Water risk is high and new equity in jeopardy, Oxera investor engagement finds

Nearly every investor interviewed by Oxera for Water UK as part of its response to the PR24 Draft Determinations indicated that risk levels in the water sector were either ‘high’ or ‘very high’.

The research, published last week, sought the views of 30 major investors in the England and Wales water and infrastructure sectors, from both the listed and unlisted markets.

Key findings included:

• Investors argued that a number of Ofwat’s PR24 policies did not appropriately reflect the broader market context, making the water sector less attractive as an investment proposition. Virtually without exception, investors indicated that Ofwat’s view of a CPIH-real CoE allowance of 4.80% was significantly below that which could be considered to be an adequate level, based on market evidence.

• Nearly every investor interviewed indicated that risk levels in the water sector were either ‘high’ or ‘very high’. Most investors also felt that the overall risk level was markedly higher than in previous periods, including PR19, and higher than would be expected for the water sector. 

• Several investors indicated that performance targets were set unrealistically high, such that outperformance would be very difficult even for the best performers. Investors also highlighted additional performance risk driven by penalties for non-delivery and/or late delivery in the price control deliverables framework.

• Many investors reflected on how, in light of the PR24 Draft Determinations, Ofwat’s regime compared unfavourably to other jurisdictions in terms of the risk/return trade-off. Nearly all investors argued that Ofgem’s regime reflected better returns for lower risk. 

Based on the findings, Oxera concluded that, if implemented as proposed, Ofwat’s Draft Determinations would likely result in significant investability issues for the sector as a whole. In particular, it identified a material risk — substantiated in its investor engagement — that the sector would be unable to raise the new equity investment required to finance the proposed investment programme for AMP8, as well as the high levels of expenditure expected over the coming decades.