UK Water – The moment of truth beckons


altIn recent days, the major quoted water companies – Northumbrian, Pennon (South West), Severn Trent and United Utilities (North West) – have announced their full-year results for 2008/09.

Whilst there were few surprises, there were concerns on several fronts. The recession has reduced metered consumption by industry, a factor that adversely affected Severn Trent in particular. Moreover, higher energy and pension costs have also reduced the sector’s profits.

The reality, though, is that - like Banquo’s ghost - these results were overshadowed by Ofwat’s forthcoming five-year regulatory review.

On 23rd July, Ofwat will make its eagerly awaited announcement about the financial projections for the water sector during the 2010/15 five-year period.

Central to Ofwat’s calculations will be the projected capital expenditure total, which is likely to be close to £20 billion – an increase on the current five-year investment cost.

For investors, the most critical figure will be Ofwat’s assumed range for the Weighted Average Cost of Capital (WACC), which is key to determining financial returns.

In the 2005/10 period, Ofwat assumed a 5.1% post-tax WACC, which was widely regarded as generous; it has been a central pillar in sustaining water sector valuations subsequently.

Previously, Ofwat had promised a ‘far lower’ WACC this time round. However, the credit crisis and a fundamental re-alignment of bond yields - notwithstanding massive UK gilt issuance plans - have made the task of setting a five-year WACC very challenging.

Arcane though the arithmetic may seem, water consumers are directly affected by Ofwat’s forthcoming decisions – they will set water charges for the next five years. With the exception of 2000/01, domestic water charges have risen almost inexorably since privatization in 1989.

Hence, there are many interested parties waiting on Ofwat’s 23rd July announcement.