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Running a water utility, a natural monopoly that provides an essential service to its captive market, should not be a difficult task. When England privatized its regional water companies, starting with zero debt, it seemed like the perfect opportunity. However, three decades later, investors have burdened the sector with debt and extracted billions in dividends, while the infrastructure deteriorates and public frustration grows due to leaks and sewage discharges. The news this week, stating that the government is prepared to temporarily take over Thames Water in case of a potential collapse, is a clear indication that the privatization experiment has failed.
Thames Water presents a particular problem. Years of poor performance, combined with the rising costs of servicing its £16bn debt (partly inherited from its previous ownership by Macquarie, an Australian company that sought substantial returns), have left Thames Water unable to finance all of its projected expenses in the coming years. Approximately half of its debt is linked to an inflation measure higher than the one used to calculate its bills.
Raising additional debt is challenging, so Thames Water expected its current owners to contribute. However, equity shareholders, comprising foreign and domestic pension funds, and sovereign wealth funds from China and Abu Dhabi, have only provided £500mn out of an expected £1.5bn. They are understandably hesitant to invest more money into a failing enterprise, resulting in a standoff.
The government will undoubtedly be reluctant to take Thames Water under public control, as this would impose costs on taxpayers and losses on shareholders, including UK university pensions and foreign investors that the government relies on for other infrastructure projects. Nevertheless, a resolution is necessary.
Thames Water is the most debt-laden company in the sector, but the regulator Ofwat expressed concerns about the resilience of four other suppliers in December last year. The root cause of the sector’s troubles is that what should be simple businesses became playgrounds for financial engineering. The predictable revenue streams of water companies made them attractive to leverage and enticing for buyout funds. Nearly all of England’s originally publicly-quoted water companies have been taken off the market, except for three (Scotland and Northern Ireland remain in the public sector, and Wales now operates as a not-for-profit entity).
Companies and the regulator argue that privatization has resulted in significant efficiency gains, keeping bills lower than they would have otherwise been. Ofwat claims that investments have roughly doubled. However, buyers often employed complex structures to maximize leverage and minimize tax, and these companies have paid out over £72bn in dividends. Consequently, a sector that was debt-free three decades ago now has accumulated debts of £60bn, while environmental standards were poorly enforced for a long time.
Few countries have followed England’s Thatcherite experiment with full privatization of water supply. Currently, changing the ownership model would be challenging and costly, unless these businesses start failing. However, their management and supervision require a comprehensive reevaluation. Ofwat has already updated its rules this year to ensure that companies align their dividend policies with performance for customers and the environment. It should be granted additional powers to monitor balance sheets, financial structures, and overall financial health. Considering a cap on leverage would also be prudent.
Ultimately, it is the customers who bear the costs of past mistakes, as well as the expenses related to meeting stricter pollution targets and adapting to climate change, through increased bills.
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