Thames Water is in a mess, primarily of its own making. And next month looks like crunch time for the future of the beleaguered utility company, which provides water and sewerage services to 16 million customers across London and beyond.
On 17 December, Thames will seek High Court approval for a £3 billion emergency financing deal to keep it alive. Two days later, water industry regulator Ofwat will hand down its verdict on how much the company should be investing over the coming five years, and how that will be paid for.
Thames is mired in both financial and operational crisis. The company owes a staggering £16 billion, with only enough cash in the bank to last until next summer. It’s also struggling with the day job, the most prominent example being the large amounts of raw sewage it’s regularly pumping into London’s waterways. One report suggests £23 billion-worth of its assets are in urgent need of repair. So what will this month’s decisions mean for the capital?
One thing is certain – bills will go up. Thames’s latest pitch to Ofwat as the regulator finalises its five-year settlement with the water companies, agreeing spending levels on services and infrastructure investment as well as setting charges to customers, is for a hike in the annual household bill from today’s £436 to £600 by 2030.
Ofwat’s draft proposals would limit that increase to £535. But Thames continues to argue the point, and industry observers expect some movement next month. The company may then appeal to the final arbiter, the Competition and Markets Authority. Whatever happens, customers can expect to pay more. And the outcome could determination whether the company continues to exist.
If the £3 billion bailout Thames wants is approved, it will provide the breathing space for a more permanent restructuring. But Ofwat’s current proposals, on bills and on returns to investors, would not, according to chief executive Chris Weston, allow Thames to raise enough cash. In fact it would “prevent the turnaround and recovery of the company,” he has said.
Ofwat boss David Black outlined to MPs earlier this week at a Commons Environment, Food and Rural Affairs committee hearing, his vision of a restructured and refinanced business, ready to “take responsibility for turning operational performance around”. But without an improvement on Ofwat’s currently proposed 3.72 per cent return to investors, that might be hard to achieve.
It’s a tricky balancing act. Overall, Ofwat wants the water companies to triple investment to £35 billion over the next five years to tackle sewage spills and upgrade water mains, as well as addressing future supply needs. But it also has to protect customers, who have nowhere else to go, from unreasonable price hikes as well as allowing enough of a return to keep investors on board.
Thames, along with the industry as a whole, says the regulator hasn’t got it right, keeping bills too low for too long. That has a knock-on effect on the company’s capacity to sort itself out and improve its performance, they say.
This time round, for example, Ofwat plans to cap Thames’s 2025-2030 spending at £16.9 billion rather than the £19.8 billion requested, while continuing to tighten performance standards and limit investors’ returns. A lot of cash needs to be raised, but will Ofwat’s position make that more difficult? As one commentator noted, alternative investments such as UK gilts currently offer better returns, “without the hassle of fixing the water network”.
Thames Water isn’t flavour of the month, and letting investors take higher returns won’t be popular. However, as Black told MPs, it was clear when the companies were first privatised that debt, as relatively low-cost source of financing, was going to be in the mix when it came to boosting investment. Without that investment, Londoners may find that the pollution problems which have provoked so much anger in the capital won’t be fully fixed any time soon.
So far, Ofwat is sticking to its guns. It has declared Thames’s 2020 to 2025 business plan “inadequate” and argues that the proposed 3.72 per cent return will allow the company to “attract the borrowing and equity it needs to deliver a step up in performance”.
What if Thames Water doesn’t survive? If that happens, not many tears will be shed, and Black seemed relaxed about the prospect. “The regulatory regime always anticipated that a company might fail. It’s not Ofwat’s responsibility to stop companies going bust,” he told MPs.
The regulator’s role, he went on, is to protect the customer: “That’s the test – that even though the company fails, customers still get service and ultimately there will be a new or turned-round company stepping into the situation. We are confident we can manage that.”
The previous government was apparently drawing up plans for that final step – effectively renationalisation – to keep the taps from running dry. But Labour seems less keen on an option which would inevitably mean additional costs and a significant debt burden transferring to Whitehall.
Its focus is its new law, curbing bonuses and tightening up on pollution monitoring, and on its wide-ranging review of water sector regulation, launched last month, which has the aim of delivering a “sufficiently robust and stable regulatory framework to attract the investment needed to clean up our waterways, speed up infrastructure delivery and restore public confidence in the sector”.
What might a reformed water sector landscape look like? Black had some advice: the companies need to set long-term goals, invest more, improve their governance and demonstrate, he said, “how they can make decisions in the interests of consumers and the environment”. Would that make them more like the stock market-listed public companies they used to be, reformed in the way some observers have suggested in return for a better deal from Ofwat?
It remains to be seen whether Thames Water in its present form will be around to play a part in this or how long it might take any new entity that emerges from its ashes to improve performance. All we definitely know, given that Thames has no source of revenue apart from its customers, is that directly or indirectly, it will be us who pay.
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How the company reached this point brings to mind the famous exchange in Ernest Hemingway’s novel The Sun Also Rises:
“How did you go bankrupt?
“Two ways. Gradually, and then suddenly.”
David Black gave MPs a helpful potted history. In 1989, the water companies were sold off debt-free. But what were originally “low risk, low yield” companies, listed on the stock exchange, were progressively taken over by private equity firms wanting higher returns.
Thames fell under the control of Australian bank Macquarie in 2006. During its 11-year stewardship it was able to take advantage of a regulatory regime which allowed debt to rise, while investors benefited from high dividend returns – around £2.7 billion, by some accounts. When Macquarie pulled out in 2017, the company’s debt stood at £11 billion and has continued to grow.
In a detailed rebuttal of the criticism widely levelled against it, Macquarie disputes the £2.7 billion figure, saying it includes “movements in inter-company accounts”, with payments to shareholders amounting to £1.1 billion of that total. It argues that Ofwat had encouraged the water companies to raise debt to fund vital investment and all the conditions set by the regulator had been fulfilled.
Post-Macquarie, with interest rates and costs soaring, Thames’s debt proved unsustainable and the situation came to a head. “They’d tried unsuccessfully to turn themselves around in recent years and that has reached a point where the current owners have refused to invest further in the business,” Black told the committee. In March, shareholders pulled the plug on a promised £500 million injection, saying the company was now “uninvestible”.
Macquarie has taken most of the flak, but Ofwat doesn’t come out of the saga well either. Its regime encouraged companies to take on significant debt while, arguably, under-policing what was happening with all that investment and relying too heavily on credit ratings for assurance. “Thames Water took it too far,” said Black. If a similar situation arose today, he added, “Ofwat should intervene earlier”.
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The problem is not debt, but the fact the debt was used to fund lavish dividends to the investors rather than capital investment, which was clearly a failure of oversight.