Ofwat has warned that a post-Brexit scenario which foresees higher inflation, lower interest rates and lower growth, at the same time as their customers become poorer and find it harder to pay their bills, could pose a very significant challenge for the water sector in terms of customer legitimacy.

In a wide-ranging speech at the Water Market Reform 2016 conference this week, Ofwat Chief Executive Cathryn Ross analysed the implications of Brexit in terms of UK  politics, its legal framework and the economy and what they mean for the water sector. She said:

 “it is a scenario in which water companies could remain a very attractive investment proposition, water companies and their investors could enjoy substantial financial outperformance, at precisely the same time as their customers become poorer and find it harder to pay their bills.”

“There are undoubtedly a lot of people engaged in scenario planning exercises right now. And I would encourage water companies to plan now for that scenario. And to think about what they would do to avoid a potentially significant impact on customer legitimacy, on trust and confidence.”

On politics, she said the predictability and stability provided to the sector via independent economic regulation was valuable to both the water companies so that they can plan over the long term and to investors who can make their decisions based on long-term expectations about what the sector holds. It was also valuable for customers who benefitted from lower and more stable prices as a result.

Commenting on the legal framework, Cathryn Ross said the obligations of water and wastewater service providers are not set out in European directives and she did not see a need for the economic regulatory regime in water to changes as a result of Brexit. On the appetite of the UK government to “row back on environmental regulation” that forms part of UK law, she said:

“It is also important to remember that water companies’ contribution to the environment does not only reflect compliance requirements. Customers and society value the environment, and they expect water companies to play their part in its stewardship. This is reflected in the performance commitments the companies have made to their customers. And it will remain important for water companies to deliver against those commitments and deliver for the environment over the long term.”

From companies and investors perspective some of emerging scenarios look favourable

On the economy, Ofwat’s Chief Executive highlighted some of the potential benefits of Brexit, saying:

 “From the perspective of companies and investors, some of the emerging scenarios actually look favourable.”

“ I’m not in the business of speculating on macroeconomics, but there is talk, for example from the Bank of England about higher inflation and there is also discussion about the prospect for lower interest rates driven by concerns over lower economic growth. Especially taken together these things could lead to financial outperformance for water companies.”

Ross said that under one scenario that is being discussed at the moment – high inflation, low interest rates, lower growth, Brexit could have a significant impact on customers, describing it as:

“One in which the cost of living rises at a faster rate than household incomes. A scenario in which more customers than at present are struggling to pay their water bills – and we know that right now around 20% report themselves as struggling. And potentially also a scenario in which more customers are finding themselves in circumstances of vulnerability.”

Cathryn Ross also said that even if companies do find themselves doing well as a result of higher inflation and lower financing costs, they need to ensure that there is no let up in their search for totex efficiencies.

Household competition - Ofwat is finding “significant potential for new business models to emerge”

Commenting on Ofwat’s current  work looking at the costs and benefits of competition for residential customers in England prior to reporting back to Government in early September, Ross said:

“We are finding customers to be very interested in the idea of being able to choose their supplier – indeed somewhat unclear why they can’t now. We are finding some scepticism about whether on the basis of current business models the price savings on offer would be sufficient to get customers excited.”

However, she said Ofwat was also finding significant potential for new business models to emerge, which have the potential both to increase scope for price savings, to reduce switching costs and to engage customers on issues such as water efficiency.

The regulator is also planning to report its emerging findings on the issue early next week.

Brexit decision itself doesn’t prompt great changes to legal and policy framework for sector

Ross concluded:

“As far as regulated water and wastewater markets are concerned, the fundamentals remain very much as they were and are sound. The independent economic regulatory regime insulates the sector as it has done since privatisation from the effects of political turbulence. And in any case the Brexit decision itself doesn’t prompt great changes to the legal and policy framework for the sector.”

“The challenge I do see in all of this for the water sector is that of maintaining customer legitimacy. Not a new challenge – a perennial challenge for the sector. And if we have a higher inflation, lower interest rates, lower growth scenario, one that could look a lot like the challenge the sector faced at the end of the last control period.”

“It is imperative that the sector meets that challenge. The good news is that we know companies can do this.”