Water industry regulator Ofwat is planning further consultations on its proposals to make radical changes to the way it sets prices following high-level concerns expressed by the water companies and both UK and overseas investors.

Currently the water companies’ licences specify that each time Ofwat sets prices, it must set a single price limit for a five year period – i.e. the fixed AMP investment programmes.

The regulator will now extend the engagement process following its December 2011 consultation on its Water Industry Act 1991, section 13 proposals to modify the licences of all water and sewerage and water only companies.

Ofwat said it now plans to hold meetings in April and May with the Chairman and Chief Executive of each of the companies, together with investors and other respondents “to understand the particular drivers behind their responses and explore how we can address their substantive concerns.”

The regulator received 31 written responses to its consultation, with three respondents requesting that their responses remain confidential. Investors who responded include Alinda Capital Partners, Citi Capital Advisers, Government of Singapore Investment Corporation, Greenberg Traurig Maher, iCON Infrastructure, Infracapital and Lloyds. 

Ofwat changes will "reduce attractiveness of investment in UK infrastructure - and not just the water sector"

The concerted opposition from both the water companies and investors alike is particularly interesting in the context of the Prime Minster’s and Chancellor’s recent efforts to attract significant funding from overseas investors in UK infrastructure, including Asia.

The response from the Government of Singapore Investment Corporation (GIC)– a major sovereign wealth fund with well over £5 billion of equity invested in privately-held UK infrastructure, and one of the largest investors in Kelda, owners of Yorkshire Water, will presumably have already provoked Ministerial efforts to reassure prospective investors. In a letter to Ofwat setting out GIC’s concerns, Stuart Baldwin, Head of Infrastructure, Europe at GIC, said:

“We also note that through the previous conversations that GIC has had with UK government departments such as HM Treasury and UK Trade & Investment regarding future investment in UK infrastructure, one of the key arguments put forward by the government for making such investment is the stable and transparent regulatory regimes in place. This is clearly set out in the Governmenmt’s recently published National Infrastructure Plan 2011 and DEFRA white paper.”

“We believe the proposed licence modifications would significantly undermine this position and therefore reduce the attractivenenss of investment in UK infrastructure, and not just the water sector, at the time when the UK government is actively trying to raise new sources of capital to fund large infrastructure projects."

Alinda Capital Partners, ultimate owners of Cambridge Water and South Staffordshire Water, expressed similar views, saying the Ofwat proposals constituted a significant change and that it was “deeply concerned” about the following three proposed licence amendments:

• Removal of the link between price controls and RPI
• Elimination of the reference to a five-year price control review
• Absence of any constraint on the number of price controls that can be set

Alinda said that if the link was eliminated it could face “ a persistent and growing mismatch” of its water company’s cash flows and liabilities which could harm its ability to finance its capital programme. It warned that the proposals could ultimately lead to higher prices for customers.

Alex Black, Managing Director of Alinda Capital Partners said:

“ We believe these proposed changes will also deter investors or increase acceptable returns from investing new capital in the sector, particularly within the context of significant political encouragement for UK and international pension funds to increase investment in UK infrastructure. “

"Customers of the water industry would ultimately be worse off if Ofwat were to continue in the direction as currently described.”

Citi Capital Advisers said that as a shareholder group which had invested significantly in Kelda, the parent company of Yorkshire Water, it was writing to express its “strong concern” regarding the Ofwat proposals. The shareholder group said that the proposed changes would lead to a significant increase in the cost of both the debt and equity capital needed to support the Yorkshire Water business. Holly Koeppel, Co-Head and Partner at Citi said:

“We believe that customers of the water industry would ultimately be worse off if Ofwat were to continue in the direction as currently described.”

Ofwat has now extended its consultation timetable “to accommodate additional engagement and to allow us to understand concerns”  - however, the regulator said this could not be open ended. Ofwat now needs to finalise its methodology for the next price review in time to give water companies and other stakeholders sufficient certainty about the price review process – which it could not do if the legal basis for the price review has not been resolved. In May Ofwat will publish its future price limits framework and principles.