Tight rein on prices expected from Ofwat

By William MacNamara

Published: November 26 2009 02:00 | Last updated: November 26 2009 02:00

UK water companies have braced themselves today for a pricing ruling they say could undermine the investment case for the whole sector, which may struggle for years with high fixed costs and stagnant revenues.

Ofwat, the regulator, will today reveal the prices that the UK's 22 water and sewerage companies will charge their customers for water over the period from 2010 to 2015.

The companies had requested price rises to cope with maintenance and expansion. But they were all told in July to expect either lower-than-requested price increases or price declines. For example, Thames Water, the privately owned company that runs London's water infrastructure, asked Ofwat for a 3.9 per rise over the period. It was told to expect a 0.8 per cent decrease instead.

Such discrepancies have meant that the usual tension accompanying Ofwat's five-yearly determination has this year turned into antagonism.

Thames Water is just one of the companies threatening to appeal to the Competition Commission against Ofwat's price determination - made on a company-by-company basis - if today's results are not improved from July.

But Ofwat's stance, an undoubted boon for consumers, is not so draconian that it will damage the UK's water infrastructure, say water executives and sector analysts.

They say that the real damage will be to water companies' debt-heavy capital structure and ability to finance their costs and attract investors.

"Since July," says Phillip Green, chief executive of United Utilities, "I have pleaded with Ofwat to demonstrate more balance in their final determination, so that we can retain the support of the debt and equity markets and invest at the levels we need to invest."

United Utilities Water's gearing (debt to equity) level is 65 per cent. Severn Trent's is 72 per cent.

In the years before the recession the sector took on extraordinarily high debt at favourable terms because of lenders' perception of water as a low-risk industry, underpinned not only by a reliable revenue stream but by rising water prices.

The companies constantly refinance their debt, spending it on the high fixed costs involved in pumping a heavy substance around thousands of miles of deteriorating pipes.

The companies could find that refinancing harder to achieve now that a squeeze on revenues threatens their credit rating.

Among the listed companies, Pennon and Northumbrian are in better financial shape than United Utilities and Severn Trent, says Lakis Athanasiou, water analyst at Evolution Securities.

But even for the better-placed companies, the requisite capital will somehow have to be freed over the next five years.

"There is no particular danger of the companies not being able to fund the capital investment required," says Richard Laiken, a director at Ernst & Young.

"The more interesting question is what return investors can really expect if they get squeezed because the companies continue to fund this required investment."


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