In her last speech as Chief Executive at Ofwat, Cathryn Ross has said that in the world of financing costs, over the past twenty years the direction of error has been consistently in favour of companies rather than customers.
Speaking at this week’s Water 2017 conference, Ross said the biggest issue in the responses Ofwat received to its July consultation on PR19 was probably the balance of risk and return across the review. This was “most obviously, and predictably” focussed on the regulator’s approach to determining the weighted average cost of capital (WACC) in the review, she said.
Ofwat envisages a change in its approach to the cost of equity which would see a shift away from basing an estimate of the sector-wide cost of equity over the next 5 year period on history and regulatory precedent, and towards making greater use of market observations and future expectations.
Ross commented:
“When we published our July consultation we further said that our view was that the PR19 WACC would likely begin with a two.
“I think it is fair to say that some companies aren’t fans of our proposed approach. We received a number of responses along the lines that we couldn’t possibly move away from an approach to the cost of capital heavily based on history and regulatory precedent because… that would be … unprecedented.…we weren’t very impressed with those arguments.”
In the world of financing costs, the Ofwat chief said that trying to predict the next five years simply by looking backwards was likely to result in getting it wrong, adding that "over the past twenty years, the direction of error has been consistently in favour of companies rather than customers.”
Ofwat had also heard what Ross described as “thinly veiled threats” from several companies that a significantly lower WACC would result in levels of investment that are too low, especially in relation to resilience.
“Companies might not make the kind of base returns they have been used to… but that doesn’t amount to risk not being reasonably remunerated. Which seems to me pretty unlikely”, the Ofwat chief said.
Cathryn Ross also raised the interesting question of how it would affect the economics of the sector if data – not only at customer interfaces but also potentially about network management - becomes as important an asset for service providers as physical infrastructure like pipes and wires.
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