Outlook: Water prices

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The Independent Online
THERE'S AN expression that neatly describes how regulators tend to become too close to the industries they are supposed to be regulating, and therefore beholden to them. It's called "regulatory capture". It would not be possible to accuse Ian Byatt, head of Ofwat, of such a failing. He must be the first regulator to have gone further than the politicians in his demands for price cuts, and despite the general wringing of hands over his proposals in the industry yesterday, he has done it in a way which water companies are going to find hard to argue with.

John Prescott and his colleagues have talked about scope for a one off cut in prices of 10 per cent. Mr Byatt is proposing 15-20 per cent, though he does concede that prices will need to rise for the next four years thereafter to pay for extra capital spending. In arriving at these figures, he is assuming scope for efficiency savings in operating costs of 2-4 per cent a year, and on capital spending of between 10 and 15 per cent. Actually, these are not unrealistically high assumptions, since the water companies have in the past achieved much more.

Nor does his assumed rate of return on capital of 5.25 per cent seem unduly oppressive for the monopoly utilities that are the water companies. Remember, if the industry achieves greater efficiencies than Mr Byatt is assuming, that rate of return rises. Real dividend increases are not going to be as easy to achieve as they were in the past, but the City can still look forward to a much securer source of income from water than many other industries.

Interestingly, Mr Byatt is making it clear that he does not want to see mergers as a way of achieving these cost reductions. The industry and the City had rather assumed that the price cuts could be traded off against the freedom to merge. Mr Byatt seems to be ruling that out, or at least making clear that those companies wishing to merge will have to achieve even greater price reductions. That's going to spoil many a planned investment banking bonus.

But on the whole, the industry doesn't seem to have much room for legitimate complaint here. And as British Gas proved, it would be dangerous to think the Monopolies and Mergers Commission a more sympathetic judge of these things. BG appealed to the MMC only to find itself worse off than if it had accepted the regulator's strictures lock stock and barrel.

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