Ofwat seeks new approach to returns after review finds its method creates high allowances

Ofwat is consulting on changing its approach to calculating the return on Regulatory Capital Value (RCV) at PR24, in a way that would likely lower returns.

Ofwat’s current approach in the PR24 financial model is to calculate the return on RCV by multiplying the real wholesale weighted average cost of capital (WACC) by the average RCV balance during the year. The consultation, open until 16 May, set out that an external review had found a departure in the convention applied by Ofwat and other regulators in the calculation that applies the allowed return to the RCV to calculate allowed revenues.

The review found that Ofwat’s current approach generates a structurally higher allowance than an approach calculated on a net present value neutral basis – “extra revenue equivalent to circa 11 bps on the return on regulated equity. We therefore believe there is a clear case for changing our current approach.”

The options are adjusting the WACC or amending the return on RCV calculation. The consultation proposed amending the return on RCV calculation on transparency grounds.

Separately, Ofwat is consulting until 12 May of the set of econometric models it intends to use to help set efficient base expenditure allowances at PR24, covering wholesale water, wastewater network plus, bioresources and residential retail models.