In an Expert Focus article for Waterbriefing, Suzanne Rab barrister from Serle Court discusses the prospects for Bristol Water in its second price control referral.

Suzanne Rab:  Bristol Water did not accept Ofwat’s final determination on its price control limits for the period 1 April 2015 to 31 March 2020.  The Competition and Markets Authority (CMA) will now decide the matter.  This is the second time that Bristol has rejected Ofwat’s price limits.  The CMA referral is a bold move on Bristol’s part, set against the rather mixed experience on previous challenges.

Why is Bristol Water challenging the price control before the CMA?

Ofwat set the next round of price limits for all the water and water and sewerage companies in England and Wales in December last year.  All the companies had until 12 February 2015 to decide whether to accept or reject the regulator’s determinations. Bristol Water was the sole objector, preferring instead to have the matter re-determined by the CMA.  Although Bristol has accepted Ofwat’s retail price control it has refused to abide by the regulator’s wholesale price control asserting that this is based on unrealistic assumptions of the financing costs that are necessary to deliver on what customers want.

It will be recalled that on the last price review in 2010 Bristol similarly rejected Ofwat’s determinations which triggered a referral to the Competition Commission. Now the CMA (which took over the functions of the Office of Fair Trading and the Competition Commission on 1 April 2014) will review the matter afresh.

Bristol says that Ofwat’s final determination makes it very difficult for it to maintain service levels and undertake the necessary investment to deliver the enhancements to improve and protect the water supply to its customers. It has criticised what it has described as Ofwat’s “flawed modelling” which it argues has resulted in a major discrepancy between Bristol’s own business plan and the final Ofwat determination.

What are the main points of difference between Bristol Water and Ofwat?

Ofwat places total costs at £409 million in stark contrast to the £541 million in Bristol’s business plan. Ofwat would like to see customers’ average bills falling by about 23 per cent over the five year period.  Bristol believes that a 4.5 per cent drop is more realistic based on the services its customers have said that they want now and going forwards. Ofwat does not accept that all the planned investments are needed. Bristol’s proposed Cheddar reservoir has been deemed unnecessary by Ofwat and is one particular area where the regulator and the company disagree on relevant costs.

It is not unusual for the company and the regulator to disagree – and sometimes quite markedly – during the price control process. Bristol was not the only company to be some way apart from Ofwat, at least at the start of the process. United Utilities and Thames Water looked set for a battle with Ofwat at the beginning but made adjustments and have apparently managed to get comfortable with the final Ofwat determinations. Bristol, however, was not prepared to accept Ofwat’s final word on the issue.

Why does it matter?

Bristol Water has stepped up to challenge the regulator’s determination which will prolong the inquiry in its case for another six months. Quite apart from the points of principle at stake it is worth taking a look at the impact on the company – or more precisely its shareholders - of Ofwat’s calculations

The owners of Bristol Water (Capstone Infrastructure of Canada, Sociedad General de Aguas de Barcelona of Spain and Itochu of Japan) will of course have an eye on the investment impact of any discrepancy in the PR14 estimates. Although historically investment in water companies in England and Wales has provided a relatively stable and predictable investment it cannot go unnoticed that an aggressive price determination by the regulator can hit hard on shareholder expectations and returns.  In some instances the achieved regulated capital value can even fall below Ofwat’s deemed regulated capital value so the headline numbers in the price control present only part of the picture. 

Price control review: A short history lesson

While past performance is never a guarantee of future performance a survey of water sector experience of price referrals paints is at best uninspiring and at worst depressing.

The Competition Commission has had to look at cases involving South West Water (PR94) and Mid Kent Water and Sutton and East Surrey (PR99). The companies did not obtain substantial victories and the legacy of those cases may be a blunting of the appetite to go through a referral.

Bristol’s own experience before the Competition Commission in 2010 is more nuanced. It secured a 0.6 per cent uplift on customer bills over Ofwat’s calculations but this was still some way apart from the 6 per cent increase it said was due. 

And let us not forget that a referral before the Competition Commission can also expose other aspects of the regulator’s determination that the company would prefer to remain settled. This was the case for Bristol on the last referral where the Competition Commission determined that Ofwat’s assessment of the cost of capital at 5.5 per cent was inflated and found that 5 per cent was appropriate. This is in sharp contrast to the 6.7 per cent sought by Bristol. The outcome on this element also makes interesting comparison with the 3.6 per cent cost of capital allowed in Ofwat’s 2014 final determination.  What a company wins on the swings of a referral it may lose on the roundabouts.

What’s the outlook before the CMA?

It may be asked what Bristol stands to gain before the CMA, given the track record on similar reviews. The CMA’s procedure is practically equivalent to the one conducted by its predecessor. The CMA will approach the matter without any predisposition to support the regulator’s or the company’s view; and it may adopt a decision which diverges from both those positions.

The inquiry group was announced on 11 March and comprises a multi-disciplinary team drawn from the regulatory sphere and other areas. It is chaired by Anne Lambert who has 30 years of experience in the civil service, focusing on regulation and EU affairs.  Other members include Robin Aaronson (economist), Katherine Holmes (competition lawyer), and Stephen Oram (who has a background in the regional and national newspaper industry).

On 25 March the CMA published its administrative timetable setting out the key steps in its process. The CMA will hold hearings with the main parties and give them an opportunity to make further representations. The CMA has until 3 September 2015 to complete its review and expects to issue a provisional determination in June.

By taking its case up with the CMA, Bristol Water has shown that it is prepared to subject Ofwat’s decision-making to independent scrutiny. It may be optimistic to assume that it will secure from the CMA all that it is seeking. It is probably realistic to expect that there will be some movement in its favour on some elements.  Whether that is significant enough to make the challenge worthwhile will be in the detail and the impact overall.

About Suzanne Rab:

Suzanne Rab is a barrister at Serle Court Chambers in London. She has wide experience of EU law and competition law matters combining cartel regulation, commercial practices, IP exploitation, merger control, public procurement and State aid.  Suzanne’s practice has a particular focus on the interface between competition law and economic regulation. She advises governments, regulators and businesses across the regulated sectors including in the communications, energy, financial services, healthcare/ pharmaceuticals, TMT and water sectors.

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About Serle Court:

Serle Court is a leading Chambers based in Lincoln’s Inn in London. Serle Court offers expertise across the range of commercial law and chancery matters.