Ofwat has launched a new consultation on its provisional decision requiring Dŵr Cymru Welsh Water to reduce its tariff in a long-running dispute over the supply of non-potable water to Tata Steel UK Ltd.

In a case which has important implications for the sector, the water industry regulator has issued its Draft Determination about the disputed terms and conditions of a partially treated non-potable water supply agreement between Dŵr Cymru and the steel and iron producing company at Tata’s large steel works at Llanwern, near Newport in the south of Wales.

Under Dŵr Cymru’s 2014/2015 scheme of charges, the new Tariff Price which would be applicable to Tata is 43.3p/m³ plus a fixed charge of £39,840. Ofwat has provisionally determined that the price for the supply of non-potable water from Dŵr Cymru to Tata should be 20.33 p/m3 at 2004/05 prices, with a starting price of 27.75 p/m3 effective from 1 April 2015 and covering the 2015/16 financial year.

The supply to the Llanwern site has been the subject of a number of agreements stretching back to the 1960s. The current dispute between the parties dates from 2004 when a previous agreement, signed in 1993, came to an end. At the termination of the 1993 agreement, Dŵr Cymru proposed to transfer Tata onto their standard large non-potable water user tariff. However Tata disputed this, arguing that the price for the supply to the Llanwern site should be based on Dŵr Cymru’s actual costs specific to the supply at the site.

In April 2003, and prior to the expiry of the 1993 agreement, Dŵr Cymru introduced a new standard tariff for large users of non-potable water, as part of its charges scheme for the year 2004/05. Dŵr Cymru informed Tata that, on expiry of the 1993 agreement, it intended to migrate Tata onto the new standard tariff for large users of non-potable water, with effect from 1 April 2004. However, when the 1993 agreement expired, Tata resisted Dŵr Cymru’s attempts to migrate it onto the new standard tariff for large users of non-potable water, and sought instead to negotiate a new individual agreement.

In April 2005, Dŵr Cymru issued a claim against Tata for the difference between the sums actually paid by Tata since 1 April 2004 and the sums which would be payable by Tata under the relevant tariff for large users of non-potable water. The litigation ultimately resulted in a judgment of the Court of Appeal in Tata’s favour.

Following the ongoing failure of Tata and Welsh Water to reach agreement, in 2008 both parties asked Ofwat to determine the terms of the supply. Since the expiry of the 1993 agreement, Dŵr Cymru has continued to supply non-potable water to Tata at Llanwern, for which Tata has paid an amount, known as the Interim Price.

Under Dŵr Cymru’s 2014/2015 scheme of charges, the new Tariff Price which would be applicable to Tata is 43.3p/m³ plus a fixed charge of £39,840. Ofwat has provisionally determined that the price for the supply of non-potable water from Dŵr Cymru to Tata should be 20.33 p/m3 at 2004/05 prices, with a starting price of 27.75 p/m3 effective from 1 April 2015 and covering the 2015/16 financial year.

Tata considers that Ofwat’s determination of the price of the supply should reflect the “special features” of the supply to the Llanwern site, summarised as:

• The volumes supplied to Tata at Llanwern are very large, and the economies of scale resulting from that supply, are such that the supply cannot be simply be categorised along with other large industrial users of non-potable water. In  November 2008 Tata described the supply at Llanwern at that time as “the largest supply of non-potable water made in Wales.”
• Tata’s predecessor, Richard Thomas & Baldwins Limited, contributed more than 70% of the capital/finance costs of the infrastructure currently used by Dŵr Cymru to supply the Llanwern site and that this should be reflected in Ofwat’s determination of the price of the supply.
• Tata has argued that the application of both the Tariff Price, and the Interim Price which it has been paying Dŵr Cymru since 1 April 2004, would be wholly unjustifiable, having regard to these special features.
• The steel firm also also considers that both the Tariff Price and the price which it has been paying since 1 April 2004 are excessive and unfair.

The draft determination document sets out Ofwat’s subsequent investigation and provisional determination in relation to the dispute - the regulator has provisionally determined that the price for the supply of non-potable water from Dŵr Cymru to Tata should be 20.33 p/m3 at 2004/05 prices, with a starting price of 27.75 p/m3 effective from 1 April 2015 and covering the 2015/16 financial year. From then on the 2015/16 price will be inflated in line with the average RPI inflation figure from 1 April 2015 up to 31 March of the year for which the price is being determined. However, this means that the price for each subsequent financial year will not be known until after the financial year has begun because the RPI figures for March will not be published until the middle of April. Given that the parties are proposing a monthly billing process, Ofwat is also seeking views on whether this approach is appropriate and how best to implement it.

Ofwat is now inviting comments from interested stakeholders, including Dŵr Cymru to Tata, in particular on two key questions:

Q1 Do you have any comments on our approach to resolving bulk pricing disputes in this determination?

Q2 Do you have any views on the different factors (and materiality of those factors) which may affect the costs of providing bulk water to large users? Please provide clear evidence to support your response to this question.

Sections of the Draft Determination are redacted, in particular pages 55 to 64 in the main body of the document covering non-price terms which is fully redacted. Some of the redactions include references to specific infrastructure and assets.

Appendix 1, which runs from pages 66 to 72 inclusive and which covers the draft agreement containing Ofwat’s draft determination of the disputed terms and conditions in the case, is fully redacted.

PR14 company-wide cost of capital  is “reasonable estimate” of long term cost over a 15 year horizon

The draft determination contains some interesting indications with regard to Ofwat’s views on long-term financing by the sector with wider implications for the other water companies in England and Wales.

On the long term weighted average cost of capital (WACC) approach for price determination cases, the document says that price determinations are not linked to price control periods and the prices are not set for any particular period, but rather are intended to be applied over the length of the agreement. As a result Ofwat considers that the view of all costs, including the cost of capital, used for the purpose of a determination should be its best view of long-term costs. The paper states:

“This raises the question of whether a cost of capital set for the purpose of a price control which applies for only five years should be used in the context of a price determination which we consider should endure.”

Given that price determinations are expected to extend beyond price control periods, Ofwat considers that the cost of capital applied in these and other determinations should reflect a reasonable long term view of an efficient rate of return, despite the fact that this is “inherently less precise as there is greater uncertainty about future economic conditions.”

The regulator has assessed whether, based on the evidence currently available, the PR14 company-wide cost of capital  (3.74% vanilla WACC) is also a reasonable estimate of the long term cost of capital appointed companies will face over a 15 year horizon, rather than simply reflecting the costs companies over the 2015-2020 price control period. Ofwat has analysed separately the individual building block components of the final PR14 cost of capital, including the cost of equity and debt and assessed whether they fall within a reasonable expected long term range.

Overall, the regulator says the analysis shows that even though the PR14 notional company-wide cost of capital produced for the final PR14 price control determinations is specific to the price control period, it still falls within a reasonable long term view range. Ofwat said:

“As result, we do not propose to deviate from the final PR14 cost of capital figure as the starting point of our analysis to derive a suitable forward looking cost of capital for this price determination.”

Click here to access the draft determination document online - deadline for submission of responses is 21 August 2015.