Water industry regulator Ofwat has called again for water bills to fall in the upcoming Price Review.

In a keynote opening address at last week’s Water 2013 conference, Sonia Brown, Chief Regulation Officer at Ofwat explicitly stated that said that water bills would go down or companies would explain to their customers why.

She also indicated the level said Ofwat would like to see for the weighted average cost of capital (WACC) for AMP6, saying that “the number should start with 3.” If this is the case, the figure would be significantly lower than the 5.1% real vanilla rate allowed in the current pricing review period (equivalent to 4.5% post-tax).

Ms. Brown said that with nominal bond yields down around 1.2% since prices were set in 2009 and record low interest rates, there was “a real opportunity, as I said before, for this number to start with a 3.”

This is particularly significant for those water companies who are regarded as highly leveraged - namely Anglian, Southern, Thames and Yorkshire

Commenting that Ms said that Ofwat had deliberately opted in PR14 not to issue a prescriptive set of instructions for companies to build their business plans which would have resulted in a generic set of plans that all looked the same. For the first time the companies had had the opportunity to build a business plan that is right for their customers .

Ofwat is expecting to see business plans, which are due for submission on 2^nd December, built upon the following key strands:

• customer engagement;
• affordability;
• statutory obligations;
• financeability; and
• ·board assurance.

Ms Brown said that successful business plan would provide robust evidence that these factors were being met and that if plans failed to meet any of the requirements Ofwat would not consider the plan to be “enhanced”.

On customer engagement, she said that a key part of the challenge for companies had been to find a way of communicating with customers so that they could understand and accept difficult choices to be made around infrastructure investment, planning for the future and protecting the environment.

Ofwat expects the business plans, together with the related customer challenge group  reports, to be supported by good quality evidence that customers support the proposals put forward and that where cost pressures exist customers understand what it is that they are paying for and why.

On affordability, Ms Phipps reiterated that Ofwat is expecting companies to reduce their bills and if not, providing an explanation to customers, commenting:

“There are real opportunities for companies to pass on efficiency savings and the benefits of the low cost of finance to their customers over the next five years.”

“Efficiencies from setting separate controls for retail and wholesale along with other changes such as totex, water trading and the use of an average cost to serve control create the scope for bills to be reduced even further.”

Ms. Brown also drew attention to Environment Secretary Owen Paterson’s letter from to all water companies on 5 November stating that they should not wait until the next price review before tackling bills, that the lower cost of capital than that estimated at the last price review had led to higher than expected profits and his support for Ofwat Chaiman Jonson Cox’s letter asking companies to consider whether they would in fact implement the price rises granted for 2014-25 at the last price review.

Ofwat's role is "not to provide risk-free investment"

On financeability, she made the interesting comment that the role of Ofwat is not “to provide risk-free investments’ but said the regulator was looking to companies “to ensure a fair balance of rewards to customers and investors, based on risks being allocated appropriately between them.” She added that “ a bad outcome in this space would be a sector that cannot attract investment.”

On statutory obligations, Ms Brown said that a high quality plan would include a high level of assurance that outcomes and performance commitments would result in compliance with mandatory statutory obligations. However, this did not mean that the only business plans that would be classed as enhanced were those with “gold plated” environmental improvement programmes.

Companies should deliver the most cost-effective solutions and where they were proposing environmental improvements over and above their mandatory obligations, robust evidence of customer support was critical.

On Board assurance, Ms. Brown said Ofwat expected each Board to provide a statement setting out how it considered that all the elements added up to a “high quality” business plan and explaining how the Board had held its  management team to account and challenged and tested the proposals.

Ms Brown said that for successful companies, the prize at the end of the process would be a “lighter touch procedure which will save costs and give them an early start on implementing their plan – put simply if a company is enhanced, we will get out of its way.”

Early start wil provide "clear opportunities for engaging with supply chain"

She added that an early start would also provide “clear opportunities in terms of getting going with engaging along the supply chain.”

Ms. Brown commented that companies with enhanced plans would gain reputational benefits. They would also have the opportunity to gain higher performance incentive rewards via access to ‘enhanced menus’, providing them with the potential for further rewards when they outperform.

Acknowledging that under the new process some companies would not achieve enhanced status, Sonia Brown said:

“In that instance we will ask that company to take parts or all of its business plan apart and start again.”

“Some plans – standard plans – will need revision to part of the plan prior to the draft determination to deal with the issues we highlight. Other plans that have more systemic failure will need to be resubmitted in their entirety.”

She added that Ofwat would work throughout 2014 with companies who needed to resubmit to ensure they could also produce a good plan by December 2014. However, it would be the company who rebuilt the plan with Ofwat’s support – not a re-working of the poor elements in the plan by the regulator.

Ms. Brown concluded that wherever a plan comes out following the risk-based review “we will end up with all companies providing the best service possible to its customers at the best price’ and emphasized:

“In case you have not heard it clearly enough already listen well – customers’ bills will go down or the company will explain to its customers why.”