The Outturn Adjustment Mechanism (OAM), proposed by Ofwat post PR24 draft determinations to mitigate risk on outcomes delivery, should be applied annually rather than at the end of period, and should exclude enhanced payments when water firms push forward frontier performance.
That’s according to Water UK, responding on behalf of the whole industry. The trade body said annual payments would “sharpen incentives, reduce uncertainty and help to overcome financeability concerns with the proposal as it currently stands”. Excluding enhanced payments would “remove disincentives for companies to collaborate and share knowledge, ensuring that the customers of all companies are able to benefit from new innovations and discoveries”.
Under Ofwat’s initial plan, the OAM would be applied at the end of the period to all Outcome Delivery Incentives including those measuring customer experience. It would adjust the realised equity returns for all companies, based on the outcome performance of the median company, measured as a proportion of regulated equity. The mechanism would have the effect of rebasing the sum of returns for all companies: half earning positive returns to add to their base return, and half incurring negative returns that subtract from their base return.
Water UK said the OAM was cold comfort more widely. In a letter to Ofwat, chief executive David Henderson said the mechanism was “better than ignoring the problem altogether” but left two fundamental problems unresolved:
“First, the need for this late-stage mechanism appears to be an attempt to fix the symptoms of a much deeper problem: Ofwat’s general approach to setting performance targets.” He said 90% of companies would fail to meet regulatory targets in the current period, “despite performance improving in nine out of Ofwat’s 11 target measures since 2020, and many areas of company performance in England and Wales exceeding that of most other OECD countries”. Henderson called for “stretching but achievable targets, matched by adequate levels of funding”.
Second, complexity driving uncertainty. Henderson said: “This late addition [he called it “unprecedented” to consult on a new mechanism between draft and final determinations] adds yet another layer of complication onto an already convoluted framework. There are now many layers of different mechanism designed to reduce the financial risk ultimately created by Ofwat’s approach to setting targets and allowances – all of which interact in complex and unpredictable ways, including limited exclusions in performance commitment definitions, an array of different caps, collars and deadbands, new aggregate sharing thresholds, standard and enhanced cost sharing rates, and real price effects mechanisms.”
Water UK wrapped up by reiterating its call for Ofwat to revisit wider aspects of the price review, including to ensure expenditure allowances are sufficient, performance targets are deliverable and the balance of risk and return is reasonable. Henderson warned: “Addressing these issues and ensuring the final determinations for PR24 are deliverable, financeable and investable will avoid years of delay and the lost progress that will be inevitable from potential mass appeals to the Competition and Markets Authority in 2025.”
An Ofwat spokesperson said: "Every five years, we set water companies stretching targets and provide financial incentives to improve outcomes for customers and the environment.
"Our draft determinations proposed an unprecedented tripling of investment in the sector, however, the whole purpose of the recent OAM consultation process was to get feedback from customers, environmental groups and the industry to ensure it attracts the investment we need at a fair price for customers to deliver a step change in investment. We will consider all views received on this option before making final decisions as part of the PR24 final determination package next month."
Comments