Thames Water and the ownership of utilities

Good morning from New Economy Brief.

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Last week, reports emerged that the Government was on standby to put Thames Water into special administration. Despite the initial promise of efficiency and investment following privatisation in 1989, critics argue that Thames Water and other privatised water companies have neglected essential infrastructure upgrades, leading to pollution and mounting corporate debt. With debts reaching approximately £14 billion (roughly 80% of the value of the assets of the business), Thames Water faces the risk of collapse, prompting concerns about the continuity of water and sewerage services for its 15 million customers. While the UK government may step in to manage the company temporarily, many see this as a much needed opportunity to renationalise. 

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In this week’s newsletter, we explore the lessons from Thames Water, the problems with water privatisation and what can (and can’t) be done about it.

A lost three decades? The potential collapse of Thames Water isn’t the first time that water privatisation has been deemed a failure from across the political spectrum. Amid droughts last summer, former David Cameron advisor Camilla Cavendish wrote that it was “time to admit that water privatisation has been a failure”. One of those who actually worked on the privatisation of water in 1989, Jonathan Portes, has called the policy an “organised rip-off”. 

• A list of failures. Whatever your politics, it would be difficult to argue that England’s privatised water companies have done a good job in recent years. According to Ofwat, water companies in England and Wales lost more than one trillion litres of water via leaky pipes last year. Since privatisation, water companies have sold off 25 reservoirs (and not replaced them). And of course, who can forget sewage dumping. In the words of the Environment Agency, the environmental performance of England’s nine water companies is “the worst we have seen for years”.

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Investment has declined since privatisation. Privatisation has failed to deliver what it was supposedly introduced to achieve: increased investment, argues Professor David Hall of the University of Greenwich. In fact, companies have invested “no net additional shareholder funds (equity) since privatisation” meaning that “money has been taken out, not put in”. 

• Debts are climbing. At the beginning of privatisation, all water companies were debt free. Now, however, they are collectively in debt of nearly £52 billion and a large (and increasing) bill for interest. Analysis by Karol Yearwood in 2018 found that any investment that does occur is almost entirely financed through income from customers, “usually with sufficient cash remaining to cover interest payments”. As Professor David Hall argues, companies are essentially getting further and further into debt simply to pay huge shareholder dividends. 

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Who are the shareholders? The privatisation of water has been described as “a cash cow for investment firms and private equity companies”. According to Professor David Hall, English water companies paid shareholders a total of £18.9 billion in dividends from 2010 to 2021. Thames Water alone has paid out a total of £7.2 billion in dividends since privatisation. But who are the shareholders receiving these payouts while failings continue? Well, the answer to this question has been described as “as murky as the water in the river”.

• Overseas investors. Since 2006, Thames Water “has been owned by a consortium of institutional investors, including funds from China and Abu Dhabi”. Infamously, it was managed by the Australian Macquarie Capital Funds, notorious for its “focus on profits”. However, Macquarie sold its shares in 2017, leaving Thames Water “with an extra £2bn debt burden”. Now, the largest share (26%) of Thames Water belongs to Kuwaiti and Canadian investors, represented by the Kemble Water Holdings holding company. This is where it gets murky - there are about seven other intermediary companies between Kemble and Thames Water customers (helpful diagram here). England is unusual in having all of its water companies in private ownership, but most of the beneficiaries of this system are based overseas. Research by the Guardian found that 72% of English water is owned by offshore investors which include “private and state-owned international funds, banks, multinationals and billionaires headquartered outside the UK”. 
• “An experiment in complex financial engineering”. The huge debts we see at Thames Water and other companies may in fact exist by design, not by accident. England has been “at the forefront” of the ‘financialisation’ of infrastructure in which “diverse physical structures have been transformed into financial assets”. According to Kate Bayliss, this can be traced back to the 2000s when “a new kind of financial investor began to dominate the [water] sector”. By 2021, nine out of 15 English water and sewage companies were owned by “special purpose companies”. These investors, made up of private equity funds, pension funds and sovereign wealth funds, have been able to generate significant shareholder returns by “hiking up debts”, Bayliss argues. Increased debt has been used to refinance water companies “so that investors could repay themselves part of the original cost of buying the water utility”, she explains. However, a “perfect storm” of inflation, high interest rates and pressure to improve performance mean that the high levels of debt we see now, as in the case of Thames Water, are becoming increasingly unsustainable.

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So, what now? It is possible that the shareholders of Thames Water could bail out the company. But failing that, the government will have to step in in some way. One option is that Thames Water will be put into special administration, a power outlined in the Water Industry Act 1991 which can be used when a private company is on the brink of collapse. This would enable the company to carry out its functions and provide a public service until either being transferred to another private company (in the case of Bulb in 2022) or into public ownership. 

• Renationalisation? Many view the current situation with Thames Water and the apparent failure of privatisation more generally as an obvious case for renationalisation. Of course, public ownership would eliminate profit motives and dividend obligations. However, this isn’t necessarily so straightforward. Opponents of renationalisation argue that taking Thames Water into public ownership would require transferring corporate debt onto the government's balance sheet, which some would argue is unfair for taxpayers to foot the bill and pay the debts incurred under poor management. Additionally, the administration process typically involves asset sales to repay debts, but in the case of a water company, the integrated and complex infrastructure makes breaking up assets impractical. Buying the assets from the shareholders would entail an enormous cost, necessitating adequate compensation for existing shareholders, including pension funds.
• Reducing the costs to the Treasury. Think tank Common Wealth argues that the answer to this problem lies in the 1991 Water Industry Act. Under the act, they argue that the government could trigger special administration proceedings and use these to facilitate the transfer to public ownership: “the special administration procedure enables secured debts to creditors to be reduced, subordinated, or removed, where they would not be “consistent with the purposes of the special administration order”. Such an order’s purposes include ensuring a water company’s “functions... may be properly carried out” such as stopping leaks or pollution. This will reduce or eliminate the cost of transfer to public ownership.”
• Regional ownership. Nationalisation does not have to mean direct ownership by central government. All three failing water companies (Southern Water, South East Water and Thames Water) could be taken into special administration but then, instead of being renationalised, could be “transferred into public ownership under the councils in the region as the first regional publicly owned water company”. 
• Enforcement. The Water Industry Act 1991 also enables ministers and regulators to issue enforcement orders to control the company’s behaviour. They could order the company to pay down debts, restructure, reduce payouts or keep bills down. Critics of this approach argue that this is essentially renationalisation but without the same level of accountability. 
• Let it go bust. Some have suggested that the government could let Thames Water go bust and take it back into public ownership then. However, this would have profound implications for customers and as the Guardian’s Environment Correspondent Sandra Laville explains, is “simply… not allowed”. 
• The Welsh model. Academics Robert Branston and Phil Tomlinson propose that Thames Water follows the “unusual” example set in Wales. “Welsh Water has a unique corporate structure, with no shareholders and is run solely for the benefit of its customers. It is commercially run, with professional managers held to account by 62 independent trustees. While not perfect, its performance in recent years compares favourably with that of the other privatised water companies”, Branston and Tomlinson argue. They admit that creating such an organisation “would not be easy” but does have a precedent in the case of Network Rail “which was created when its commercial predecessor Railtrack went bust”. Railtrack’s debts were subsumed into Network Rail and underwritten by the government. Branston and Tomlinson explain that “while it is true that these public-interest companies are funded by debt, a government debt guarantee helps keep the costs of servicing this debt down (while costing the government very little)”.
• Regulation and social purpose. Purposeful Company co-chair Will Hutton argues that through good regulation, water companies like Thames Water can deliver social purpose while remaining in the private sector. “The sunshine of accountability” could ensure that Thames Water gets serious about its environmental responsibilities, invests properly and banishes “opaque ownership structures”, says Hutton.

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Lessons from Thames Water. You’d be hard pressed to find anyone who could enthusiastically defend the record of water privatisation over the last 34 years. As the climate crisis worsens and debt becomes more expensive, reforming the water sector so that investment is put before shareholders has never been more urgent. The legacy of years of privatisation can be difficult to unravel, with high debts and the need to make up for historic deficits in infrastructure investment both providing significant barriers to action.

• Funding the future. Ultimately the question of how necessary future infrastructure upgrades will be financed is the long term challenge facing the sector. Common Wealth argues that if the industry remains in private hands, even with additional stakeholder responsibilities, bills will rise significantly. This is because such capital demands a return, and this return can only be extracted from consumers. In contrast they argue that the public sector can borrow for upgrades at lower rates, making public ownership “a cheaper and more strategic mechanism to fund the water industry’s future”.
• Voice and value. But who gets a say in the industry's future is also a vital question. For example newly renationalised water companies could be structured so that consumers, workers and other stakeholders are represented on the board as with the newly remunicipalised Eau de Paris in France (where bills fell by 8%). This would end the domination of shareholder interests, which has arguably led to the current mess in the industry.