UK water companies will hear from the industry regulator next Thursday, 19 December, what level of pricing and returns they will be allowed for the next five years.
Investors will first look for the levels of allowed returns, with Ofwat's draft determination in July proposing an allowed cost of debt of 2.8%, an allowed cost of equity of 4.8%, and an overall weighted average cost of capital (WACC) of 3.7%.
The draft determination allowed water bills to be lifted by an average £19 per year to fund investment into infrastructure, which was below the average requested by water firms.
Ofwat proposed total investment spending to increase 50% to £88 billion between 2025 and 2030, with water companies needing to triple investment in new infrastructure and resources “to improve the environment, resilience and service”, with each company set targets for up to 23 areas of performance that are important to customers.
For companies that do not meet their targets each year, the watchdog warned there will be automatic penalties, reflected in reduced bills, with the other side of the coin seeing incentives to beat the targets and good performance rewarded.
The Output Delivery Investment (ODI) framework, which is the mechanism of financial rewards and penalties used by Ofwat to drive performance improvements and align water companies' actions with customer priorities, is going to be a key point for companies and investors too.
Analysts expect there to be plenty of adjustments, which should be good news for listed water firms Pennon Group PLC (LSE:PNN, OTC:PEGRY), United Utilities Group PLC (LSE:UU.) and Severn Trent PLC (LSE:SVT).
Ahmed Farman at Jefferies said he expects increases in both the allowed real return on capital and the allowed cost of equity, plus “favourable updates” on other regulation, including the risk-reward balance on output delivery incentives and a higher allowance for costs.
He noted that the water sector has been “vocal” that the ODI framework (in terms of its impact on returns) has “a strong downside bias” and, based on industry discussions, there is “likely to be a recalibration”.