The UK Water Report: Initial* summary of key points from yesterday’s PR24 Final Determinations

*this will be expanded for Monday’s The Week In Water

1) Expenditure 

• Final determinations (FDs) allow £104bn, including contingent allowances – a 71% increase on PR19, and 7% (£8bn) below companies’ latest business plan (BP) proposals of £112bn. The 7% challenge is slightly bigger than that imposed at PR19 (5%), which Ofwat said was due to the greater proportion of enhancement expenditure this time around. Ofwat said it had cut expenditure that it considered inefficient, not properly justified, not required or previously funded. (30% of the enhancement cost challenge results from the removal of schemes covered by base allowances, and 10% from the removal of schemes previously funded. Ofwat said a large part of this is from Thames Water).  

• £104bn is a £16bn increase on draft determination (DD) totex. The uplift reflects new statutory requirements that emerged after DD; increased base costs including for energy and business rates; additional evidence from companies to address Ofwat’s DD concerns; and improvements to Ofwat’s cost assessment approach.

  
  

• Base allowances at £61bn compare to company requests of £64bn, an average 4% gap. Base allowances are 19% higher than at PR19 and 7% more than companies have spent in the last five years, Ofwat said. They include £0.7bn for network reinforcement to cope with population growth, and £1.5bn to improve resilience (double PR19). Ofwat published a new Roadmap for enhancing asset health understanding as part of the FD document suite.

• Enhancement allowances quadruple from £11bn at PR19 to £44bn. 90% of this is statutory (National Environment Programme / Water Resource Management Plans / Industrial Emissions Directive / Drinking Water Inspectorate requirements). The enhancement cost gap is 10% (August plans = almost £50bn).

• Company cost gaps show wide variation. Ofwat’s totex for South Staffs, Portsmouth, Yorkshire and Welsh are just about on or above company plans. At the other end of the spectrum, substantial totex gaps remain for Southern, Thames, Wessex, South East and SES. Sizeable base gaps at Thames and Wessex are likely to pose particular difficulties for both companies. More struggle with large enhancement gaps: Southern, Thames, UU, Wessex, Bristol, South East and SES.

  
  

• Investment funding will be ring-fenced, with a claw back mechanism so any unspent money is returned to customers. 

Key items of expenditure include:

£24bn for improving the environment – to reduce pollution, reduce harm from storm overflows, improve river water quality, and increase biodiversity. To include:

• £12bn for 2,884 storm overflow projects – to see spills reduced by 45% by 2030 on 2021 levels (companies proposed 41%).

• £6bn of upgrades to combat nutrient pollution for around 1,000 sites and catchments, to reduce phosphorus entering rivers from water company activities by 28%.

• £3.3bn for nature-based solutions: £2.6bn to reduce storm overflow spills; £250m for nutrient removal including via catchment and nutrient balancing as well as reed beds and wetlands.

• £259m for Advanced WINEP: Anglian Water – Partnership Centre of Excellence to encourage nature-first solutions; South East Water – to implement innovative catchment approaches to reduce nitrates entering groundwater; and UU – to put in place 58,000m³ of equivalent storage through rainwater gardens, swales, permeable paving and natural flood risk management.

• Net zero allocations pegged to the 2050 national target. £66m additional base expenditure for infrastructure needed to adopt low carbon vehicles and heating. £0.5bn of net zero challenge funding for Anglian, Welsh, Hafren Dyfrdwy, Severn Trent, UU, Wessex and Yorkshire to fund 33 schemes to deliver innovative projects to understand better how to reduce emissions – principally process emissions from the treatment of wastewater.

  
  

£12bn protecting the water system

• £5bn to expand supply. This includes £2bn to kick off a major expansion in new water assets, including nine new reservoirs, progressing nine large-scale water transfer projects and 12 water recycling plants under the RAPID programme. In all, 30 major projects ultimately to be worth £50bn are being supported, and are expected to provide enough water to meet the daily needs of around a third of the population of England and Wales.

• Getting leakage down by a further 17% (£720m)

• 10m smart meters (£1.7bn)

• Tripling the rate of replacing water mains - there is an expectation that all companies replace at least 0.3% of their water network each year through base allowances. Overall, companies are expected to replace 8,445km of water mains during 2025-30, with base and enhancement expenditure allowances. This equates to the replacement of 2.4% of the sector's total length of mains by 2029-30, at an average rate of 0.45% per year.

• £2bn for drinking water quality improvement, including on addressing PFAS and replacing lead pipes.

Competitive funds

• £400m Innovation Fund

• £100m Water Efficiency Fund. 

  
  
  
  

2) Bills and affordability 

• Ofwat said it had cut a total of £11bn from company plans: £8bn of totex and £2.8bn through its approach to setting a rate of return.

• The FD put bill rises at £31/yr on average – £157 (36% up) over the period (before inflation). This compares with August BP proposals of £39/yr (44%).

• The increase will be front loaded, with the average bill increase in 2025-26 at £86 (20%), excluding inflation, with smaller percentage increases in each of the next four years.

  
  

• The rise is driven by increased investment, higher financing and operating costs, and more spend on asset health measures. The cut to BPs is driven by Ofwat reducing planned expenditure and pegging returns to a lower level than some companies based their plans on. 

• The average figures mask wide variation. Bill increases range from 21% at Northumbrian and Wessex, to 53% at Southern and 47% at Severn Trent. Thames was held to a 35% rise, shy of the 53% it requested. Average annual bills will be £597 by 2030, ranging from £510 at Northumbrian to £645 at Welsh Water and £642 at Southern Water, from an average £440 today.

• Affordability support will more than double to over £500m over five years. 9% of customers, up from 4%, will be on social tariffs. Significant shareholder contributions proposed by some companies.

• Wholesale charges for business customers will on average increase by 42% before inflation between 2025 and 2030. This compares to Ofwat's estimate of an average increase of 41% in the wholesale charge element of household bills.

3) Outcomes

• The DD 24 Common Performance Commitments (PCs) stand. One is reputational (river health) and 23 have financial incentives. Eight of these are new environmental PCs. 

Key PC reductions targeted include:

• 30% total pollutions

• 29% customer contacts about drinking water quality

• 20% per capita consumption (to 2038)

• 17% external sewer flooding

• 27% internal sewer flooding

• 17% leakage

• 16% sewer collapses

• 6%  the need to repair water mains bursts.

  
  

• Seven bespoke PCs were accepted, one fewer than at DD: four related to embedded greenhouse gas emissions (Anglian, ST, SWW, UU), plus one each on lead pipe replacement (Hafren), street works collaboration (Thames) and ‘Wonderful Windermere’ (UU). Affinity withdrew its bespoke PC on low pressure, which Ofwat had previously accepted.

• There was considerable change to the outcomes package on the back of representations and 2023-24 outturn data, “which gives a more pessimistic view of what performance is likely to be early on in PR24”. Ofwat also made changes to its risk modelling, resulting in a greater range of risk than in the DD models. Consequent changes were made to performance commitment levels (PCLs), outcome delivery incentive (ODI) rates and risk protections. Ofwat said the new package should lead to the median efficient firm achieving -0.20% return on regulatory equity (RoRE) over PR24 and provides a “fair outcome across stakeholders”.

• On PCLs, Ofwat made changes to some start and end points; and reduced stretch on four PCs for the top performers. It said it took account of “compelling regional factors” and moved UU from a common to a company-specific PCL for internal sewer flooding.

• ODIs – reduced ODI rates were set for 15 PCs.

• Risk protections – these have been increased. Collars now apply to almost 80% of all PCs, and caps to 70% of PCs, compared to 60% for each at DD. Deadbands now apply to all companies for compliance risk index, discharge permit compliance, repairs to burst mains and serious pollution incidents. A small number of companies have deadbands on customer contacts about water quality, bathing water quality and operational greenhouse gas emissions.

• Outturn Adjustment Mechanism (OAM)  –  Ofwat said its new outcomes package is balanced, but as a backstop it would implement the OAM consulted on in October, in case there is materially different sector performance than expected. Responding to feedback, Ofwat said the OAM would be applied on an annual basis and separately for water and waste, and that a deadband would be introduced before the OAM is triggered.

• Aggregate sharing mechanism – no change from DD. Payment sharing threshold at ± 3% RoRE.

4) Deliverability and accountability

Measures to support deliverability include: 

• Board assurance on deliverability was a key part of business plan quality assessment.

  
  

• 27 large schemes to be delivered outside of price controls via SIPR/DPC.

  
  

• Incentives included for on-time delivery.

  
  

• Price Control Deliverables (PCDs) introduced to hold companies to account on delivery and return money to customers if outcomes are not delivered in full. 

• A Delayed Delivery Cashflow Mechanism will also be introduced for all companies, so Ofwat can return to customers money for enhancement investments where these are delayed so bills reflect actual delivery profiles.

  
  

• For Thames and Southern, Ofwat introduced a Delivery Mechanism, under which some expenditure will only be accessible once firms prove they can deliver the schemes it will fund. This means customers will not fund spending until Ofwat is clear on the timing and profile of elements of the companies’ plans. If triggered, this would increase average 2030 Southern bills by an additional £20, and Thames bills by £11.

5) Risk and return, and financeability

• Ofwat has taken steps to significantly recalibrate the overall risk and return package, including through its changes to cost allowances, the outcomes package, and the allowed return.

• The FDs set an allowed rate of return of 4.03%, compared to 3.72% at DD and 2.96% at PR19. This FD rate reflects a cost of equity of 5.1% and debt at 3.15% and is underpinned by a gearing ratio of 55%. Ofwat said the increase reflected recent market data suggesting a higher cost of finance, and targeted changes to its methodology.

• The cost of embedded debt was updated to include issuance in 2023-5, and the allowed return on new debt includes a positive 30 basis point benchmark adjustment to reflect sector-wide increases experienced by water companies in 2024.

• The Pay-As-You-Go rates set out in company business plans have been applied, subject to technical adjustments. Overall, the average run-off rate in the determinations is 4.15%, resulting in an average period over which the cost of the Regulatory Capital Value (RCV) will be recovered of 24 years.

• BPs indicate £7bn of new equity needed by 2030. Ofwat said it expected the requirement to be higher and had used £12.7bn when assessing the financeability of company plans. The amount of debt companies forecast they need to raise in 2025-30 is 60% higher than the level of raised in 2020-25. Ofwat said some firms would need to take steps to bolster their financial resilience. It confirm it will provide funding for the net efficient costs of a company raising equity through a new stock market listing, by means of a logging up adjustment to the RCV at PR29.

• A base dividend yield of 4% is considered reasonable for a company whose in-the-round performance aligns with the determinations – though some firms are expected to take less or nothing.

• Despite its view that gearing levels that exceed 70% may not be sustainable in the long term, Ofwat will not pursue any of the options set out in the DD to introduce licence amendments or other interventions that would restrict companies from paying dividends beyond this gearing threshold. The regulator will consider these issues separately.

  
  

• The retail margin was set at 1.5%, up from 1.2% in the DD.

  
  

6) Uncertainty mechanisms

• 55% of totex will be covered by true ups relating to external price input factors, including for energy in base; and materials, plant and equipment in enhancement.

  
  

• Cost sharing rate reduced to 40% of over/under spending on enhancement expenditure to insulate companies more from overspend, and provide customers with a greater share of the benefit of underspend.

  
  

• For complex or novel schemes of £100m+, expenditure will be gated; PR24 allowances only provide for development funding and companies will recover additional spend at PR29. Construction funding for strategic resource options to be contingent on schemes proceeding.

• The FD included a new provision for additional revenue to be added should there be changes in legal requirements on cyber security, PFAS and a transition away from sludge to land.

7) Business plan grading

• Plans were assessed on quality first (against 26 expectations across six areas), then ambition (against affordability, and stretch and efficiency), and a complex array of rewards/penalties applied depending on how companies performed and how much Ofwat had to intervene to reach the FD position. These incentives relate to a financial adjustment to RCV, and cost sharing rates on base expenditure.

• The two ‘outstanding’ companies (Severn Trent and South West), the eight ‘standard’, and two ‘standard with intervention’ (South Staffs and Welsh) remained as per DD. South East, Wessex and Southern met Ofwat’s conditions at FD, meaning their cost sharing rates returned to the standard 50:50 and the RCV penalties they were exposed to at DD were dropped. Thames however was deemed to remain ‘inadequate’ and has kept its 30bp penalty and 60:40 cost sharing rate.

  
  

8) Appeals

• Deadline for referrals to the Competition and Markets Authority: 18 February.