Southern Water has called into question Ofwat’s 2019 Price Review decisions, saying that its acceptance of the regulator’s final determination (FD) should not be interpreted as accepting that “Ofwat had, in all cases, arrived at the correct balance of costs, outcomes, and financeability.”

The comment comes in the water company’s response to the Competition and Markets Authority (CMA) current inquiry into appeals from four water companies to the CMA for a redetermination following the price review.

Writing to Kip Meek, the inquiry Chair, Ian McAulay Chief Executive Officer said that accepting Ofwat’s FD was “a finely balanced decision” for Southern Water which reflected the water company’s specific circumstances. The utility is “part way through a significant and necessary company-wide transformation” which it had weighed against “the significant draw on management time that an appeal would have represented.”

“While it is right that Ofwat should challenge companies’ plans on behalf of customers, Ofwat’s policy choices have ultimately led to an AMP7 package that appears to be skewed towards short term bill reductions” the letter says.

McAulay describes the level of efficiency challenge set by Ofwat to support the bill reductions as “beyond what is reasonably achievable in the time period, with implications for our ability to invest to deliver the necessary step change in resilience in light of the challenges we face.”

According to the water company chief, the CMA’s judgement on key industry issues and how to strike the right balance between customer bills and investment to deliver more resilient service will play “a vital role” in shaping the 2025-2030 price review.

The letter draws particular attention for the need to secure long-term resilience for the sector which both Defra and the National Infrastructure Commission have highlighted.

McAulay writes:

“In the region we serve, twenty-five years from now we will have lost a third of our water sources through climate change, seen a reduction in the amount of water we are allowed to take from rivers and underground sources, and our population will have grown by 15%. The resilience of their water supply and wastewater service is a key priority for customers.

“Ofwat’s approach does not, in our view, give sufficient weight to the need to invest to address these challenges.”

The letter calls into question the fact that while Ofwat has allowed for some increases in the level of enhancement expenditure compared to previous periods, its base cost allowances are derived from “backward-looking econometric models that do not adequately capture how different the future will be.”

Commenting on resilience, the water company CEO said ”we keenly await the CMA’s assessment of whether the “need for investment” established by the sector’s Water Resource Management Plans, and in the future Drainage and Wastewater Management Plans has been adequately reflected in Ofwat’s Price Review funding."

McAulay makes the key point that Ofwat is “uniquely placed” to take a broader cross-company perspective on resilience, working within the context of regional plans and that its econometric, company-by-company approach had missed this opportunity at the 2019 price review.

"Perception that Ofwat had sought to redress balance of past failings of equity investors...by significantly reducing equity returns"

Referring to resilience in the context of financeability, the letter says there is a perception that Ofwat had sought to redress the balance of “the past failings of equity investors in the sector to act in a way that is aligned to water companies’ public purpose” by significantly reducing equity returns while at the same time expecting equity to bear greater downside risk.

McAulay comments:

“Many of the previous investors, who Ofwat believe have not acted in the best interests of customers, are no longer in the sector and Ofwat’s approach, in targeting potential returns and increasing downside risk asymmetrically, has the effect of significantly reducing base and potential cash flow within the regulatory system that could otherwise be used to absorb risk.”

He also points out that the credit rating agencies’ assessment of the credit quality of the sector has been steadily dropping and has reached an all-time low. “In aggregate we consider Ofwat’s PR19 final determination has weakened the sector’s financeability and financial resilience.”

The water company chief also tackles the importance Ofwat places on customer engagement in the business planning process, pointing out that it had engaged directly with over 42,000 customers, local and regional stakeholders and experts, gained insight from broader engagement with more than one million customers and had a continuous dialogue with its Customer Challenge Group (CCG).

Southern Water had then submitted a plan to Ofwat that was supported by over 80% of its customers, with 76% considering the proposals affordable.

McCaulay comments:

“We were therefore surprised that this customer voice was not more evident in the final determinations, which in places appeared to substitute what customers have said they actually want, in favour of Ofwat’s own view of what they should value.”….

“This type of customer engagement is both costly and time consuming, but in a sector where customers can not choose their supplier is of vital importance. It is important that it is clear how Ofwat has taken into account the customer voice and balanced between customer views and its own sectoral policy objectives.

“Without this clear ‘line of sight’, there is a risk that customers become disenfranchised from these processes, or that companies cannot in good faith submit business plans that allow for their customers’ priorities to be adequately reflected.”

The letter says there were “many positive aspects” to Ofwat’s process and the water company was supportive of their over-arching ambitions in relation to resilience, innovation, affordability and vulnerability, and service levels.

However, McCaulay concludes by saying:

“We have highlighted … a number of areas where we believe Ofwat have not struck the right balance in its final determination decisions. Taken as a whole the final determination package does not, in our view, move us toward the more resilient sector that our customers and other stakeholders want to see.”

Click here to read Southerrn Water's submission to the CMA in full.