Environment elevated in PR24 draft methodology

Ofwat unveiled a draft methodology for PR24 on Thursday that paired its traditional price review focus on affordability and customer expectations with a newly elevated focus on the environment and the long term.

There were four overarching ambitions.

Focusing on the long term

As well trailed, water company business plans for the first time need to be set in the context of 25-year Long Term Delivery Strategies based on an adaptive planning approach. Ofwat will also provide greater clarity on its treatment of multi-period investments and outcomes.

Delivering greater social and environmental value

There were a suite of new environmental Common Performance Commitments (CPCs), including on river water quality, storm overflows, bathing water, serious pollution incidents, strengthening biodiversity and reducing greenhouse gas emissions, as well as a potential new approach to water demand incorporating non household consumption.

Reflecting a clearer understanding of customers and communities

Alongside the joint research approach already decided for PR24, Ofwat has proposed new “open challenge sessions” for customers and stakeholders to have as say on company business plans.

Driving improvements through efficiency and innovation

This includes continuation of the Innovation Fund established at PR19 and an expectation of a step change in efficiency.

The building blocks of the methodology were largely in line with PR19 policy, though with refinements in some areas and some genuinely new elements beyond those noted above.

Summaries of features to note

Half the number of Performance Commitments from PR19, with all but two to three per company CPCs. Financial incentives on all PCs. Sharing rates to be applied to total rewards to manage risk exposure. Enhanced incentives for exceptional performance.

Some account to be taken of forward pressures in setting cost allowances.

A new “net zero challenge” for the most efficient companies to go further and faster on reducing carbon.

An expectation that all companies should deliver an average of no more than 20 spills per storm overflow for 2025 and go further where their legal duties require.

Support for greater use of nature-based solutions.

A new CPC, BR-MeX, to incentivise companies to perform better for business customers and retailers.

No indicative cost of equity yet, but an expectation that the cost of debt to be materially lower than at PR19.

Full indexation to CPIH from 2025.

Signalling that a lower notional gearing might be adopted, with a decision to follow in the final methodology.

A consultation to follow this summer on strengthened ring-fencing provisions in water company licences to deal with financial structures perceived as risky.

An expectation that dividend and executive pay policies will be aligned with delivery for customers and the environment.

Direct Procurement for Customers by default for all projects worth over £200m totex.

Continued funding for strategic water resource schemes.

Twin-track planning for scenarios with and without the introduction of a single social tariff by April 2025.

Business plans to be categorised into four groups: outstanding; standard; lacking ambition; and inadequate – with associated financial, procedural and reputational incentives including up to +/- 30 basis points on regulated equity.

Combining the business plan assessment and draft determination phases of the review, resulting in two phases rather than the three used at PR19.

A new collaborative approach in Wales, reflecting different policies and the specific ways of working there, via the new PR24 Forum.