U.K. water and sewerage regulator Ofwat announced last week its preliminary price determination regarding how much a British water company is allowed to charge over a five-year review period that begins April 2005. Although Ofwat cut back the business plans for all water companies in the country, the preliminary draft determinations will have no immediate impact on the ratings of these companies, analysts at Standard & Poor's said.
The impact of the latest tariff review is considered one of the most important since the industry was privatized in 1989, according to S&P and its outcome determines whether the creditworthiness of U.K. water companies will continue to deteriorate or remain at current levels.
The water utility sector, once this regulation is hammered out, is expected to be one of the growth areas for whole business securitization in the U.K. going forward (see ASR 10/27/2003).
Initially, concerns were that the new base rate set for water companies across the board might adversely affect credit ratings of many of these companies. Ofwat determines a water company's pricing structure after a business plan submission. Water companies are regulated according to an incentive regime where any efficiency saving that is made during a five-year pricing period is discounted on the following year, reducing the company's base count. The regulator takes whatever savings realized into account when setting tariffs for the new base rate, meaning a water company must strive to achieve results below this threshold throughout the five-year period.
"The overall draft proposal is moderately more generous than initially indicated by the regulator," analysts at Deutsche Bank reported. In its preliminary draft determination, the water regulator highlighted the assumed overall cost of capital of 5.1% on a post-tax basis and the average annual price increase of 3.1% over the retail price index, versus the 6.1% requested by the water companies. A capital expenditure of GBP15.7 billion (US$28.7 billion) was specified, as opposed to the GBP20.7 billion (US $37.8 billion) capital expenditure actually spent by the companies.
So far, it looks like Anglian Water will be allowed an average increase in price limit of 1.5%, though it initially requested a 4.6% annual hike. The pricing difference, said Deutsche analysts, will be achieved through higher efficiency-based savings, a lower-than-requested raise in operating expenditure, capital expenditure and a lower cost of financing assumption. Southern Water was granted an average price increase of 4.0%, although it initially requested a raise of 7.7%. Meanwhile, the Welsh Water Company Dwr Cymru has its base rate increase at 4.5% compared to the 5.9% requested by the company.
"Among the securitized businesses, Welsh Water was the only company where the regulator aligned its finding with that of the company in terms of efficiency targets, with the draft average household bill calling for only GBP1 worth of further efficiency gains relative to the company's own proposals," said analysts at Deutsche. "Most of the difference between the price requested and Ofwat's draft determination comes from sharply lower capital expenditure assumptions compared to the Dwr Cymru's business plan."
But industry sources added that at this initial stage, it's difficult to determine exactly what impact the new base rates would have over the long term on the sector's credit ratings. Analysts at S&P said that they would determine the credit profile of each company following ongoing discussions with management. Further, these draft determinations will be subject to a period of consultation that could potentially see tariff rates shift before anything is set in stone.
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