Water industry regulator Ofwat has indicated its initial thoughts on the AMP6 Business Plans submitted by the water companies setting out their proposed investment programmes for 2015-2020.

Graham Taylor, City Adviser at Ofwat, gave a broad overview in a presentation to the City yesterday – preceded by the following provisos:

• The data he was working with was incomplete and the validation of data tables alone was likely take until next week.
• The data was also subject to change. The error rate on the last round of tables the industry submitted in August ranged from 2% to 40%, and was unlikely to have fallen to zero.

He also emphasized that “absolutely nothing” he said should be interpreted as pre-judging any of the business plans and that it was much too early for Ofwat to have formed views on individual companies’ plans, adding:

“Please don’t try to read between the lines.”

Summarizing, Mr. Taylor said that on average, the water companies were proposing real price decreases and had put forward a range of innovative solutions. All of the companies had put forward measures to address affordability, mostly through social tariffs, and all had proposed a number of outcome incentives against which they could be judged.

With only two exceptions, the companies are proposing flat or declining real bills for their household customers. Eleven companies have proposed real reductions for their household customers, six companies flat bills and two increases. A 10% increase from Thames Water is associated entirely with the Tideway project; excluding this the firm would be proposing a small decrease. The other increase is from Dee Valley Water, a small WoC which is proposing three substantial investment projects in this period.

Thirteen have proposed social tariffs, with most of the others suggesting other targeted measures to address affordability. In total, companies have proposed around 580 outcome measures against which they would be judged and incentivised.

Ofwat is currently still in the process of uploading data and reading hundreds of pages of submissions from each of the eighteen companies. The regulator has also been meeting three or four companies a day, and will be continuing to do so for the next week.

Mr. Taylor also highlighted the fact that in PR14 there are no draft and final business plans and that companies have been asked to submit their best and final offers.

The current stage of the process, which began last Monday, is Ofwat’s “risk-based review” where the focus is on identifying business plans and elements of business plans that require particular scrutiny, while "getting out of the way" of companies with consistently strong and well-justified plans. This stage is scheduled to end on 4th April, with any “enhanced” companies receiving their draft determinations at the end of the month. Others will have to wait until the end of August, with final determinations for both following in December.

The wholesale weighted average cost of capital (WACC) proposals range from 4 to 4.5% for the WaSCs and 4.2 to 4.9% for the WoCs, with none of the the companies responding to Ofwat’s suggestion that the figure “should begin with a 3.”

Mr. Taylor said that Ofwat’s hope is that the incentives in PR14 will reduce both the temptation for companies to bid high and the size of the changes necessary later in the process.

On average, 38 outcome delivery incentives (ODIs) have been proposed by each WaSC and 24 from each WoC . Mr. Taylor said this would be “administratively complicated” for Ofwat but consistent with its new approach that emphasises the responsibility of companies to engage meaningfully with their customers and to respond to local needs.

In its July methodology document, Ofwat talked about the situations in which reputational benefits, penalty-only financial incentives, and balanced penalty and reward incentives might be appropriate. The regulator’s expectation was that there would be less of the former and more of the latter.

Mr. Taylor said that the business plans in fact contained relatively few ODIs with balanced penalties and rewards, with some companies noting that their customer challenge groups didn’t support them and said this was something which Ofwat would “need to look closely at.” He added:

“We have also noted that a high proportion of targets in some plans are based on no improvement in performance during the period. It’s too early to say whether this simply reflects lack of ambition.”

On the risk-based review, Mr. Taylor said that Ofwat would have finished the assessment of business plans by 4th April, testing them in the broad categories of outcomes, costs, risk and reward, and affordability and financeability. Only business plans which met “high hurdles” will be classed as enhanced. He commented:

“To be clear, there are no quotas or forced rankings. We will not burden customers with a poorly justified business plan for the sake of a press release.”

“But any companies that do get enhanced will see meaningful benefits. We have committed to accepting their business plans without significant adjustments. They will get their draft determinations in late April rather than late August, giving them a significant head start. They will get explicit financial benefits through enhanced totex menus which give them a greater share of cost outperformance.”

Commenting on the Water Bill which is now going through its Commons Committee stages, Mr. Taylor said the Bill represents the first major piece of legislation in the sector since privatisation and had significant intersections with the price review – particularly the provision that will allow non-household customers to change supplier.

Concluding the presntation, Mr. Taylor said:

“We are very conscious that private capital has made the industry’s transformation possible, and that water will continue to require significant investment for the foreseeable future.”

“We are also aware of how important an informed and engaged investor community is in focusing the attention of management teams, as I think we have seen on the question of retail costs to serve.”

“Ofwat will continue to ensure that efficient companies have the ability to finance on reasonable terms. We will continue to speak directly to the City, to avoid surprises in price reviews and to include you in genuine consultations on future regulatory changes.”