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Water e-brief August 2016

  • United Kingdom
  • Brexit
  • Energy and infrastructure - Water


New Secretary of State and Minister at Defra

Andrea Leadsom has been announced as the Secretary of State at Defra, taking over from Elizabeth Truss. The Minister responsible for water is Therese Coffey, previously deputy leader of the House of Commons, replacing Rory Stewart.

Household retail reform

Ofwat’s interim report into the costs and benefits of extending retail competition to household customers was published in July. The report does not express a view either for or against household retail reform (which is a decision for government) but makes a number of interesting points.

56% of customers polled think choice in the water market is a good thing; 50% would be interested in switching. However, customers stated that a saving of 25% would be required to make switching worthwhile. This is considerably more than Ofwat’s estimate of a maximum saving of £6 (2%).

The report highlights the fact that protection of vulnerable customers would be a key issue. A more detailed report is due in September.

Possible Brexit impact

Ofwat has warned that water companies may face a challenge of maintaining customer legitimacy if a possible scenario of higher inflation, lower growth and lower interest rates materialises. In those circumstances, water companies would remain an attractive investment proposition and enjoy financial outperformance at a time when customers are struggling to pay water bills.

Otherwise, Brexit is not considered likely to have any immediate impact on the sector. The independent regulatory regime insulates the sector from political turbulence. Longer term, it remains to be seen whether there will be any shift away from the extensive influence of EU Directives on UK environmental and water law.

Ownership/M&A/Retail exit

These have been areas of considerable activity so far this year.

Pennon Group, the owner of South West Water, acquired Bournemouth Water earlier this year. The deal has received clearance from the CMA.

Future Fund, an Australian sovereign wealth fund, has sold its stake in Southern Water to Hermes Investment Management.

Earlier this year Mitsubishi Corporation acquired a 25% holding in South Staffordshire Plc, owner of South Staffs Water and Cambridge Water, from KKR. Macquarie’s 26% stake in Thames Water is reported to be for sale.

Severn Trent and United Utilities have created a JV company to combine their non-household retail activities which has received merger clearance from the CMA. Based on 2014/15 figues, the combined business will have sales of £940m and hold approximately 26% of the market in England and Scotland.

Wessex Water and Bristol Water will operate in the business retail market through a JV company, Water 2 Business Limited.

Southern Water is to exit the non-household retail market. Its business customers will be served by Business Stream (the business retailer spun out of Scottish Water). Portsmouth Water has announced that it will exit the business retail market, off-loading its business retail functions to Castle Water, a new entrant Scottish company. Thames Water has also announced its intention to exit the business retail market with Castle Water stepping in.

Further activity, including new entrants to the market, is expected over coming months.

Frequency of price reviews

Ofwat has announced that it is to review the length of the price control period. Since privatisation, price reviews have been conducted every 5 years. The current period, AMP6, runs from 2015 to 2020.

Ofwat’s review will take place after the next price review, PR19, has concluded; the control period for AMP7 will remain at 5 years (2020-2025).

Ofgem works to an 8 year period for energy sector networks; in Northern Ireland and Scotland the review period for water is 6 years. The pros and cons of a longer review period for the water sector in England and Wales are seen as providing greater investor certainty but at the risk of locking any financial problems into the settlement for a longer period.

A staggered approach has not been ruled out, whereby different elements of the overall price control could be dealt with at different times.

Indexation of water prices

Ofwat has stated that it intends to switch from an RPI linkage for water bills to the “more legitimate” CPI. Ofwat say that the switch will be revenue-neutral for companies but the proposal has raised concerns, for example in relation to embedded debt which is typically RPI-linked.

Sludge trading

Ofwat has set up a sludge market working party to explore possibilities around the greater use of markets in sludge treatment, recycling and disposal, including development of a centralised information platform.

Severn Trent has publically stated that competition in sludge treatment is likely to be introduced before 2020. As with business retail reform, this would require the creation of a level playing field for all participants to ensure fair access to the market.

Licence modifications for business retail reform

The Water Act 2014, which introduces business retail reform, allows Ofwat to modify the conditions of companies’ instruments of appointment where it considers it necessary or expedient to do so in consequence of the reforms.

A number of modification proposals have been published by Ofwat, including introduction of the so-called stapling condition to ensure compliance with the Wholesale-Retail Code and introduction of a customer protection condition requiring adherence to the Customer Protection Code of Practice. These have generally been regarded by the companies as non-contentious.

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