NERA Responds to UK Regulator’s Cost of Debt Consultation for 2019 Price Review

In a recent report commissioned by UK water supplier Portsmouth Water, NERA analyzed an approach proposed by Ofwat, the economic regulator of the water sector in England and Wales, for setting the cost of debt allowance for the 2019 price review.

NERA Associate Director James Grayburn, Consultant Zuzana Janeckova, and former NERA Economic Analyst Jinzi Guo concluded that Ofwat’s proposed method for compensating water companies for their debt costs based on the industry average cost and market benchmark costs over the past ten years would not allow Portsmouth Water to recover its efficiently incurred debt costs. The regulator’s approach assumes that companies have issued debt regularly over time whereas Portsmouth has a single public bond instrument due to its relatively small size.

The NERA experts recommend that Ofwat recognize the market benchmark debt costs associated with the time of issuance of Portsmouth’s debt because this would meet Ofwat’s objectives for setting the cost of debt allowance in the first place, including: protecting customers from facing the costs of financing inefficient financing structures; ensuring that customers only face the efficient cost of debt for a notionally structured company; and providing incentives for companies to outperform.

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