Severn Trent Wants Water Regulation to Allow for Deflation Risk

Severn Trent Plc, the U.K.’s second-biggest water company, wants the regulator to make provisions for a potential extended period of deflation when it rules on utility spending plans.

“We’ll be putting forward a plan that says maybe they should make an allowance for deflation,” Tony Ballance, the director of regulation and competition for Severn Trent, said in an interview in London yesterday. The market would struggle with two successive years of deflation, he said.

Falling consumer prices are a risk for utilities because they would reduce their allowed income without curbing costs in areas such as remuneration to the same extent. They may also increase financial ratios for debt, according to Ballance. The water companies’ spending and revenue is determined by the regulator in five-year plans, the next of which starts in 2010.

“The market fears sustained deflation,” Lakis Athanasiou, an analyst at Evolution Securities Ltd. in London, said yesterday in a telephone interview. If there’s prolonged deflation “you start having some very big problems.”

The regulator already has “a number of tools available” in the event a company is unable to finance its operations or deliver services, Regina Finn, the chief executive officer of regulator Ofwat, said in an interview. “The businesses are reasonably robust to short-term deflation.”

‘Substantial Effect’

Ofwat is able to reopen its regulations if there’s a “substantial effect” on businesses caused by factors such as deflation, Finn said. In any case, “these companies are really quite robust, solid investment prospects for the future and we think that they can withstand the current climate,” she said.

Ofwat said in December the U.K. water companies needed to reduce their capital spending plans for the five years starting 2010 from levels set out in draft proposals because they exceeded its expectations.

Severn Trent has done “a lot of work since the draft to scrutinize our plan,” said Ballance. It’s deferred some proposals and removed other projects to produce a “better, more robust plan,” he said. United Utilities Group Plc, the largest U.K. water company by market value, also said yesterday it will reduce plans for capital expenditure.

Severn Trent is confident it will be able to finance the projects that it’s proposing, Ballance said. “We’re well funded through the next couple of years, so raising money to invest is not a problem in the short term,” he said.

To contact the reporter on this story: Paul Dobson in London at pdobson2@bloomberg.net

To contact the editor responsible for this story: Stephen Voss at sev@bloomberg.net

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