17th Feb 2016 08:12
LONDON (Alliance News) - UK water regulator Ofwat said it believes it is right to have favoured consumer interests over the financial interests of UK water companies by changing the rules concerning how companies' regulatory capital value is calculated.
The regulator published the changes in an update to its 2014 price review reconciliation rulebook published Wednesday, as it addressed its treatment of the capital expenditure incentive scheme.
The update will end up affecting London-listed water companies Severn Trent PLC, United Utilities PLC, Pennon Group PLC, which owns South West Water, and SSE PLC, which owns SSE Water, and Dee Valley Group PLC.
The capital expenditure incentive scheme is a critical component of how the price limits imposed on UK water companies is determined by Ofwat every five years. Currently, the industry is in the second year of the 2015 to 2020 price period.
When Ofwat sets price limits, it factors in an amount for the capital expenditure which is required from water companies to maintain and improve services. If companies can deliver on the investment for less than what Ofwat assumed it will cost, then they keep some of the saving as a reward, providing an incentive to companies to deliver investment efficiently.
However, Ofwat identified an "inconsistency" in how the regulatory capital value of companies was calculated following the introduction of the capital expenditure incentive scheme in the 2010 to 2015 regulatory period.
The regulatory capital value is also a vital component of how price limits are calculated, and is used to measure the capital base of a company when setting price limits. The regulatory capital value represents the initial market value of a company, including debt, plus new capital expenditure obligations.
Currently, the regulatory capital value of a company reflects capital expenditure adjusted for inflation, but Ofwat is now proposing to change that so it reflects the actual capital expenditure spent.
"Under our preferred option, the regulatory capital value, from April 2020, would reflect the actual capital expenditure rather than be inflated as a result of the inconsistent use of indexation in the models used to derive the regulatory capital value adjustment," said Ofwat.
"This would lead to a one-off change to the regulatory capital value for all companies. At an industry level, this would equate to around 2% of the regulatory capital value, but the exact adjustment for each company will vary according to its actual capital expenditure," the regulator added.
However, Ofwat conceded UK water companies have not welcomed the move, and said it believes it has made the right choice in prioritising consumers' interests over the financial interests of the industry.
"Four companies agreed with the principle of changing the true up but proposed alternative options, but the majority of companies objected to our preferred approach," said Ofwat.
"We are satisfied that, on balance, we should favour the consumers? interest over the companies? financial interest as it is reasonable to assume that the [2019] final determinations will take into account the companies' financeability going forward. In addition, we do not consider that the past inconsistency should be resolved in favour of the companies at the expense of customers," Ofwat added.
Ultimately, the regulator believes the change will establish the correct baseline for the regulatory capital value of companies moving forward, and avoids the situation where the regulatory capital value is inflated as a result of the difference between two inflation indicices, and therefore is the "option that best represents the interests of customers".
"We consider it is in customers' interest that the effects of the inconsistency do not persist longer than is necessary and so we will address this issue with a one-off adjustment to companies? opening regulatory capital values at the start of the next price control. In addition, companies will have had time to plan for the adjustment, as they have been aware of the possibility that the adjustment will be made to the regulatory capital value in 2020 since our consultation in March 2015," said Ofwat.
Importantly, Ofwat said the changes will have no effect of the "financeability at all or in any material way" under the current 2015 to 2020 regulatory period - as it will only come into affect during the next regulatory period between 2020 and 2025, with Ofwat setting new price limits beforehand for that period.
The regulator originally published the 2014 price review reconciliation rulebook back in July, but didn't address the capital expenditure incentive scheme as it was waiting for the Competition and Markets Authority to finish an investigation concerning an appeal from one non-listed company.
Pennon shares were down 0.6% to 808.50 pence per share whilst Severn Trent shares were trading flat at 2,123.28p. SSE shares were up 0.4% to 1,363.0p and United Utilities shares were down 0.2% to 916.50p.
By Joshua Warner; [email protected]; @JoshAlliance
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