Ofwat is minded to shift to indexation of new debt at PR19. This approach would tread a middle path between existing arrangements, where the cost of debt is fixed for five years, and full indexation.
Existing practice has come under fire from, among others, the National Audit Office and the Public Accounts Committee, because debt costs fell faster than expected at the time previous price controls were set, to the substantial benefit of investors but without associated benefit for customers. Under full indexation, customers would benefit from market reductions in debt costs, but would also be exposed to the risk of increases.
The regulator said indexing new debt only (embedded debt costs would remain fixed) would enable forecasting errors to be corrected without the over reliance on market benchmarks that could result from full indexation and “which may not accurately reflect the efficient cost of debt for the water sector and so result in customer bills being higher than necessary”.
The proposal came in a consultation issued this week and running until 17 October. Ofwat also said in the paper it was minded to:
Adjust bills in response to new debt indexation at the end of each review period to minimise bill volatility in-period.
Stick with setting the cost of debt on the on the basis of an efficient notionally structured company. “This approach means that companies, their investors and management are responsible for their own financing and capital structure and bear the risks associated with their choices.”
Encourage but not mandate companies to consider wider pain/gain sharing, including around the cost of debt, as part of their business plans for PR19, where this is in the interest of customers.
In addition the regulator welcomed views on its future approach to the cost of equity at PR19. It did not specify a preferred approach but said: “We are seeking views on an approach adopted by an Australian regulator, which provides for different levels of the cost of equity to recognise the differences in ambition and risk inherent in company plans. It also incorporates a menu based incentive for companies to accurately self-assess their plans.”