The UK water sector's total expenditure (totex) is likely to more than double in the upcoming AMP8 2025-2030 regulatory period, according to Fitch Ratings latest UK Water - Relative Credit Analysis report released this morning.

The ratings agency’s detailed 27 page analysis assumes that there will be upward revisions in the AMP8 Business Plan updates by the water companies in England and Wales following their initial submissions.

Fitch says the increase in totex will be largely driven by higher investments in combined sewer overflow (CSO), pollution reduction, and nutrient mitigation, as water and wastewater companies attempt to meet tougher statutory requirements.

Fitch believes issuers with low rating headroom will have to inject equity into the regulated licenced operating companies to comply with Ofwat’s updated licence requirements for a minimum rating of ‘BBB’/Negative, effective from April 2025.

This represents the regulatory licence lock-up level – the expectation is that issuers will target ratings above this level. Fitich is expecting early guidance from water and wastewater companies on their capital structure expectations after the draft determination is published by Ofwat on 11 July.

“We believe Ofwat may ultimately opt for a more measured approach in setting outcome delivery incentive (ODI) benchmarks for AMP8. The regulator may indicate that the targeted standards might exceed what is reasonably achievable for water and wastewater companies if a significant portion of the industry experiences net penalties”, Fitch says in the report.

The UK Water - Relative Credit Analysis report sets out a detailed assessment of issuers, categorising them into three distinct tiers based on their performance metrics. Fitch views totex performance across the peer group as broadly ‘average’, which does not inherently signify operational inefficiencies or suboptimal cost management practices, despite the general trend of totex overspend. In the ratings agency’s view, totex overspend predominantly stems from higher investment activities.

Positive outliers in the ODI category tend to earn the highest net ODI rewards in the peer group, while issuers with the highest net ODI penalties are at the other end of the performance spectrum. Fitch Ratings’ assessments are based on a range of metrics that fell short of Ofwat’s benchmarks. Return on regulated equity (RoRE) is an important way to see if a company is meeting the final determination's expectations. Doing better than expected or spending less can lead to a higher RoRE, which may mean higher distributions to shareholders or increased investments.

The ratings agency’s assessment of CSO incorporates several factors, although it is based on a relatively short history of event duration monitors reporting. Heightened regulatory oversight of CSO is shifting the regulatory landscape as authorities impose stricter controls. Ofwat can levy fines of up to 10% of a company's annual turnover, whereas the Environment Agency has the power to impose unlimited fines.

The UK water-licenced ringfenced operational companies have generally maintained adequate or comfortable rating headroom in their net debt-to-regulated capital value (RCV) ratios in AMP7, with a buffer against Fitch’s negative rating sensitivities. Comments on individual companies in the report include:

• Southern Water Services (downgraded by one notch in 2023 with a Negative Outlook) and Kemble Water Finance Limited (an intermediate holding company for Thames Water; in Restricted Default) are negative outliers.
• United Utilities Water Limited has limited net debt/RCV headroom. Fitch expects its significant investments, which are above its baseline allowance, and early investments from the forthcoming AMP8 price control, to provide additional headroom through shadow RCV.
• Anglian Water’s holding company Osprey Acquisitions Limited also has limited net debt/RCV headroom, but its Stable Outlook is supported by year-on-year improvements in its post-maintenance interest coverage ratio, especially at the end of AMP7.
• Yorkshire Water Services – Fitch expects adequate gearing headroom by end-March 2025 following the gradual repayment of GBP940 million intercompany loans.

Click here for more information about Fitch Ratings UK Water - Relative Credit Analysis report