Ofwat Chief Executive David Black has set out the regulator’s expectations for water companies and investors at the upcoming Price Review in 2024.
Ofwat Chief Executive David Black has set out the regulator’s expectations for water companies and investors at the upcoming Price Review in 2024.
Speaking at the Infrastructure Investor Forum: Europe 2022, he began by saying that the water sector had been an attractive place to invest and would remain so for responsible, long-term investors, commenting:
“…it seems to me that in a world seeking ESG investment opportunities the water sector in England and Wales has some major advantages - low risk, gold standard regulatory regime, inflation protected returns in businesses that have real scope to create value – for customers, the environment, society, and shareholders.”
However, he warned his audience that the sector and its investors do not command public confidence and faced challenging times with high levels of public dismay at the environmental performance of the companies - concerns which needed to be addressed at the same time that customers face a cost-of-living crisis. Commenting on affordability, he said that general inflation and the escalation of energy bills is resulting in the largest fall in real disposable incomes ever recorded - with energy bills expected to increase further by 30% to 50% in October.
He went on to explain that addressing these challenges this will require:
- investment that will pay off over the long term
- innovation and new business models
- tighter operational performance - including better utilisation of the assets for which customers have paid
David Black told delegates that Ofwat did not start from a pre-determined view as to whether customer bills should go up or down. The regulator sought to align interests of companies and their investors with the best interests of customers by ensuring strong incentives on operational performance as part of our outcome based regimes.
Setting out Ofwat’s expectations of companies at PR24 and what they will mean for investors and the positioning of the sector, he said the regulator would be looking at a number of areas in order to support the case for investment at PR24.
Where companies go above and beyond their performance commitment levels, they earn higher returns, where they fall short, returns are reduced, he said.
He went on to outline the following five key areas that can help companies to a successful outcome at PR24 and the role investors can play:
- Companies are efficient and innovative – driving the frontier forward on service and cost efficiency
- Effective use of competitive procurement for major infrastructure projects
- Companies have credible long term adaptive plans with clear understanding of risks to resilience and priorities for their investment between PR24 and future periods
- Companies are financially resilient and are financed for the long term
- Companies that demonstrate they are operating in the public interest and that their corporate behaviours are consistent with serving the interests of customers and the public
"Low hanging fruit of reducing operational costs following privatisation is long gone"
Commenting on efficiency and innovation, David Black said:
“The low hanging fruit of reducing operational costs following privatisation is long gone. In order to improve service and operational performance, companies must innovate and find new ways to deliver to unlock value.”
“So, the question for investors is how far along are companies on the innovation and change curve? Companies that already lag behind on their current performance will face an even bigger challenge at PR24.”
He went on to highlight competitive procurement for large infrastructure projects which enables competition to provide finance and construct new infrastructure as a new opportunity for investors to enter the sector. The Ofwat Chief cited the £4.6 billion Thames Tideway Tunnel which is currently under construction, together with United Utilities’ upcoming Haweswater Aqueduct Project.
He also referenced 18 upcoming strategic water resources solutions in the RAPID programme, including reservoirs, water transfers and recycling schemes, which are also likely to be procured by competitive procurement processes.
Key focus at PR24 - companies are financially resilient and are financed for the long term
David Black emphasised that a key focus for PR24 is on the long term, saying that water companies needed to have a clear Long Term Delivery Strategy which employs adaptive planning techniques, identifies no regrets investment, and develops options to meet future challenges.
To do this, companies would need to be financed on a sound long term basis, with structures that are able to finance new investment, he said. They would also require good levels of resilience to handle operational performance risks in a regulatory regime with strong and increasing levels of returns linked to good operational performance.
Ofwat remains concerned about poor financial resilience of several water companies
David Black drew particular attention to the experience of Southern Water and Thames Water, who have incurred packages of penalties worth about a quarter of a billion over recent years.
In the case of Southern Water, the penalties for poor operational performance and financing decisions resulted in need for injection of £1 billion of equity in the business, with the existing owners losing much of the value of their equity investment in the company.
“A salutary lesson for investors on the importance of good operational performance for returns and their investment value,” he said.
He also warned that Ofwat remains concerned about poor financial resilience of several water companies struggling with high gearing and risky structures.
However, in his view this is not about what the sector says it is doing or even external accreditation of its virtue, but ultimately the way that companies act that matters, including company dividend policies and executive pay. “Customers need to be confident that water bills are going to be used to fund environmental improvements and betterservice and not be siphoned off for the benefit of management or investors” he said.
He concluded by telling his audience:
“Addressing the environmental challenges will require substantial investment – but that’s the easy part . It'll also require the large-scale deployment of innovative solutions, strong operational performance and much greater engagement with customers and catchment partners.
“As a regulator, we value the contributions that long term responsible investors can make to the sector, we are expecting investors to help drive high performance companies and responsible long stewardship of assets and the environment. … I also want to be clear we don't welcome short term investors focused on cash returns or those seeking to make gains from risky financing structures.
“ The sector provides significant growth opportunities in a low-risk regulatory environment – and in return seeks responsible investors who can help add value to the sector.”
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