A new report commissioned by the Consumer Council for Water (CCW) has found that if Ofwat replaced its ‘early view’ on how much it will cost water companies to raise finance to deliver investment for the 2024 Price Review with a ‘market-led-view’, it could save customers £2.6 billion over 5 years.

The consumer watchdog commissioned MCC Economics to review Ofwat’s weighted average cost of capital (WACC) ‘early view’ for the upcoming Price Review in 2024 (PR24).

This is the assumption the water sector regulator makes on how much it will cost water companies of raising finance to deliver investment to improve water and wastewater infrastructure and the services people receive. This is an important part of the price review process - the assumption has a significant impact on customers’ bills.

MCC Economics’ scope of work focused on Ofwat’s December 2022 final methodology Appendix 11: allowed return on capital alongside other relevant Ofwat publications, including Ofwat’s cost of debt model and the water companies’ Annual Performance Reports (APRs).

The report examines various aspects of Ofwat’s indicative PR24 WACC, including:

• The overall WACC allowance and cross-checks
• Debt and financing assumptions
• Equity assumptions, specifically the:
• risk-free rate
• total market return; and
• equity beta.

Key findings

The review of data, assumptions, and methods used by Ofwat found 24 signals that the true cost of capital is lower than Ofwat’s ‘early view.’ By replacing its ‘early view’ with a ‘market-led-view,’ Ofwat could save customers £2.6 billion over 5 years, equivalent to around £20 per household per year.

The report says that in December 2019, Ofwat’s allowed return on capital of 2.92% for the previous price control review in 2019 (PR19) was accepted without dispute by most water companies.

However, by December 2022, Ofwat’s early view for PR24 on the allowed return on capital was 3.23% - an increase of approximately 11%. The report says:

“However, if MAR ( Market-to-Asset-Ratios) evidence suggests that investors are signalling that returns are high enough already, an increase of this magnitude in the allowed return on capital looks unwarranted.”

MCC Economics’ outputs include questions that Ofwat could consider in advance of taking a final view for PR24 and indicators (signals) that the true WACC is below Ofwat’s ‘early view’.

The report acknowledges that the WACC allowance may change when Draft and Final Determinations are made for PR24, as seen in PR19, when there were changes to equity allowances and debt allowances. The report concludes by asking whether Ofwat could save consumers £2.6 billion by setting a lower WACC allowance.

Click here to download the report in full