Out-Law News 1 min. read

Competition and regulatory changes for the water industry could increase project credit risk


Government plans to increase competition in the water industry, combined with proposed changes to the way that price limits are set by the regulator, could increase the credit risk assigned to water projects, ratings agency Moody's has warned.

In a new report (registration required) Neil Griffiths-Lambeth, a credit officer with the agency, said that certain elements of the proposed reforms could become "credit negative" for the sector depending on the outcome of two consultation processes. This could push up the cost of bank loans to finance new projects in the sector.

The regulatory changes, which would be in force from the next regulatory review period in 2015, will "likely lead to the largest changes in the water sector in England and Wales since privatisation with market forces playing a much greater role, potentially to the detriment of the sector's credit standing," Moody's said. The agency added that the water sector was currently regarded as "one of the most stable and predictable".

Companies that proved "unable to adapt" or were "weakly positioned in their ratings categories" would likely experience pressure over time as the changes took effect, Griffiths-Lambeth said.

Ofwat, the water regulator for England and Wales, published a consultation document in November setting out how it plans to set price limits from 2015. Possible changes to the regulatory framework include greater customer engagement, a focus on outcomes rather than outputs, simpler and more direct incentives for water companies and separate price caps for retail and wholesale activities.

In December, the Government published its plans for increased competition and deregulation in the water industry in England and Wales in a 'Water For Life' White Paper (105-page / 4.16MB PDF), with legislation due to follow later this year. Under the plans, new entrants to the market will be able to own and operate their own infrastructure such as mains, pipes, storage and treatment that is connected to the network. In addition, opening up the market to greater competition will allow business customers to choose their own supplier for water and sewage. The paper also proposes measures designed to encourage better water efficiency and to improve the water quality and conditions of rivers.

"Although the financial and thus credit impact of the proposed upstream and downstream competition may be limited, proposals to set retail price limits by reference to the average cost to serve could prove very expensive for less efficient companies. In addition, the proposed focus on 'outcomes' rather than 'outputs' and having performance measured against regulatory targets will challenge UK water companies. As a result ratings may, in future, diverge outside of the current narrow range based on operational performances," Griffiths-Lambeth said.

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