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28 March 2024

Who killed Thames Water?

Britain’s biggest water company is at risk of insolvency, and there is plenty of blame to go around.

By Will Dunn

Shareholders in Thames Water, the largest and most indebted of the private companies that supply Britain’s water and sewerage services, have withdrawn from a plan to invest a further £500 million investment in the company. Thames had been seeking higher bills and lower penalties from the regulator, Ofwat, but now say they see the company as “uninvestable”. The government has reportedly drawn up plans for its insolvency – a process that would, like the rescues of Britain’s privatised and deregulated energy companies, come at huge cost to the public. Who’s to blame?

Sajid Javid

He’s not an obvious suspect, but during his brief stint as chancellor, Javid made one very consequential decision: in 2019 he ignored the UK Statistics Authority (UKSA)’s strong recommendation to end the use of the Retail Price Index (RPI) as a measure of inflation. RPI is a wrong, old measure that overstates inflation by multiple percentage points, but Javid’s response to the UKSA was that he’d get round to it in 2030, once we’d made a success of Brexit. (He left the Treasury five months later.)

Thames Water is £16.5bn in debt, according to the latest recent regulatory filings, and most (57.6 per cent) of this is linked to RPI, which peaked at 14 per cent in 2022 and remains at 4.5 per cent. However, for raising bills it is only allowed to calculate inflation using the newer, more accurate CPIH inflation measure (currently 3.8 per cent). This helps tip the scales towards an ever higher ratio of debt to earnings.

Australian investment managers

Who borrowed all that money in the first place, and what did they buy? In 2006, Thames Water was failing to meet many of its objectives under its German owner, RWE, so it was sold to the Australian investment company Macquarie for £8bn. When you’re buying a large company there’s no need to pay for it entirely with your own money. You can issue debt, which then becomes your company’s debt; to a certain extent, the company buys itself (this is known as a leveraged buyout, or LBO). Elon Musk did this when he bought Twitter, loading the social media company with $13bn in debt. And it’s what Macquarie did when it bought Thames Water, almost doubling its debt pile. After the 2008 crash, debt became much cheaper because of low interest rates, so it borrowed even more. By the time it was sold on again in 2017, the company’s debt had grown from £3.4bn to £10.8bn.

As the CEO of Ofwat, David Black, admitted to me recently, a lot of the money borrowed by Thames and others wasn’t invested in the kind of infrastructure that would have helped them avoid filling our rivers with faeces, but went straight into the pockets of investors: “Companies have increased their debt levels to pay dividends,” he confirmed. (Ofwat has since granted itself new powers to prevent dividends being paid.)

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It could be argued that these dividends were paid from profits. But Richard Murphy, professor of accounting practice at Sheffield University, told me he has conducted a 20-year analysis of investment in “tangible assets” (things like reservoirs, or pipes) by the nine big water and sewage companies, and found that it almost exactly matched the other items on their balance sheets. This means that in aggregate, “there was no net capital provided by shareholders over 20 years in the industry as a whole”.

The weather

Before Thames Water’s erstwhile CEO, Sarah Bentley, stepped down last June she blamed weather for the huge amounts of water – 630 million litres a day – lost to leaks and the 7,000 hours in which raw sewage had been pumped into London’s rivers in the previous year. It is certainly true that climate change is making it more difficult to run a water company. Weather systems increasingly move between extreme temperatures and droughts to extreme rain; last March was the wettest for 40 years. At the same time, increased car use means more ground is paved (which creates more floods) and farming is more intense (which creates more pollution).

A more adaptable system is needed to balance the newly unpredictable loads and demands. The time to start raising the money to build this system was at least 20 years ago, when it became clear that the UK would have to cope with climate change. Other than the major upgrade of the Thames’ Tideway tunnel (financed separately), that hasn’t happened in anything like the volume it should have done. Thames now has urgent environmental and operational concerns that will be expensive to fix, but the age of cheap debt is already over and investors aren’t showing up to help out. Which brings us, inevitably, to…

Margaret Thatcher

Thatcher’s policies were not damaging because of their aspirations, but because of the ideology that accompanied them. Selling people the council houses they lived in could have worked, for example, if councils had been allowed to borrow to build more council houses to replace them – but this would have been contrary to the dogma of a market-led, small-state economy. Similarly, when Thatcher came to power in 1979, her government curtailed the borrowing of regional water boards, deliberately underfunding Britain’s critical infrastructure, until by 1987 the only answer was to ask private capital to intervene.  

It wasn’t the only answer, however. “The government can always borrow cheaper than business,” explained Murphy, “so all these debts could have been more cheaply funded by the government than by the companies themselves.” Investors – who can always take their money elsewhere – demanded good dividends and light regulation; it was clear from the start that this was highly likely to introduce extra cost into the system.

Thames Water may limp on – the Conservative Party will be keen to defend its legacy in this respect – but the whole water industry is now more than £68bn in debt and highly “geared” (indebted relative to its capital value). Ofwat’s last financial resilience report found that nearly half the water industry is of “elevated concern” or needs immediate action, and they will not be rescued by the return of cheap debt. The water sector’s crisis is only beginning.

[See also: Why Ofwat CEO David Black doesn’t go wild swimming]

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