Future price limits

Photo: Southern Water

A major change in the way the water industry is regulated is underway. Ofwat in its Future Price Limits – statement of principals maps out the intended changes. The biggest changes are the move to setting outcomes and not outputs with the outcomes set in conjunction with customers. The rational is to encourage water companies to innovate and outperform.

But has Ofwat gone far enough? Several key constraints of the current system will remain. Regulated Capital Value stays as a vital determinant and the regulatory period stays as five years. This means that two of the biggest concerns of the current system are likely to remain, the inherent bias towards capital solutions and the adverse impact on the industry of the drop in investment at the end of each regulatory period.

Ofwat states that: “While we were reviewing our price setting tools, many stakeholders told us that the way we treat capex and opex separately has become complex and burdensome. We have also heard that our approach may create perverse incentives, ranging from a bias towards capex to a rigid, technical and inflexible approach from companies that are driven by the detailed mechanisms we use. Others have perceived that our overall approach may encourage ‘gaming’ or ‘padding’ of business plans by companies that may consider it in their interest to inflate costs in their original submission.

But while Ofwat propose to move to a total expenditure model as the way forward they then qualify the statement by suggesting that a lot more work is needed to work out how it can actually be done and that it might not be possible to implement it in the next regulatory period!

Its clear that the water sector remains highly attractive to investors, what is not clear is whether Ofwat has got the balance right between the need to sustain investment while delivering an affordable service. With the harsh economic environment – it is likely pressure from customers to rebalance the equation will increase.