IB 28/13: Change to Ofwat’s price review process
19 December 2013
This information bulletin explains a change Ofwat is making to its plan for PR14 delivery.
Ofwat is publishing it in advance of further guidance in the New Year, in order to provide stakeholders with as much notice of the change as possible and to allow Ofwat to deploy its resources efficiently.
Since receiving the water companies’ business plans on 2 December Ofwat has held meetings to hear their proposals. A number of these meetings were very positive and demonstrated a significant focus towards customers.
Ofwat’s initial testing of the companies’ plans has highlighted a number of areas where it requires further information. As a result, Ofwat has notified companies that it will be extending its query process to gather the information that it needs.
Ofwat’s initial testing of companies’ views on risk and reward has shown that they are not in alignment with market evidence for the water sector. As a result, Ofwat will be providing companies with a further opportunity to secure the best possible outcome for customers:
- In January 2014, Ofwat will issue further guidance on risk and reward, including its view on the cost of capital and other key financial parameters given the risks that companies should be taking and those which customers will be bearing. This guidance will include the flexibility that companies will have in areas such as pay-as-you-go (PAYG) ratios.
- For a business plan to be enhanced, Ofwat must be satisfied that it is in customers’ interests for it to accept the company’s plan without intervention except to set industry-wide incentives such as the average cost to serve for household retail customers.
- Ofwat proposes to pre-qualify companies that have business plans which pass its tests for outcomes, costs and affordability, and which have demonstrated robust Board assurance – such companies will have already demonstrated that their business plans will deliver outcomes that customers want, at bill levels they can afford.
- In March 2014, Ofwat will invite the Boards of these pre-qualifying companies to accept its published guidance in relation to the risk and reward components of price limits and in doing so gain enhanced status. At that point, in addition to reputation and procedural benefits, the financial gains from enhanced status will be quantified. If a pre-qualifying company chooses not to accept our published guidance, its business plan will be classified as standard.
- The remaining non-qualifying companies will receive the outcome of the risk-based review for them on 4 April 2014 as planned.
In addition to these changes, Ofwat has decided that the determination of default tariffs will be removed from the risk-based review. Further information will follow on Ofwat’s approach to determining these tariffs.
Ofwat will continue to work with all its stakeholders to ensure that PR14 delivers the best possible outcome for customers and it looks forward to further constructive engagement.
Further details on the process are shown in this diagram
What is the price review?
The 2014 price review (PR14) is Ofwat’s process for setting the price and service packages (‘price controls’) that each monopoly company must deliver over the five years between 2015 and 2020. On 2 December 2013, each company sent Ofwat its business plan, setting out its plan for prices and services for its customers.
In ‘Setting price controls for 2015-20 – final methodology and expectations for companies’ business plans’ (the ‘methodology’), published in July 2013, Ofwat explained how it will set companies’ price controls for 2015-20 and the information it will require. A key feature of Ofwat’s methodology is that it is more focused on customers.
What is the risk-based review?
Ofwat is currently in the process of carrying out a series of tests (the ‘risk-based review’) on each company’s plan. This includes it looking at how well the company has listened to their customers and how affordable their plans are for customers.
Ofwat will use the results of these tests to classify the quality of each company’s plan as one of three categories – ‘enhanced’, ‘standard’ or ‘resubmission’. The category a company receives for its plan will determine how and when Ofwat sets its price controls. An enhanced company will receive rewards such as early draft decisions (‘determinations’) on their price controls.
What are the benefits of being an enhanced company?
- Enhanced reputation – giving a clear signal to investors and other stakeholders that allows them to identify those companies that have high-quality plans and those companies can expect to benefit from this
- Procedural benefits – enhanced companies can expect lower costs from a reduced regulatory burden such as early draft determinations and the possibility of early final determinations, reduced scrutiny of very high-quality proposals
- Financial gains – greater proportions of retained profit from cost outperformance, the level of which will be announced in March 2014
- Ofwat will ensure that it does no harm to enhanced companies if we make their determination earlier. In particular, if Ofwat's assessment of the appropriate industry-wide cost of capital changes between the date of our guidance and final determinations, it will ensure that this revised cost of capital is also applied to enhanced companies
How will pre-qualified companies decide if their plan remains financeable as a consequence of agreeing to follow Ofwat's guidance?
Companies remain responsible for ensuring that their business plans are financeable. Consistent with the guidance Ofwat provided on 25 October 2013, it expects companies to consider all appropriate options to address financeability constraints, which may include, for example, accepting lower levels for certain financial ratios than those adopted at PR09 or defined by credit rating agencies for a particular rating band. Pre-qualifying companies may wish to consider modifying their PAYG ratios, RCV run-off rates, outcome delivery incentives and/or other pain/gain sharing mechanisms, in order to manage cash flows and to manage the risks associated with delivering the outcome commitments they have already set out in their plans, following customer engagement. If companies determine that these adjustments would be insufficient to ensure financeability given Ofwat’s new guidance, they should consider more substantial modifications to their plans outside of the process for enhanced companies.
Notes to Editors
- The Water Services Regulation Authority (Ofwat) is the economic regulator of water and sewerage companies in England and Wales. It exercises its powers in a way that it judges will protect the interests of consumers, promote value and safeguard future water and sewerage services by allowing efficient companies to carry out their functions properly, and finance them.
- Media enquiries to Ofwat Press Office on:
Benedict Fisher 0121 644 7642 / firstname.lastname@example.org
Harbinder Babra 0121 644 7616 / email@example.com