Is infrastructure at risk of a doom loop? Lessons from the water sector

The UK’s water sector is experiencing mounting financial strain, highlighting broader risks for infrastructure sectors.

The sector urgently needs increased investment due to a combination of aging infrastructure, rising environmental pressures, and stricter regulatory requirements. At the same time, gearing ratios in the sector have continued to rise for two decades, so equity must be the marginal source of financing due to already exhausted balance sheets [See A Step change in UK infrastructure].

Ofwat has responded, by doubling expenditure allowances to £109bn for AMP8 (2025-2030), and increasing the allowed weighted average cost of capital (WACC). However, if these incentives do not attract sufficient equity investment, the sector could spiral into a doom loop—where rising costs and underinvestment lead to deteriorating service quality, higher consumer costs, and increased financial instability.

PR24: Further details

The UK’s water sector is the first regulated industry to significantly expand its capital program under PR24, reflecting urgent investment needs. However, financing this investment is increasingly complex due to high gearing ratios and rising interest rates. The sector’s debt-to-equity ratio has climbed over the past two decades, making it more vulnerable to economic and regulatory shocks, while making further fundraising reliant on equity.

In response, Ofwat has introduced:

• A doubling of allowed investment from £51bn (PR19) to £109bn (PR24).
• Higher maximum performance penalties, increasing from £1.44bn to £2.27bn.
• A higher WACC, rising from 2.96% (PR19) to 4.03% (PR24), reflecting new market conditions.

Despite these measures, structural risks remain. The water sector may be trapped in a negative feedback loop if:

1. Cost of equity (CoE) does not accurately reflect future risks, under-incentivizing equity investors
2. Under-investment, leading to worsening asset conditions and service disruptions
3. Consumer outcomes decline, as operational failures increase
4. Equity risk rises, reinforcing financial instability and making future equity financing even more unattractive

These issues are not confined to water alone. Other regulated infrastructure sectors, such as energy and rail, face similar investment challenges. With Ofgem’s RIIO-T3 (2026) and RIIO-ED3 (2027), and ORR’s PR8 (2027) on the horizon, these sectors must prepare for potential regulatory and financial recalibrations.