Latest CMA base cost modelling slashes allowances

(by Karma Loveday)

The latest base costs modelling from the Competition and Markets Authority (CMA) would leave the companies challenging their price settlements – and the wider water sector if it was applied across the board – with lower allowances than Ofwat’s final determination (FD) and the CMA’s October provisional determination (PD).

The CMA published a Base costs modelling working paper last week, which is open for consultation until 7 January. The outcome was: “Our updated models produce wholesale water and wastewater allowances that are 1.5% lower sector-wide and 1.0% higher for disputing companies than those in Ofwat’s PR24 FD before applying modelled efficiency challenges. Our models do, however, result in a stronger efficiency challenge. Once this stronger efficiency challenge is applied, our models produce allowances that are 7.1% lower sector-wide and 4.8% lower for disputing companies than Ofwat’s PR24 FD.” This equates to a reduction of around £600m for the appellants, and £3bn at sector level.

Base costs have emerged as the key battleground in the appeals.

The new paper was published alongside long-awaited responses to the PDs from the main parties (Ofwat and Anglian Water, Northumbrian Water, South East Water, Southern Water and Wessex Water), together with their responses to others’ base cost modelling representations, and submissions from third parties – with many industry voices also raising concern about the base cost modelling approach adopted in the PDs. The CMA has diverged from Ofwat’s well-tested base cost models, and – in relying heavily on modelling – also diverged from the direction of travel recommended by the Independent Water Commission.

To respond to this criticism, the new paper set out the CMA’s latest thinking on technical aspects of its approach, with improvements and refinements including “improved predictive accuracy, simpler cost models, and a transparent data-driven approach to select cost drivers that have an engineering and economic rationale.”

The new paper is likely to attract considerable push-back from the industry, given the outcome is lower base cost allowances at a time when asset health is moving up the agenda. The developments also suggest the CMA’s FDs are likely now to come towards the end of the statutory deadline of 17 March.