PR19 – Ofwat overstates RoRE rewards for notionally efficient company says EY

An Ernst & Young report for United Utilities has questioned the deliverability of the risk and reward package Ofwat put on the table for water companies in its draft methodology for PR19.

In its July documents, the regulator proposed to test its package of risk and reward using Return on Regulatory Equity (RoRE) analysis. It illustrated three RoRE ranges which it proposed companies would be able to achieve depending on which business plan category (exceptional; fast track/slow track; and significant scrutiny) they attained.

EY considered whether a notionally efficient company (NEC) could reasonably be expected to achieve the assumed scale of RoRE rewards and penalties. It found such a company would not be capable of achieving some of the upside assumed on individual RoRE components; that companies do not typically lead across all areas, which would be required to receive full RoRE upside; and that some rewards would prove smaller than Ofwat assumed.

EY concluded: “Overall, our analysis indicates that the RoRE ranges which a NEC would face are likely to be skewed to the downside, rather than the symmetrical shape Ofwat assumes. Ofwat should revisit the way it has calibrated cost efficiency targets, cost sharing incentives, PCs, ODIs and CMeX and DMeX to ensure the amount of RoRE upside Ofwat assumes is actually available to a NEC. If the RoRE ranges were to remain skewed to the downside for a NEC, the allowed cost of equity would need to be increased so that an investor in the NEC would expect to achieve its required rate of return on equity.”

Coming soon – THE WATER REPORT's comprehensive analysis of the PR 19 consultation.