt, to make sure they are resilient financially. And companies might do well to consider different routes, beyond private investment, including whether funding might be raised publicly through the listed route, or by championing other models, as happened with the Thames Tideway so-called super sewer.”