Using Oxera’s bespoke financial model developed for the Environment Agency, Oxera modelled several hypothetical scenarios for the potential price limits at the 2004 price review of the UK water sector. The model provided a useful and easy-to-use tool for a detailed examination, at the aggregate industry level, of several scenarios regarding the main building blocks (eg, operating expenditure efficiency, capital expenditure, depreciation, and the cost of capital).
In particular, the model assessed the possible impact on price limits of different levels of water quality and the environmental improvement programme. The future prices modelled in the scenarios were particularly sensitive to the cost of capital assumption in the model. Although financeability considerations were not explicitly modelled, this also illustrates the impact, in setting price limits, of potential adjustments to the allowed rate of return to reflect financeability considerations.