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UK Water: Odious ODIs?
Andrew Moulder - Head of Utilities
Bozhidar Dinkov - Analyst, Utilities
EXECUTIVE SUMMARY
- One of the most contentious issues around PR24 is the level of the outcome delivery incentive (ODI) performance commitments set by Ofwat in its draft determination given the high profile, punitive aspect to the regime.
- We ran the numbers through the Ofwat modelling tool, and, based on company business plans, it is projecting all but one of the main water and sewerage companies, South West Water, being in net negative territory.
- Thames faces a massive potential £1.1 bn fine from external sewer flooding, but this results from incorrect statements of past performance and Thames has now restated numbers after a review by external assurers. We expect this to change at the final determination stage.
- Thames has the largest projected penalties, but other companies such as Southern, Anglian and UU also face penalties on individual measures around the £100 mn mark. The relevant companies are making representations against the Ofwat performance commitment levels.
- We attended an Ofwat roundtable where it admitted it had been surprised by the negative reaction of investors and the rating agencies to its performance commitment levels and ODIs. Ofwat stated that it may need to think again about ODIs, so there is a clear possibility that these PCL and consequent expected penalties and rewards may change by the final determination.
Financial Metrics
We have written a lot recently about Thames Water, but the UK water sector is not just Thames Water. Thames is one of 11 Water and Sewerage Companies (WaSCs) and there are a further five water only companies (WoCs). All these companies are going through the same PR24 price control, and while the final determination (FD), currently due on 19 December 2024, is a much needed piece in the puzzle that will determine the future of Thames Water, it will also be an important decision for the other 15 UK water utilities.
Water companies submit business plans that lay out what the companies believe they need, and the outcomes they believe they can deliver with reasonable certainty. These plans and the financial metrics that come out of them do not tend to assume any under or outperformance of key commitments, but a top performing company with a good track record would expect that it could outperform on some of its business plan commitments. In terms of delivering good returns for shareholders and ensuring financial resilience, how a company performs against targets can be very important. Allowed returns may be low, but if a company, after evaluating the commitment levels and investments embedded in its final determination believes it will be able to outperform and achieve an additional 2% – 3% on its return, then overall, that may be a package a company could accept.
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