Ofwat has said it will “carefully consider the thoughts of the PAC”, following publication of the House Of Commons Public Accounts Committee report which said over-estimating by the water regulator had led to the water companies making at least £1.2 billion in windfall gains over the last five years.

Responding to the PAC report, Cathryn Ross, Ofwat Chief Executive said:

“Holding companies to account and protecting customers is at the heart of what we do. That’s why we’ve made sure bills will fall five per cent by 2020 and companies will deliver more. We will carefully consider the thoughts of the PAC.”

“PAC’s comments on gains relate to decisions Ofwat made six years ago. Since 2012, we’ve stressed that customers are having a really tough time, and stepped in to claw back £435m from companies. We then challenged companies to reduce bills further, resulting in £3 billion of savings, which will mean bills fall 5% in real terms over the next five years. Service will continue to improve and we will have kept bills below inflation over two decades.”

“Yet it’s no time for complacency. We’ve made changes so that companies become more transparent and resilient. And plan more changes to help create a sector customers can trust. That means making companies more efficient, more accountable and much better at responding to what customers want.”

“In the last decade, we have clawed back £800m from companies’ shareholders, where they have let customers down. If companies don’t step up, we’ll step in.”

Ofwat said that a report by the National Audit Office for the Public Accounts Committee, published in October, recognised that in 2009, when Ofwat previously set prices, it was following the severe global financial crash and a time of significant uncertainty.

Ofwat said at it made a decision at that time to shield customers from further turbulence by locking in financing costs then. Companies did however subsequently make gains through unexpectedly low borrowing costs, as well as high inflation and changes in tax rates.

According to the regultor, the NAO recognised that Ofwat’s approach would have protected customers, and kept bills down, if borrowing costs – and changes in tax – had increased costs significantly.

In 2014, Ofwat set the lowest cost of capital ever set in the utility sector (3.6%). However, it has announced that it will review how it sets the cost of capital, including learning from other sectors and whether it now needs to change its approach to how it takes account of the costs of debt and tax.

The water regulator said it has committed to learning from other sectors and looking beyond water companies to whether information from other sectors could help drive more efficiency.

Ofwat: change in position on a windfall clawback mechanism?

Giving oral evidence to the Public Accounts Committee on 4th November as part of its inquiry into the economic regulation of the water sector, Cathryn Ross appears to have shifted position on the possibility of a windfall claw back mechanism.

In October last year Cathryn Ross categorically ruled out the possibility of a retrospective windfall clawback mechanism in the upcoming PR19 Price Review for the 2020-25 investment period.

However, it appears that this position may now be changing. Cathryn Ross told the Committee that Ofwat has no mechanism to claw back gains that companies made, with the benefit of hindsight, under the last control period.  However, the benefit had subsequently been passed on to customers on a forward-looking basis through the PR14 price control covering 2015-2020.

 Meg Hillier MP, Chair of the Committee told Cathryn Ross that Ofwat had taken “a very confusing approach”  to its forecast, commenting:

“Then when it came to a big dividend for the water companies, you sought to claw it back in a haphazard way.“

The Chair then went on to ask:

“So would you like to have the powers to have a clawback or a share of the company’s dividend if it goes over a certain level?”

In response, Cathryn Ross said:

“I think it’s a tricky thing. What I would not want to do is reach back in on an ad hoc basis and claw back gains that companies had had, or indeed put bills up for customers, as though we were talking about this symmetrically, because the value that the independent economic regulatory regime brings to the sector, particularly in terms of facilitating that £130 billion of investment that has gone in since privatisation, is stability, clarity and predictability. So if we start behaving in an unpredictable, maverick way—“

At this point the Chair intervened, commenting:

“You can write in the predictability, can’t you? On this £1.2 billion gross benefit—£800 million net—you can say they can get to £500 million net and then you will take the rest back and share it with customers. Take it off the bills or whatever.”

Cathryn Ross replied:” Yes, and I think that is the way that we would do it.”

The Ofwat Chief Executive went on to point out that if the risk profile was skewed by taking away some of the upside—capping the upside—it essentially shifted the cost to capital to the right which went straight to the customer's bill. There is a cost-benefit that would need to be treated with care, she said.

“The alternative option, which, again, we will think about, is that you do it symmetrically, so you take out the long tail of upside/downside. That is something that we could do.” Ross continued.

Commenting on the water companies’ operational performance in PR14, Cathryn Ross told the Committee that Ofwat has a sharing mechanism that allows companies and customers to share outperformance 50:50.

“So there is a precedent for that, and I am happy to look at extending that for financing outperformance in 2019. The only point I am making is that it is not a trivial exercise. There is cost-benefit that we have to deploy.” Ross explained.

In response, David Mowat MP said:

“No, it’s a lot of money. It’s hundreds of millions of pounds, so it shouldn’t be a trivial exercise. Find someone to do it.”