PriceWaterhouseCoopers, Ofwat’s delivery partner for the current PR14 Price Review, has published a paper setting out its views on appropriate PR14 household and non-household retail net margins.

The water industry regulator will set separate allowed revenues for wholesale and retail activities for the first time at PR14. This will include two binding retail controls – one for household customers and one for non-household customers.

The new paper sets out PWc’s views on appropriate retail net margins in the context of the PR14 retail controls. PWc is suggesting a range for the household segment of 0.5% to 2.0% and a higher range for the non-household segment of 1.0% to 4.0%.

The consultancy has assessed retail net margins for the separate household and non-household controls using a definition of the allowed return as retail EBIT as a proportion of retail turnover (i.e. including wholesale charges).

The paper says that household retail net margins and non-household margins have been assessed separately in the light of uncertainty regarding the level of margin that might be needed to achieve (efficient) entry when the market opens for competition in 2017:

“A balance must be struck between setting margins too high so that customers suffer unduly higher prices in the short term and setting margins so low such that competition fails to develop and customers don’t benefit from longer term cost reductions.”

The net margin is intended to provide an efficient company with a normal return that is appropriate to the capital employed and risks as a retailer. According to PWc, in contrast to the wholesale business, which has significant long lived tangible assets, the retail business is relatively asset light and working capital is a key component of the capital employed. PWc  said this means traditional return on capital approaches are less suited to assessing appropriate returns.

For non-household retail activities, the consultancy has also flagged up as a further consideration the fact that retailers will face additional risk from the opening of the market to competition from 2017. The paper says that as competition will be the key driver of prices and services levels, it is important that the default tariff and non-household retail margin allow scope for competitive entry into the market.

The table sets out PWc’s findings for the appropriate net Earnings Before Interest and Taxation (EBIT) margin range for retail water and wastewater businesses in England & Wales.

 Commenting in the paper, PWc said that over time, benefits can be expected  from competition which would  stem from the anticipated improved productivity and innovation in water retailing for non-household customers, driven by competitive rivalry between companies, including rivalry created by new entrants. Over time, this should lead to lower prices and other non-price benefits, such as improved service levels. PWc also suggest that operators may also find ways to lower the cost of procuring wholesale water, which will similarly lead to downward pressure on the price for consumers.

PWc has developed the figures using comparator analysis based on data from the Water Industry Commission for Scotland , Ofgas, Commission for Energy Regulation , Utility Regulatory (UREGNI), and Offer.

This includes actual margins from the “Big 6” energy companies as well as water retailing in Scotland, mobile telecoms retailing, train operators and postal retail operations. Following Ofgem’s supply probe, big energy companies are required to produce accounts which segment their supply and generation activities – enabling PWc to present overall retail net margins and separated household and non-household margins (domestic and non-domestic in energy) in the report.

Cllick here to download the full PWc report