Industry stability at stake

The 'have-it-all' settlement has lost its initial shine. Ofwat must revise its draft price proposals which are a prescription for damaging uncertainty, writes Barrie Clarke

We are just a few weeks away from an announcement that will have major consequences for water companies, supply chain and customers. In final determinations for PR09, Ofwat has a choice: it can revise its problematic draft proposals, or risk harming the asset most valued by consumers and stakeholders - the industry's stability.

Launched in July to muted comment from all but a very satisfied Consumer Council for Water, the draft determinations cut prices and investment. Since then, the 'have-it-all' settlement has lost any initial shine. It is revealed as a prescription for damaging uncertainty - the last thing we need at present. Only blithe Pythons and short-termists now see Ofwat's proposals as a convincing basis for investment and service improvement.

The causes of this alarming turn of events seem to lie in the regulator's lack of transparency, inability (or unwillingness) to see how much has changed, and misreading of City opinion. It is a matter of genuine regret that the industry's
success over two decades owes so much to the strength, not weakness, of Ofwat in these areas.

Fortunately it is not too late. Companies have had their chance to say how their own positions can be turned round. Ofwat must listen and act accordingly. To get a feel for the problem, look at stakeholder views and the bigger picture.

Stretch
Water UK said that a small saving (average £14 in 2015 compared with now) would be a false economy. Superficially in the consumer interest, the proposals would stretch company finances and increase the likelihood of unplanned rises that would dwarf the saving. Metering, leakage control, and solutions to sewer flooding would be delayed.

The Environment Agency is best friends with Ofwat after years of tension (not always creative). This makes it only more notable that an official welcome ("we believe it is a positive step... blah blah") is matched by a stern list of issues that must be "explicitly dealt with" in final determinations. Leakage is on the list and we can only admire the EA's restraint in "We are disappointed by the limited leakage reduction in the DD" (1). Elsewhere, Natural England's lukewarm welcome was explained by off-the record reservations ("Ofwat seem to want their
cake and eat it").

Disquiet
Meanwhile an independent survey of water investors has found real disquiet (2). Shareholders, in particular, are worried. They can't be sure that, taking the package as a whole, companies will be able to earn the cost of capital set by Ofwat. This is echoed by other City sources. Utility analysts have been consistently downbeat since the determinations were released. Share prices of listed companies fell 10% or more while the market rose strongly.

The Sunday Times Business editor summarised opinion: "This review... will hit the
sector hard if it is not diluted. The regulator wants companies to raise capital expenditure and cut prices. It doesn't need a degree in advanced economics to work out the implications. It will undermine confidence..."(3).

Bigger picture
These doubts raise questions about impacts on the economy. Will the settlement help or hinder the re-balancing away from consumption, towards investment, many people think is urgent? Ofwat will reasonably point to its £21 billion capex programme. But if, as investors are thinking, the determinations reduced access to capital at economic rates, the destabilising effect would be anything but helpful.

Unemployment is expected to rise in the first years of the PR09 period. Will uncertainty about funds help companies provide a steady flow of jobs? Or a growing pool of infrastructure skills?

Everyone wants innovation, including Ofwat. Will a cash-strapped industry be more or less likely to fund R&D?

Don't bet the house
Over half of investors surveyed thought Ofwat "had set out with the intention that average bills would remain flat in real terms" rather than decided on merits. Ofwat now has an opportunity to show it will not bet the house on a fix speciously suited to current problems.

Tempted to focus on short-term consumer interest, it must not forget that its consumer duty was a child of its time, born in a boom that was mesmerising everyone.

Ofwat should also recall another of its duties, a modest, neglected one, and opt for sustainability - of the service and the industry that provides it.

bclarke@water.org.uk

1) Response to Ofwat Consultation, Environment Agency, September 2009
2) Investor Survey, Ofwat's PR09 Draft Determinations, Indepen, September 2009
3) The Sunday Times Business, 3 October 2009

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