The Consumer Council for Water (CCWater) is today calling on Ofwat to stick to its promise to set the lowest ever cost of capital for the water industry for the 2019 Price Review.

An independent study commissioned by CCWater recommends that the industry regulator should set a Weighted Average Cost of Capital (WACC) between 1.8% and 2.5%.

The WACC – the assumption that Ofwat makes on the cost water companies will incur in raising capital to fund investment in assets like pipelines and treatment works - is one of the biggest building blocks in its price settlement for the five-year period from 2020 to 2025.

CCWater said that as water is such a capital intensive sector, returns to investors and interest and debt repayments can have a significant impact on customers’ bills. A 0.1% increase in the cost of capital can add around £2 per year to the average bill.  

The water watchdog commissioned research by Economic Consulting Associates (ECA) to make an independent recommendation of what the cost of capital should be for 2020-25.

The study looked at the financial markets, cost of capital decisions made in other regulated sectors, and water companies’ financial performance, including historical data and future forecasts. It concluded that Ofwat should set a WACC between 1.8% to 2.5%.

Tony Smith, Chief Executive at the Consumer Council for Water, said:

“Striking the right balance on the cost of capital is a difficult challenge for the regulator but Ofwat must ensure that water companies do not continue to make generous returns at the expense of customers. This independent study reinforces our view that there is an opportunity for Ofwat to set a much lower cost of capital that will help to hold down bills.”

Ofwat set the equivalent cost of capital for the current AMP6 period (2015 to 2020) at 3.74%. If the regulator had applied a cost of capital of 2.5% for this period, it would have reduced customers’ bills by about 7%.

According to the ECA study, Ofwat could set a lower cost of capital at the 2019 Price Review due to evidence of both lower costs of equity and debt financing, and a lower assumption of risk in the sector than previously assumed.

CCWater said that in the past, the regulator has overestimated this cost at customers’ expense. Since the water industry was privatised in 1989, water companies listed on the financial markets have generated returns for their investors that have been significantly higher than the average rate of return on the FTSE share index, despite water being a lower risk sector.

Ofwat has already signalled that it intends to set the lowest ever cost of capital for the water sector from 2020-25 and deliver a better deal for consumers.

CCWater now hopes ECA’s independent analysis and recommendations will help to make this happen. The water sector regulator is expected to announce its decision on the cost of capital on 13 December.

Ofwat intends to create four separate wholesale price controls in PR19 (for water resources, water network plus, wastewater network plus, and bioresources). The regulator has stated that the WACC could vary across these price controls if there are differences in systematic risk, but that it expects the same WACC to apply across the price controls. The ECA study has not considered any potential differences in systematic risk across the four activities.

Click here to read Recommendations for the Weighted Average Cost of Capital 2020 – 2025 – Final Report