FTI Consulting – Utility Week: Muddy Waters

Economic and Financial Consulting

August 30, 2013

Even after the publication of Ofwat's final PR14 methodology, a good deal of guesswork is still going on, writes Anthony Legg.

Since much of the content of Ofwat's methodology for setting prices for 2015-20 (published at the end of July) has been well trailed, one might expect it to be crystal clear how Ofwat will set prices at next year's price review (PR14) . However, look a little more closely and a number of significant uncertainties emerge:

  • how will the cost allowances for building, maintaining and operating the network be set?
  • how will finance ability tests be carried out and any identified problems solved?
  • how should allowed revenues be converted into actual tariffs and charges?
  • how will Ofwat assess business plans?

Cost allowances: Ofwat has confirmed that cost allowances will be based on an assessment of total expenditure (totex) at PR14, but it is uncertain just how an appropriate amount of totex will be determined. While Ofwat has now signaled that it will assess costs based on a range of econometric models, not just totex, the absence of any clear guidance from the regulator as to the models it will consider, and how the results from the different models will be combined, throws up a hornet's nest of possibilities.

For example, while Ofwat has watered down the emphasis it intends to place on totex models (compared with its original position in January where these models were the centre piece of its approach), the weight Ofwat will afford these models is unclear. Other models could be used simply as cross-checks, but might also be used to directly generate the range of the "cost corridors" Ofwat has proposed to use to benchmark companies' expenditures.

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