Experts claim cost of capital errors by Ofwat led to "ongoing disaster" to Thames Water customers and investors

Infrastructure investment experts have has accused Ofwat of mispricing the cost of capital to the serious detriment of Thames Water customers and investors.

In an open letter addressed to Ofwat chair, Iain Coucher, and chief executive, David Black, Professor Noël Amenc, Dr Frederic Blanc-Brude and Dr Tim Whittaker of the EDHEC Infrastructure & Private Assets Research Institute (EDHECinfra) raised concerns about Ofwat’s methodology for estimating the cost of equity capital, underlining its ineffectiveness in explaining returns and its reliance on a limited sample size.

They also emphasised that Ofwat's “mispricing” of the weighted average cost of capital (WACC) at 2-3%, was far below the market reality of 11-12% for Thames Water. The authors wrote: “Ofwat set the companies' allowed return so far from the reality of the market (by a factor of five to six in the case of Thames Water) that, far from creating positive incentives to be an efficient company, the regulator created perverse incentives for the management to run the company into the ground to maximise short-term returns and leave it, bloodless, to the next set of owners.”

The letter asserted: “The failure to use the right approach and the right data to estimate the cost of capital of regulated utilities has played a significant role over the years in distorting incentives and ultimately led to the ongoing disaster for both the end users of infrastructure services and for private investors in the infrastructure.

“End-users, having suffered years of sub-par service, will now end up paying a lot more. Meanwhile investors in UK infrastructure, including high-profile pension plans from the UK, Canada, Japan and beyond, have had to book large losses. A loss of confidence in the UK infrastructure market amongst these investors, at a time when securing their involvement is an objective of the government, is now unavoidable.”

EDHECinfra called on Ofwat to reconsider its practices and methodologies to ensure a more accurate and transparent estimation of the cost of capital.