Draft determinations underplay potential cut in PR19 allowed returns, says Moody’s

Had Ofwat based returns in its recent PR19 draft determinations on up-to-date market data, the allowed cash return could have been 37 basis points lower, Moody’s said.

The draft determination, which allowed a cash return of 2.69% – 21bps lower than Ofwat’s December 2017 view – was based on market data from February 2019. According to Moody’s, a cut of 60bps would be justified by market information available up to the time of the announcement.

It pointed out: “The full cut of nearly 60 bps would mean cash returns 140 bps lower than in the 2015-20 period. As a result, the adjusted interest coverage of a company financed in line with the regulator's assumption would fall to 1.15x in the next period from 1.3x in the current period.”

The comments came in a paper entitled Ofwat tightens the screw further. This also detailed the effect of material cost efficiency gaps for many companies (notably Anglian, Thames and Yorkshire) and increasingly downside skewed financial incentives.

Moody’s said: “The potential range of financial incentives for companies’ performance against targets has shifted toward penalties being imposed rather than rewards being paid. Given the additional tightening in performance commitments, we believe companies are unlikely to be able to achieve similar levels of rewards as in the current period.”

The agency concluded the likelihood of Competition and Markets Authority referrals is growing.