Inefficient water utilities most at risk from OFWAT’s regulatory changes, says S&P

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Ratings agency S&P Global Ratings has released a report (17 July) warning that UK water utilities may face lower returns after 2020, following OFWAT’s planned deregulation of the sector.

The report comes on the heels of OFWAT’s 9 July release of elements of its methodology for its upcoming price review (known as Price Review 19, or PR19).

S&P believes the move signals OFWAT’s intention to steer the industry towards reduced customer tariffs. To compensate for utilities’ lower takings, the regulator is proposing attractive performance-based financial incentives.

“This means that penalties for inefficient operators are likely to be materially higher than in the current period, and potentially unlimited, thus increasing downside risk for their cash flow,” said S&P Global Ratings analyst, Tania Tsoneva.

With water utilities’ future incomes likely to become less predictable, there will be increased cashflow pressure on the less efficient water companies, suggests the report.

According to S&P, the increased scope for earnings from incentives will provide partial compensation from the likely regulatory changes. But given that earnings and penalties are difficult to forecast and less stable, relative operational performance will become increasingly critical.

S&P takes the view that OFWAT’s low-risk, credit-supportive regulatory framework is dependent on its ability to maintain investor confidence in the water utility sector.

“While the announcement allows us to piece together aspects of the regulatory approach for the upcoming period, we cannot yet assess the regulatory package in its entirety and develop a view on its overall credit impact,” says S&P in the report.

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