WICS consultation on Scottish Water financing

Water Industry Commission for Scotland consultation (18 pages, PDF, plus several subsidiary papers) on financing and governance issues in relation to the review of Scottish Water's price controls for the period 2010-2014.

Whilst retaining the concept of an Ofwat-like regulatory capital value (5 pages, PDF), WICS actually proposes to set prices by reference to “an assessment by a credit rating agency of appropriate financial ratios for Scottish Water's circumstances” without relying on an estimated cost of capital — see the last two pages of the cost of capital paper (7 pages, PDF). This seems similar to the approach used in WICS' 2005 review, which led to a low notional cost of equity.

Scottish Water would be forced to hold a financial reserve (6 pages, PDF) in UK gilts of an amount determined by WICS (“gilts buffer”). The purpose would be to take the benefits of any outperformance against regulatory assumptions away from the control of Scottish Water's management, ensuring a “tight budgetary constraint” even if Scottish Water is more profitable than expected. The reserve could only be used with the permission of both WICS and the Scottish Executive.

The discussion of rolling incentives (6 pages, PDF) concludes that Ofwat's 1999 approach may be too complicated, and suggests instead what seems to amount to a partial relaxation of the policy of taking away all unexpected profits into the WICS/Executive-controlled financial reserve:

Our current preferred approach would be to link rolling incentives to additions to the gilts buffer. In doing so we would also expect bonuses for the staff of Scottish Water to be linked partly to growth in the buffer and partly to other indicators of performance such as those measured by the Overall Performance Assessment.

At this stage, our proposals exclude incentives for outperformance on capital expenditure, where we do not believe there is a clear customer interest. In particular, we consider that a rolling incentive allowance for capital expenditure could increase the risk of overscoping or overpricing of capital projects in Scottish Water's business plans.

Pressure would also be placed on Scottish Water to reopen aspects of the PPP contracts (4 pages, PDF).

Responses by Friday 19 October 2007.

For further information or advice please contact Franck Latrémolière.

Filed under Price controls, Water, WICS.

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