Setting price limits
Every five years we set price limits for the water and sewerage companies. When setting price limits, we have a duty to make sure that each company has enough money to finance its functions. The price limits we set are no higher than they need to be to allow efficient companies to run their businesses.
We determine price limits by working out how much money ('revenue') each company must collect from its customers to:
- finance its day to day spending
- finance its capital investment programme
- reward outperformance in the previous five-year period
- continue to finance previous capital investment through the return the company earns on its regulatory capital value (RCV)
- pay tax it is liable for
The sum of these costs is the revenue requirement.
We also calculate the base year revenue that the company would expect to receive without any change in prices.
The annual percentage difference between the revenue requirement and the base year revenue expected from customers is the price limit. Price limits may be negative or positive. We check that the outcome of this calculation provides annual price limits that will enable the company to obtain the capital it needs to deliver the improvements required.
The figure shows the basic building blocks of price setting:
The price limits set affect the charges in the tariff basket.
There are two ways in which price limits can be changed between price reviews:
