Ofwat has published its reconciliation rulebook as part of the 2014 price review (PR14) process, which concluded in December 2014.
At the conclusion of the price review Ofwat committed to publishing a rulebook as it acknowledged that PR14 represented a significant evolution of the historical approach to setting price controls. The regulator said the rulebook provides investors and companies with the clarity on how it expects to make adjustments to revenue and RCV to reflect companies’ performance during 2015-20 to help facilitate investment in the long term interest of customers.
Following consultation in March, the rulebook sets out how Ofwat proposes to reconcile incentives set as part of PR14 and company performance at the next review in 2019. The rulebook also sets out the reconciliation approach to the factors not reconciled from the 2009 price review.
The rulebook includes details of how Ofwat proposes to manage:
i. outcome delivery incentives (ODIs) - which provide companies with rewards for achieving stretching performance targets and compensate customers if performance is below performance targets. This covers the different approaches to calculating rewards and penalties based on companies’ actual performance over the five years from 1 April 2015. While Ofwat expects companies to report on their performance against other (reputational) commitments, the Rulebook focuses on the Performance Commitments with associated financial ODIs only.
ii. wholesale total expenditure (totex) sharing - where company over- and underperformance is shared with customers. Ofwat’s totex menu provides extra incentives for companies to reveal information and for some extra flexibility in setting totex baselines and cost sharing factors.
The totex menu generates a reward/penalty that is dependent on a company’s menu choice and its actual totex spend at the end of the 2015-2020 period. For each menu choice there is an associated level of allowed expenditure that is used to set price limits and a cost sharing rate. The cost sharing rate is used to define the amount of out or under performance that is shared between companies and customers. Ofwat wants to allow customers to share in an element of the financing costs/benefits that are generated from totex under/over performance in each year of a price control.
iii. wholesale revenue forecasting incentive mechanism (WRFIM) - which provides financial incentives for companies to provide accurate forecasts, and ensures under- and over-recovery is reconciled
iv. household retail - where the total revenue allowance is adjusted for actual customer numbers. The household retail control for 2015-20 represents the first separate price control for customer facing household ‘retail’ services. Ofwat’s aim is to provide regulatory protection over household retail prices by setting a total revenue control for each company, based on the efficient costs of retail activities and projected customer numbers. The Rulebook addresses how Ofwat will reconcile between forecast and actual customer numbers in a given year and how it will account for over or under recovery of “household retail revenues per customer type.”
The rulebook does not however include Ofwat’s conclusions on the reconciliation of the PR09 capital expenditure incentive (CIS) scheme. The Competition and Markets Authority (CMA) is currently considering Bristol Water’s price determination appeal. While the CMA has provisionally decided not to address the issue as part of the appeal, in Ofwat’s view it would be appropriate to conclude on the CIS issue later in the year when the CMA’s process has ended.
Click here to download the PR14 reconciliation rulebook