Leading provider of credit ratings, Moody’s Investor Services, say changes to the way price limits are set in the UK have the potential to increase credit risk in the UK water sector. Regulator Ofwat published a consultation document in November 2011 describing how it might set price limits from the start of the next regulatory review period in 2015.

Neil Griffiths-Lambeth, a Moody’s Credit Officer said that despite the potential benefits for customers, the changes could make investors less keen to invest in water companies: “The proposed reforms contain elements which could be credit negative for the sector.”

Ofwat is considering a number of possible changes to the regulatory framework which includes more direct incentives for water companies and disaggregated price limits.

However, Mr Griffiths-Lambeth said the changes could hurt smaller companies: “Proposals to set retail price limits by reference to the average cost to serve could prove very expensive for less efficient companies.

“In addition, the proposed focus on ‘outcomes’ rather than ‘outputs’ and having performance measured against regulatory targets will challenge UK water companies. As a result, ratings may, in future, diverge outside of the current narrow range based on operational performances.”

Moody’s report also notes that the UK government’s proposed reforms introduce uncertainty that is credit negative for a sector that has to date been regarded as one of the most stable and predictable.