Tom Hall, Chief Economist at Aqua Consultants, has raised some crucial questions about the recent determinations made by Ofwat regarding the water sector. The balance Ofwat attempted to strike between the pressing need for infrastructural improvements and the mounting dissatisfaction from customers and politicians was always going to be a tightrope walk. With the sector facing a myriad of challenges, including pollution crises, climate change resilience, leakage reduction, and the imperative to return mains renewal to pre-2015 levels, the stakes couldn’t be higher.
The recent Final Determination (FD) reflects Ofwat’s efforts to navigate this complex landscape, especially after a contentious draft determination (DD) earlier in the summer. One of the major sticking points was the cost of capital. Ofwat’s decision to settle on a cost of capital of 4.03% marks a significant shift from earlier positions, but it still falls short of what many companies argued for—4.5% or higher. This discrepancy could spell trouble. If companies feel they can challenge this through a referral to the Competition and Markets Authority (CMA), they must weigh how tight their financials are and how much return their shareholders expect.
Ofwat’s adjustments aim to cushion the blow for companies while also addressing customer concerns. By introducing improved in-period adjustments and uncertainty mechanisms, the regulator has sought to mitigate the risks that companies face. However, the potential for these mechanisms to backfire looms large; overly optimistic assumptions could lead to negative adjustments down the line. Despite these adjustments, Ofwat has remained steadfast on its frontier shift adjustment of 1% per year, which aligns with trends seen in other regulatory frameworks.
The outlook for customer bills is stark. With projections indicating a 36% increase in real terms for water and sewerage customers by 2030, the impact will vary significantly across different companies. For customers of Welsh Water, Severn Trent, Southern, and Yorkshire Water, the reality could be a staggering 50% increase before inflation. This looming rise in costs is compounded by a broader context of tightening household finances and an enduring sense of mistrust toward water companies. The legitimacy of these companies in the eyes of customers hangs in the balance, and without demonstrable improvements in performance and culture, that trust is unlikely to be restored.
As we look ahead, the next five years are crucial. Companies must grapple with the dual challenge of investing in necessary improvements while managing customer expectations and affordability. The road ahead will not be easy, but those that accept Ofwat’s determinations and act decisively to address these challenges may find themselves better positioned in an increasingly scrutinized industry. The new year will undoubtedly reveal which companies are willing to take the plunge with the CMA and how that decision will shape the future of the water sector.
