Update to ECA recommendations for the Cost of Capital 2020-2025
We believe it may be possible for Ofwat to set an even lower cost of capital at the 2019 Price Review, paving the way for further bill reductions.
An independent study commissioned by CCWater has recommended a range for the Weighted Average Cost of Capital (WaCC) between 1.7% to 2.3%. This is slightly lower than the estimate that was calculated by the same consultants, ECA, back in December 2017 in its first assessment for the Water Watchdog.
ECA’s range also falls below the initial view of 2.4% that Ofwat announced during the winter of 2017/18, a figure that will already ensure the average bill for 2020 to 2025 is between £15 and £25 lower than at the previous price review in 2014.
However, Ofwat is due to review the cost of capital again in the summer and if it were to adopt ECA’s recommendations it could lead to customers being better off by between £1 to £14 more.
We have shared the report’s findings with Ofwat to help inform its decision on WaCC, which will be a big factor in determining the final price limits for all water companies in December 2019.
The WaCC – which is the assumption that Ofwat makes on the cost companies will incur in raising finance to fund investment in assets like pipelines and treatment works – is one of the most crucial building blocks in its five-year price settlement with companies.
As water is such a capital intensive sector, returns to investors and debt repayments can have a significant impact on customers’ bills. A 0.1% increase in the cost of capital can add about £2 per year to the average bills. Returns on capital can make up as much as third of the average’s household’s bill.
We have been critical of the regulator during previous price reviews for overestimating the cost of capital at customers’ expense.
While Ofwat has indicated a record low figure in its initial view of the cost of capital, our evidence suggests there is scope to go further during the current price-setting process.