For the third in our series on bad habits to ‘kick’ in 2010 (if you’ve missed them so far, you can also read part 1 and part 2) I’m considering whether, 20 years after privatisation, the UK water utilities can adjust to austerity.

At the time of water company privatisation great store was placed on the increased benefits both in terms of cost and improvement in service to customers and consumers. The new regulators would put pressure on the companies to deliver a more efficient service and yet still maintain control over the ability of the companies to increase prices above acceptable levels. Clearly benefits to shareholders were also used to encourage investors to the companies which at the time might otherwise have been seen as facing an uphill battle to overcome the stigma that had been applied to the UK as the ‘dirty man’ of Europe.

Since then the water companies have spent many tens of billions of pounds to rectify the problems of the past under increased quality and environmental regulations. One might have expected that such crippling demand to invest in new capital would have had an effect on the companies’ ability to deliver good profits to shareholders. To the contrary, both profits and dividends have held up very well (consistently above the FTSE 100 average performance). Together with the capital growth, especially just after privatisation, I suspect most long-term shareholders are very happy with their investment.

How did the water companies manage to achieve this ‘magic’? The answer is that they didn’t spend their own money to fund their capital programme. Many manage huge debt mountains that simply couldn’t be maintained by other private sector companies trading elsewhere in the open market. Additionally water companies with large capital programmes that they could deliver at a lower cost than agreed with Ofwat were allowed to drop this ‘profit’ straight through to the bottom line. It was this ability that allowed them to deliver large profits whilst building significant levels of debt. Reminiscent of the current banking crisis, the true cost of the UK water sector’s post-privatisation capital programme will in fact be borne by our children and grandchildren. The current generation of water and wastewater service consumers are in effect only paying the interest on that debt.

After 20 years opportunities to make profits from this debt continue. It’s now the start of the ‘reporting season’ for the water companies. Alistair Gray in the Financial Times (hardcopy 21 May 2010; online edition 20 May 2010) reiterated my above points: ‘The industry enjoyed a good run in the most recent regulatory period; profits were higher than expected as companies were able to borrow at lower rates than had been assumed by Ofwat‘.

United Utilities, the largest of the listed water companies – and the one almost certainly with the largest debt mountain – has also recently reported an increase in profits. Philip Green, UU’s Chief Executive, confidently stated: ‘This is a sound set of results in a tough economic climate, reflecting our strong focus on cost management and efficiency improvement‘. But you’ll notice there’s no mention of debt interest there – and yet if interest rates had gone against the company’s projections I’ve no doubt it would have been quickly shouting from the rafters for a new settlement from Ofwat…

Understandably these massive (water) corporations established at privatisation had to develop good financial governance. However their continued ability to generate sizeable profits from ‘winning’ arguments with the economic regulator seems a very poor business model to perpetuate into the future. It is one that serves only a narrow set of stakeholders’ interests. It also seems especially crass when the UK, Europe and other countries worldwide are entering into a period of great fiscal stricture.

It could be said that the UK water utilities have so far had 20 years of  plenty. I only hope for their sake – and ultimately for ours as the consumers that support them – this doesn’t flip into 20 years of famine!

Update (15/11/2016): Featured image added from this source.

Roger Ford

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