Price Setting process & methodology
A customer driven price setting process We will make sure that customers views and willingness to pay are at the heart of the price setting process. We will ensure that prices, investment plans, and the services delivered by companies in 2015-20 reflect robust evidence of:
- what customers expect to receive from water companies;
- customers acceptability of water company investment proposals; and
- customers willingness to pay.
Company Business Plans
We will challenge water companies and regulators decisions for 2015-20 to ensure they are:
- grounded on customer evidence;
- part of a longer term strategy to develop a sustainable water industry for the future; and
- deliver value for money and efficiency, so that customers receive tangible benefits in return for the bills they pay.
Companies Final Business Plans and the associated CCG reports can be found via the links on Ofwats website here.
Ofwat PR14 methodology
The final PR14 methodology was published at the close of July. Broadly, there was little surprise as most of the final methodology is consistent with the draft. The most significant elements of the price setting methodology that CCWater supports are:
- The outcome approach to both presenting and assessing company plans, using evidence of customers views.
- The use of average cost to serve for household retail tariffs, with no increase for customers of companies that are under the average.
- The use of a default tariff for non-household customers with an associated minimum level of service.
We have some remaining concerns to follow up with Ofwat, most significantly:
- How SIM will be adapted to the retail/wholesale structure.
- How customers will get a share of the benefits when a company receives an incentive reward for a successful cross border water trading arrangement.
- How Ofwats proposed new financial performance monitoring regime will work.
Ofwat has also confirmed that the method of setting the cost of capital for PR14 will be consistent with the tried and tested method used in previous reviews. We will be working towards delivering our recommendations on the cost of capital to Ofwat by early 2014.
Customer Engagement Principles
One of the roles of CCWater is to assess water companies performance on customer engagement as they develop their business plans during the 2014 Price Review. We have developed our expectations for engagement which provide some advice on how to ensure that best practice is followed and plans are based on good quality evidence from a representative customer base. The main principles are as follows:
- Consult with all segments of the customer base that may be affected by the decision, putting extra effort into consulting with vulnerable or hard to reach groups.
- Be open and transparent with consumers throughout the process.
- Ensure that engagement is timely.
- Make it as easy as possible for people to take part.
- Provide all the information customers will need in order to give informed views.
- Provide customers with the full range of possible operating and capital investment solutions, with associated price options based on realistic cost assumptions.
- Engage customers on all aspects of the business plan.
- Show customers how their views have influenced decisions.
- Carry out at least one statistically robust and demographically reflective piece of research to determine customers priorities and willingness to pay when changes in price or service are proposed.
Cost of capital
One of the key decisions made by the industry regulator Ofwat in the price setting process is the cost of capital. This represents the cost incurred by companies in raising finance to fund future investment, and takes the form of:
- The interest paid on borrowings the company makes to finance its investments; and
- The returns to shareholders for providing equity to finance a company’s investments.
At each price review, Ofwat makes an assumption about the cost of capital and this is reflected in customers’ bills. The cost of capital makes up around one third of the average water and sewerage bill.
A 0.1% increase in the cost of capital can add around £2 per year to the average customer bill. Ofwat’s decision on the cost of capital determines the cost to companies of financing their investments, and is a factor in the level of profit companies achieve.
To provide our view to Ofwat on what the cost of capital could be for 2015-20, CCWater commissioned Economic Consulting Associates (ECA) to produce two reports that provide
- A review of the cost of capital set in previous price reviews to ‘set the scene’ for the cost of capital for 2015-20;
- A review of the condition of the debt and equity markets for water companies; and
- A recommendation on what the cost of capital should be for 2015-20, in a way that ensures companies can finance investments to deliver required services to customers, but at a level that does to lead to customers paying too much or carrying too much risk.
A copy of ECA’s reports for CCWater can be downloaded here.