Environment, Food and Rural Affairs CommitteeSupplementary written evidence submitted by Water UK

I write further to the recent Efra Select Committee evidence session on the Water White Paper, at which I appeared with Peter Simpson, Managing Director of Anglian Water, and Steve Mogford, Chief Executive of United Utilities.

We found the session very valuable and the Committee receptive to many of the points we made. The depth of understanding and, indeed, strength of feeling that many Members showed during the session was encouraging. That policy makers are so engaged with the debate surrounding the future of the water industry is vitally important and the Committee’s role in that is a crucial one.

Time pressures meant that, unfortunately, we were not able to expand on the theme of investor confidence, which is fundamental to financing continued service improvement in the sector. Given the importance of this issue I thought it would be helpful to follow-up this point.

In recent weeks a number of worrying overtures have been made by members of the investment community. HSBC’s Verity Mitchell is on record as saying that Ofwat’s Future Price Limits and licence modification proposals increase the uncertainties in the UK water industry. She suggests that although the Water White Paper does not recommend fundamental structural change those measures emanating from Ofwat represent a medium-term agenda for quite considerable structural change, with the possibility of an adverse impact on bond covenants for some companies.

Recently, JP Morgan Cazenove suggested that the market had been complacent on structural reform reflecting that it had not fully understood the ramifications of many of the proposals “Indeed, there are other changes which could have material negative implications for the companies such as removing the cost principle from legislation and replacing it with a yet to be defined wholesale access regime”.

As I mentioned in the evidence I gave, for every one percentage point increase in the cost of capital there is a five% increase in customer bills. Moody’s, the ratings agency, stated at Water UK’s City Conference two weeks ago that “Uncertainty as to the continued predictability and stability of the regulatory environment, together with changes that are expected to increase operational risk and earnings volatility for the sector, could lead lenders to require higher margins and so increase the cost of capital.”

The industry does not seek to be alarmist and it goes without saying that it is not in its interests to undermine market confidence, but unfortunately such statements represent a strengthening narrative that is now developing in some quarters of the investment community. For Moody’s to suggest, as it has, that the sector’s credit rating is at risk is extremely serious since the entire success of the sector is based on successful treasury activity within companies. This has allowed customers to benefit from extremely low financing costs despite the scale of the infrastructure challenge facing the industry—and in the UK we are the acknowledged world leaders in this area.

Indeed, yesterday, the Prime Minister has been talking about financing other forms of infrastructure based on the water and sewerage model, so it would be unfortunate to put the financing of water and sewerage infrastructure under a cloud just when the Government is seeking to use it as a template for other infrastructure investment.

Again, thank you for a very valuable session with the Committee and if I can be of any further assistance please let me know.

20 March 2012