Unchanged PR24 Draft Determinations could lead to £2bn of penalties and mar Moody’s view of regulation
Moody’s has warned it could lower its view of the English and Welsh regulatory framework's stability, predictability and supportiveness, if Ofwat holds fast to its PR24 Draft Determination (DD) position at Final Determination (FD). This in turn could have consequences for credit quality, with companies needing to strengthen their credit ratios to maintain current credit quality.
The tough cost and performance targets proposed by the regulator come in response to public and political concerns over the sector’s performance – but also increase the risk that sector returns may be insufficient to attract necessary equity, Moody’s explained.
Among Moody’s observations following its analysis of the DDs were:
Most companies will occur net penalties if they performed in line with business plan assumptions under DD terms, in aggregate totalling £400m a year or £2bn over the period. Potential penalties are particularly heavily weighted to environmental outcomes, including total pollutions, bathing water quality and internal sewer floods. Should performance not improve from current levels, penalties could exceed £9bn, though would be capped at around £7.5bn due to the aggregate sharing mechanism.
Cost allowances are 16% below company requests, increasing the risk of cost overruns (albeit cost sharing rates for cost overruns are better, particularly on enhancement expenditure). Wessex, South East and Thames are hardest hit (see chart). Notably, resilience expenditure has been cut, exposing companies to higher long-term risk and loading costs onto future customers.
Allowed returns may not attract enough equity – equity returns are higher for energy networks, plus water companies may not even achieve the returns allowed.
Moody’s observed FDs are typically less onerous than drafts. “However, the DD increases the sector's business risk, a credit negative. A change in our view of the stability and supportiveness of the regime or companies' ability to recover costs and earn a fair return could lead us to adjust our ratio guidance.”
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