Competition watchdog seeks views on 0.3% drop in cost of capital in PR19 appeals

The Competition and Markets Authority (CMA) is consulting until 27 January on updated estimates to elements of the cost of capital, which would decrease the weighted average cost of capital (WACC) by 0.3% if they were locked in when final decisions are issued in mid February for the Yorkshire, Bristol, Anglian and Northumbrian Water appeals.

The WACC decrease would mean average bills fall 11% over the 2020-25 period, compared to the average 9.3% reduction proposed by the CMA in its Provisional Findings in September 2020 and the 12.5% cut proposed by Ofwat.

The CMA updated its thinking on specific elements of the cost of capital in two working papers published on Friday.

• In the first paper it proposed a total cost of debt allowance of 2.12% in CPIH-real terms. This is a 33bps reduction versus the 2.45% used in the Provisional Findings. The impact on WACC (at 60% gearing) would be a reduction of approximately 0.20%. The paper adjusted the Authority’s approach to setting the cost of embedded debt allowance, estimating new debt, and the ratio between the two.

• The second paper dealt with choosing a point estimate for the cost of capital, comprising a point estimate for the cost of debt (dealt with in the debt paper) and a point estimate for the cost of equity within a determined range. The CMA set the latter at around 0.25% above the mid-point of that range. It argued its view remained that choosing a point above the middle of the range would be beneficial and result in “an appropriate balance of risk in the round across the determination” –though it noted that: “We consider that the risk of setting the cost of equity too low is not as high as we had implied in our Provisional Findings, since there is a greater probability that the right estimate is towards the middle of the range.”

The CMA said it will be consulting on two further working papers in January 2021.