Pierre Georges
Pierre Georges, Senior Director - EMEA Utilities, S&P Global Ratings

Rated water companies across England and Wales may be pressured by aspects of Ofwat’s new pricing methodology, according to the latest report from S&P Global Ratings, which analyses the water regulator’s final methodology for the 2019 price review (PR19), published in December.

S&P believes that utilities’ credit metrics could be hit to the extent that negative rating actions are taken – particularly for the more inefficient and highly leveraged utilities. The price review could also hinder investment in the sector as cash flows become less stable.

“Our report finds that Ofwat’s 2019 pricing review (PR19) could put pressure on the more highly leveraged and inefficient water companies across England and Wales, explained S&P Global Ratings’ senior director for EMEA utilities, Pierre Georges. “Of most pressing concern for water companies, in our view, is the revision to the allowed cost of capital, which has fallen by about 80 basis points (the allowed cost of capital falling from 3.6 to 2.8 per cent). This could potentially cause revenues to shrink by between one and five per cent from 2020 and 2025.

The report also notes Ofwat’s introduction of a new cost allowance, which is no longer based on a company’s historical cost performance – but also on benchmarks from both in and outside the water industry.

Georges comments: “The introduction of more stringent performance benchmarks could keep utilities on their toes. The revised benchmark will also encompass an econometric model, thereby creating a benchmark that also takes into account the performance of companies both within and without the water industry.”

However, water companies still have time to modify their financial policies – as they have done for previous price reviews. It is therefore plausible that utilities will continue to achieve strong performance even against the stretching requirements of the new methodology.

“Though PR19 could be troublesome for the more exposed players,” concludes Georges, “it remains in an early phase: water companies have some flexibility to mitigate the anticipated negative effects. For instance, they can proactively alter their financial policies to maintain their credit quality – much like they did in the first two years of the current pricing period, which began in 2015. It remains plausible, therefore, that many water utilities will continue to post promising performances.”