Utility watchdogs to close profit-boosting debt loophole

The UK's utility regulators are considering radical proposals to prevent companies exploiting a financial loophole that has encouraged a takeover frenzy in the sector.

Regulators including Ofwat and Ofgem estimate every five years how much it will cost companies to raise the finance - mostly through debt - to invest in the UK's water businesses and electricity networks.

But when the current price reviews for electricity network operators and water companies were being conducted in 2004, regulators overestimated how much it would cost to raise the £23bn needed. Because of low global interest rates, the cost of raising debt is now about half that estimated two years ago.

Consumer prices are regulated according to estimates of company costs. As companies can pocket the savings from cheaper financing, there is positive encouragement for such highly priced deals as the £8bn takeover of Thames Water by Australian bank Macquarie last month.

Regina Finn, the new chief executive of water regulator Ofwat, is talking with energy regulator Ofgem about scrapping this practice. The regulators are looking for alternatives to fixing the cost of debt every five years.

"One thing being considered is a floating cost of debt," said Ms Finn. This would be pegged to interest rates during the regulatory period.

"That is something which was suggested in consultation with Ofgem on the financing of utility networks," she said. "We have said we will look at this further with Ofgem."

The proposed measure could be introduced as soon as next year for the owners of the UK's electricity transmission networks, National Grid, ScottishPower and Scottish & Southern Energy. The next price reviews for the water and electricity distribution networks take place in 2009.