PR19 – margin squeeze looms, says AECOM

AECOM has warned water companies that an inflation-related AMP7 margin squeeze looms.

The integrated infrastructure specialist has forecast a 60% gap between water companies’ totex costs (forecast to rise 18%) and CPIH (forecast to rise 11%) in 2020-25. Ofwat’s draft methodology for PR19 confirmed the regulator’s plan to shift its indexation mechanism from RPI to CPIH. AECOM said this will “undoubtedly affect revenues, as historically CPIH has increased at a reduced rate compared to RPI. Over the last five years for example, RPI increased 12% whereas CPIH only reached 8%, a third less than RPI.”

AECOM cautioned water companies that failure to innovate in inflation management will inevitably lead to a margin squeeze. Senior consultant Edward Day said: “A significant rise in inflation will undoubtedly have an impact on margins. Water companies will need to aggressively innovate [for example, on procurement, contract and incentive models] and more efficiently deliver works in AMP7 since their costs are likely to rise at a faster rate than indexed revenues.”

Day continued: “Combine this regulatory change with the PR19 process set to be the most challenging to date, the uncertainty surrounding Brexit and its effect on sterling, the significant skill shortages persisting in the infrastructure industry and increased infrastructure output buoying contractors’ margins, and it appears likely that water companies’ resultant cost inflation will significantly exceed CPIH during AMP7.”

Over the last eight years the water sector has experienced an unchallenging period of inflationary growth that has

been less than, or aligned with, RPI. This has enabled the industry to deliver programmed works within the allowed revenues as indexed by Ofwat “even where company inefficiencies existed”.

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