S&P Global Ratings is warning that water companies across England and Wales could come under pressure from aspects of the water sector regulator Ofwat’s new pricing methodology for the 2019 price review (PR19).

According to the ratings agency's latest report which analyses Ofwat’s final methodology for PR19, the water companies will be particularly affected by the reduction in the allowed cost of capital and introduction of more rigorous benchmarks on costs efficiencies and service performance.

S&P has calculated that Ofwat’s reduction in the allowed cost of capital to 2.8% from the current 3.6% would lead to a 1%-5% fall in water companies' revenues between 2020-2025. The new elements of the methodology could make the water sector less financially attractive to investors as they could lead to an increase in the level of competition and to less predictable and less stable cash flows, S&P said.

However, it notes that companies that run major non-regulated operations and companies that earn significant revenue from incentives are less exposed to the risk of decline in revenue.

The ratings agency says that the water companies’ credit metrics could be hit to the extent that it takes negative rating actions, especially in the case of the more inefficient and highly leveraged utilities that will be in a weaker position to adapt to the changes.

However, the analysis says that PR19 is still in an early phase and water companies maintain some flexibility to mitigate the negative impact, with innovation and new technologies identified as important drivers for cost reduction and cost optimization.

S& P expect to be in a better position to determine the credit impact on each company individually after the business plans are finalized and submitted to Ofwat in September 2018 and once the regulator provides its initial assessment of the business plans from January 2019.

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