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19 June 2023

“We need water companies that are fit for purpose”: the CEO of Ofwat on regulating England’s polluted rivers

After a decade at Ofwat, David Black remains optimistic that the industry can somehow be encouraged to stop pumping sewage into Britain’s waterways.

By Will Dunn

David Black is not a wild swimmer, a fisherman or a surfer; he prefers, he admits, “more land-based” pursuits such as cycling and walking in the Surrey Hills. A couple of years ago he hiked the Dales Way, which runs for a section alongside the River Wharfe, where in 2019 locals successfully applied to have a popular bathing spot designated as the UK’s first river bathing site. The extra testing required by the designation quickly confirmed that water quality in the Wharfe was “poor”, meaning it does not meet minimum standards for bathing safety. This was not news to campaigners, who had collected extensive evidence of human faeces, wet wipes and sanitary towels flooding into the river from Yorkshire Water’s storm overflows.

The public outcry at the state of the Wharfe is part of a pattern that has been repeated across the country in recent years, and it is partly a result of decisions taken in the last decade by Ofwat, the water regulator, of which Black is the chief executive. “We’ve been requiring companies to put in place more monitoring equipment over the last seven or eight years,” Black explains. Now that the data is becoming available, he says, “their performance is more transparent than it’s ever been before”. It is thanks to this data collection that we now know that raw sewage was pumped into English rivers and the sea 825 times a day, on average, in 2022.

England and Wales are the only countries to have sold its entire water supply and sewage treatment infrastructure to private companies. Privatisation was enacted by the Thatcher government in 1989 in an attempt to avoid the cost of the EU’s new environmental standards being paid by the state. As it turned the regional water boards into private companies, the government also set up Ofwat to oversee their responsibilities to consumers and the environment.

David Black has been at Ofwat for more than a decade. He grew up in New Zealand, where he trained as an economist and worked at the Treasury. He moved to the UK to work for the telecoms regulator, Oftel, and joined Ofwat in 2012; he has been the regulator’s chief executive for the last two years. Ofwat has live investigations into six of the ten major water companies, and is seeking new powers to regulate them. Its success as a regulator has been questioned, however; in March the House of Lords Industry and Regulators Committee found that “Ofwat has failed to ensure companies invest sufficiently in water infrastructure”.

[See also: Sewage map shows potentially illegal “dry spills”]

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“We don’t see it as our role to defend the industry,” Black told me as we spoke in Ofwat’s offices overlooking the Thames in Canary Wharf, although he added that “we are concerned that there are sometimes misunderstandings” between the public and an industry that has paid tens of billions to its shareholders while hosing excrement into the nation’s waterways.

One such misunderstanding, he says, is the widely cited observation that water companies have reduced investment in sewage networks by hundreds of millions of pounds a year since the 1990s. “There has been some underspending by water companies, but it’s been relatively modest, actually,” Black said, explaining that the methodology in Ofwat’s price reviews (conducted every five years; the next price review will be completed in 2024) has changed, as has the funding model used for the biggest investment to date, the Thames Tideway super-sewer. “If you just compare numbers over time, you don’t always draw the right conclusions,” he said.

This is an odd thing for an economist to say; comparing numbers over time is most of the job, although the numbers can become inconvenient. In 2018, for example, Greenwich University’s public services research department compared investment made by water companies with their profits over decades, and found that it would have been possible to fund their capital investments entirely from their profits. They hadn’t, though; in fact, companies had borrowed vast sums – the industry as a whole is more than £60bn in debt – and paid out an even greater amount (more than £65bn so far) to their shareholders.

“We had a number of problems with that research,” Black responded, observing that the report was written “by a PhD student”. But he agrees that in principle, dividend levels have been unjustifiably high. “In some cases, companies have increased their debt levels to pay dividends… That’s not the right thing to be doing. They need to change that.”

It’s for this reason that Ofwat recently announced that it will prevent water companies paying dividends if their “financial resilience” is not sufficient. It’s a drastic new power for an increasingly drastic situation. Water companies are monopolies, given assets at knock-down prices by the government (which also cleared the old water boards’ debts when they privatised them), but despite this almost unbreakable business model they have managed to make themselves precarious. Eight of the 17 major companies operating in England and Wales have finances that are of “elevated concern” or are in need of immediate action, according to Ofwat. More than half of their immense debt pile is index-linked, meaning it grows at the rate of inflation (as measured by the retail price index, which reached 14.2 per cent in October).

How long will it be before – as has happened repeatedly in the deregulated energy sector – one of England’s water companies has to be rescued, leaving the rest of us to foot the bill? Black conceded that some companies “have financed themselves with significantly more debt” than is appropriate, and that “we are very clear that the finances of those companies are not where we expect them to be, or we would like them to be”, but again he was keen to keep things positive: shareholders at Southern and Yorkshire Water have injected a billion pounds; Thames has chipped in half a billion.

It is unclear how investors would ever be persuaded to accept lower dividends, however. The whole point of buying shares in utilities is that, while they will never grow in tradeable value like a tech stock, they will make strong, predictable profits and return a decent amount of those profits to shareholders via dividends. “It’s supposed to be a boring, low risk, low return business,” agreed Black.

Changes in the environment mean the water business is becoming anything but boring, however. Britain’s sewers are overflowing, much as our A&Es are overflowing, not only because they have been starved of investment but because the systems that connect to them have also been mismanaged and underfunded. Transport is one example: the UK adds around 2,500 miles of new roads and paves over about 1.5 million front gardens each decade. London alone tarmacs an area more than twice the size of Hyde Park each year to provide new parking spaces. The water runoff from all this hardened ground is too much for sewers that were built in another century, when the land was more absorbent, there were fewer people and no washing machines. When it rains they are overwhelmed and the combined sewer overflows (CSOs) have to open. In Yorkshire 50 such outlets open directly into the River Wharfe. In London CSOs send around 39 million tonnes of untreated sewage a year into the Thames.

As climate change makes extreme weather more regular, companies will no longer be able to delay investing in the kind of upgrades that should have been done in the past. Investors will need to be persuaded to pay the upfront cost, but “over time, those costs are going to be recovered from customers”.

[See also: Sewage, spills and shortages: why UK water companies have failed]

In a time of profound environmental, demographic and economic change, it is more important than ever that Ofwat becomes a muscular, interventionist regulator. It will have to ensure that companies change too, in ways their past performance suggests will not be welcomed by their investors.

Does Ofwat have what it takes, or is it – as is said of many regulators – too close to the industry to really be effective? Before our interview, I compiled a list of 27 former Ofwat employees who now hold senior positions in water companies, including the directors of strategy and regulation at Yorkshire Water, Severn Trent, Thames Water and South West Water. Black’s predecessor, Rachel Fletcher, left to take up a new job with a utility company in a sector (energy) that she previously regulated; Ofwat’s former chairman, Jonson Cox, was the former CEO of Anglian Water. There is no suggestion that these people have done anything improper – but can Black ensure Ofwat’s regulators negotiate forcefully with the industry when they’re often speaking to future colleagues? Black wasn’t a fan of this question – he called it “a cheap allegation” – but he argued that having people with experience of regulated sectors is important to understanding the companies they’re regulating.

Perhaps Ofwat employees would stay longer if they weren’t able to secure such large salaries elsewhere. Last February Black wrote to the remuneration committees of major water companies warning that Ofwat would be paying close attention to executive pay, but it doesn’t seem to have worked: top executives at the ten major water companies trousered an average £1.1m last year (a 20 per cent pay rise). Liv Garfield at Severn Trent (which was fined £1.5m for dumping hundreds of tonnes of effluent into a stream) was paid £3.9m. Susan Davey, CEO of Pennon Group (which owns South West Water) was paid £1.6m last year. South West Water leaked 90 million litres of water a day in 2021-22 and sewage pollution incidents were almost four times over target, as they have been every year for the past decade; its customers are currently restricted by hosepipe bans despite the wettest March for 40 years.

Last year the Environment Agency released a statement in which it argued that water company executives should face prison sentences if their companies continue to pollute severely. “I’m not sure it would make a substantial difference,” Black said when I asked if he agreed; he considers that “demonising individuals isn’t actually helpful”. He does, however, think that having “the power to bar directors from getting involved in managing other water companies, or the same water company in future”, would be “a useful addition to our toolkit”.

Throughout our conversation Black remained determined to see the bright side. He noted, for example, that while the public has lost faith that private companies will deal responsibly with sewage, “trust in companies to provide safe drinking water is much higher”, as if the ability to confidently drink tap water, 130 years after the last reported case of cholera, was some sort of achievement.

For Black, the 2021 Environment Act is the “game changer”. The financial and environmental crises in the water sector are “the birthing pains of a new set of arrangements, in terms of companies acting in a more responsible way. I think they are starting to get it.” Black is clearly committed to that turnaround; his expertise and his enthusiasm for the economics of utilities are obvious. “What we need to see is a water company that’s fit for purpose”, he said, “and that’s going to require changes in the way water companies are run.”

But even after a decade regulating the water industry – a decade in which no other country has followed England’s example, and in fact many have “remunicipalised” water services – his core belief remains that the interests of private capital and public services can, in this sector, be reconciled. Perhaps a dip in the river would help.

[See also: “I put 7,000 oysters in the skip”: the fishing industry fights for survival in polluted waters]

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