This is a crucial week for the water industry.
Regulator Ofwat will make its “final determination” on Thursday on how bills will rise over the next five years.
Before that, Britain’s largest company Thames water hopes to gain court approval for a £3bn bridging loan to avoid running out of cash in the spring.
Together they constitute the biggest test of the water system, the only fully privatized network in the world.
To understand how we got here and what might happen next, it helps to go back to the beginning.
In 1989, 10 regional public water and sewerage companies in England and Wales were sold by Margaret Thatcher’s government, raising £7 billion for the Treasury. The companies were sold debt free, but never intended to stay that way.
The logic was that the private sector could raise the billions needed to upgrade Victoria’s sewerage system and finance it from customer bills, so the state didn’t have to do it.
So borrowing was always part of the plan and, since this year, companies have accumulated £70bn of net debt, with a gearing ratio of around 85%.
In the water sector, the problem with debt is not the total amount, but whether companies can afford to service it and what they have done with the money.
The answer to the first question varies between operators, but water companies have invested billions in infrastructure and other investments. Adjusted for inflation, investment amounted to between £4bn and £9bn last year, a total of £210bn at today’s prices, spending which helped reduce leakages and improve water quality according to certain measurements.
But it has not been enough to meet public expectations for basic services, wastewater control or to meet the challenges of climate change and a growing population. To cite just one example, the UK has not built a new reservoir since 1992.
At the same time, company shareholders extracted dividends of £83 billion (as calculated from Ofwat figures by the University of Greenwich and adjusted for inflation).
But like debt, dividends are a deliberate part of the privatized system. Investors in any industry need to make a profit.
Water UK, the companies’ trade body, says that since 2020, when the regulator started paying more attention to payments, dividends have averaged 2.7%.
The level of dividends and executive bonuses has become more difficult to defend with the emergence of the water industry’s dirty secret; waste water outlets.
These occur when pipes shared by sewage and stormwater are flooded and, as a safety measure, are deliberately discharged into watercourses through storm overflows to prevent sewage from backing up into the homes and businesses.
For decades, the extent of their use remained unknown, with industry, regulators and the public in the dark due to a lack of oversight. This has changed over the past decade, with comprehensive monitoring of almost 15,000 overflows in England revealing more than 460,000 wastewater discharges in 2023.
Sewage discharges have sparked controversy. File photo: iStock
Public outrage has pushed the issue to the top of the political agenda, increasing pressure on businesses.
The water industry can boast some success in improving water quality since privatization, with phosphorous and ammonia levels reduced and 85% of bathing water classified as “good” or “excellent” by the Environment Agency.
But none of them are found in rivers, where wild swimming and the public activism that accompanies it are a recent phenomenon. And as public expectations for water quality increase, so do costs.
The challenge for the industry is that the cost of resolving disaster – whether physical, financial or on its own – has become higher.
Water was once a haven for long-term investors who enjoyed reliable returns from monopolistic suppliers of a critical resource. For many years, the water sector has benefited from a “halo effect”, with lower borrowing costs than other industries.
This chart shows water sector bond yields, effectively the interest rate on their debt, compared to an index of other UK corporate bonds. While borrowing costs for everyone have increased following the surge in global inflation in early 2022, water has remained cheaper.
In July 2023, after the scale of the crisis at Thames Water became apparent, the lines were crossed and water debt became more expensive. Water now comes with a premium, which will increase to almost a percentage point by the end of this year.
And it’s not just the Thames. Rating agencies have downgraded several water companies, damaging confidence across the sector. Every firm is facing higher borrowing costs, from listed firm Severn Trent to struggling Thames, which is trying to secure terms for a £3bn bridging loan at a rate breathtaking 9.75%.
To cope with these rising capital costs, water companies are now arguing that Ofwat should not only let them increase their customers’ bills, but that investors need a better return for committing money to the sector.
Luke Hickmore, investment director at abrdn, part of Thames Water’s creditors group, said: “Water companies are facing a significantly higher cost of financing while seeing a growing need for infrastructure investment. to maintain water and sewer systems.
“Investors have placed a risk premium on the entire sector due to uncertainty over the ability of the regulatory framework to meet this increased investment need, and this decline in confidence has accelerated since the draft of Ofwat’s determination in July.
“Weaker and more indebted companies have suffered more, just as many are seeking additional capital to meet customer and environmental needs for the next five years and beyond.
“These financial stresses and deteriorating investor support translate into a higher cost of borrowing, which ultimately trickles down to customer bills. »
All this means your water bill is about to go up, although it depends on where you live, and unlike other privatized utilities, you can’t switch services.
In July, Ofwat said bills could increase by 21% on average to fund £88bn of spending, but water companies are I am now asking for 40% to cover an investment of £107 billion.
Wherever Ofwat draws its line, it will be the biggest bill rise since privatization. For decades the regulator and politicians have focused on affordability, leaving bills lower in real terms today than they were a decade ago.
But it is clearer than a wave of chalk that this approach has created problems, and whether mismanagement, corporate greed, lack of regulation, political indifference or the very principle of privatization are to be blamed. , the industry is facing a critical moment.