2019 Price Review – setting the scene for the cost of capital financing

During each Price Review, the water regulator Ofwat makes an assumption for the cost water companies incur for raising capital financing (through equity and borrowing) to fund required investment.

Water companies’ returns to equity shareholders and repaying debts can account for up to 28% of the average customer bill, so it is important  that the cost of capital strikes the right balance in ensuring companies can finance investment needed in their infrastructure, but at a reasonable cost to customers.

To help inform the debate over the cost of capital for the 2019 Price Review – which will set prices for the 2020-25 period – we commissioned Economic Consulting Associates (ECA) to examine company financial performance in the first year since the 2014 Price Review, current capital market conditions and expected regulatory developments at the 2019 Price Review that may affect the cost of capital decision.

In their report, ECA raise the following key points:

• Water companies have raised debt in recent times at costs generally around the level of market benchmarks and below Ofwat’s allowance at the 2014 Price Review.
• Rather than fixing allowances for the cost of debt as previously for PR19, Ofwat is considering adjusting them (retrospectively) according to a market index. This could greatly reduce (if not remove) companies’ scope to outperform cost of debt allowances. However, under this approach, increases in the cost of debt within the period would ultimately be borne by consumers. With rates currently very low, and an expectation that they will increase, this is a real risk for consumers.
• Share price returns of the four quoted water companies are generally greater than returns to the FTSE All Share index (ECA’s market proxy).

Read a copy of the report below