Thames Water is in trouble: cash-strapped, struggling to control sewage outflows and water leakage, and without the storage capacity to deal with shortfalls during hot weather.
Concerns over the future of Britain’s biggest water provider reached a peak this week when investors refused to inject £3bn of much-needed equity, despite nearly a year of negotiations with the water industry regulator, Ofwat.
Thames Water, the government and Ofwat are now rushing to find a solution.
The stakes are high: for consumers who will have to pay higher bills; for investors, including pension funds that may take big losses; and for the government, which may find itself forced to take responsibility for delivering about a quarter of the population’s water and sewage supplies.
Will Thames Water be renationalised?
The government and Ofwat are determined not to bring Thames Water back under government control, not least because it will pile pressure ahead of the general election later this year.
There may be no choice. The company needs £3bn of equity by 2030 just to pay its staff and suppliers, and to pay for maintenance and infrastructure improvements.
The nine existing shareholders in Thames Water’s parent company, Kemble — which include the pension funds Omers and the USS — injected £500mn equity in the form of a loan bearing 8 per cent interest last year.
But they are unwilling to invest more unless Ofwat gives way to demands for higher bills, dividends to allow them to pay debts, and some easing of regulatory fines. That includes the £500mn due by the end of March that investors had conditionally pledged last year.
Although neither Labour nor the Conservatives are calling for renationalisation, there is growing pressure from the public, as 69 per cent of people believe water companies should be nationalised, according to a YouGov poll in June last year.
If the government is forced to renationalise, the closest parallel may be Railtrack, the rail infrastructure company. That faced similar public opprobrium over safety issues and was eventually taken into special administration in 2002. The government eventually paid £500mn to shareholders and renationalised the business as Network Rail.
What are the other options?
Ofwat and the government are keen to find new investors for Thames Water, but there are several potential obstacles.
Regulatory uncertainty coupled with years of under-investment do not make Thames Water an attractive opportunity.
Potential new investors would need to wait for the outcome of Ofwat’s draft findings in mid-June, which will set out the extent to which Thames Water can increase customer bills over the next five years.
Before then, £190mn of debt at Thames Water’s parent company, Kemble, is due April 30, which the company has said is unlikely to be repaid without new equity coming in. This could trigger a messy debt restructuring or insolvency of this holding company.
Bondholders and banks could theoretically push to take control of the company through a debt-for-equity swap.
But it is far from clear that they would want to own a troubled company that needs billions of pounds of investment and that has attracted public anger over sewage outflows.
How has Thames Water become so indebted?
When the former prime minister Margaret Thatcher privatised the water monopolies in 1989, she wiped out their debt. Since then, Thames Water’s group borrowings have grown to £18.3bn as the company passed from owner to owner.
By 2006, when the Australian asset management firm Macquarie bought Thames Water from the Germany utility group RWE, the water company had £3.4bn in debt.
By the time Macquarie sold its final stake in Thames Water in 2017, the company had spent £11bn from customer bills on infrastructure. But far from injecting any new capital in the business — one of the original justifications for privatisation — £2.7bn had been taken out in dividends and £2.2bn in loans.
Meanwhile, the pension deficit grew from £18mn in 2006 to £380mn in 2017. Thames Water’s debt also increased steeply from £3.4bn in 2007 to £10.8bn at the point of sale.
Now Thames Water says it will not be able to deliver its turnaround plan if it does not receive more cash from shareholders.
More than half of Thames Water’s debt is index-linked, according to rating agency S&P, burdening it with higher interest repayments as inflation soared over the past 18 months.
The utility may also face large fines as part of the Environment Agency’s criminal investigation into alleged failings at sewage treatment works.
What are the operational challenges that Thames Water faces?
Thames Water has admitted that ageing infrastructure, such as water pipes and sewage treatment plants, are increasingly vulnerable. It is having to spend more on repairs, leaving less cash for improvements.
Households throughout London and the south-east have been left without water for several days on at least two occasions in recent months, mostly as a result of failures at pumping stations.
The average water trunk main — some of which are large enough to require scuba divers for repairs — is more than a century old in London.
An additional issue is that some pipes are made of asbestos and lead, which should be replaced. However, Thames Water’s historical pipe replacement rate of just 0.5 per cent a year since 2015 means not only that it would take 2,000 years to replace the capital’s entire network but also that it falls well short of international standards.
There is also widespread anger over sewage pollution. According to data from the Environment Agency this week, 47 overflows owned by Thames Water discharged raw sewage more than 100 times last year.
The annual varsity boat race will take place this weekend despite warnings over high levels of “dangerous” pollution caused by sewage in the river Thames.
What is the political fallout?
Thames Water is politically controversial for two reasons. First, it is part of a hugely unpopular industry that regularly ejects sewage into Britain’s beaches and rivers. Second, critics see the highly indebted behemoth as proof that water privatisation was a huge mistake.
Michael Gove, levelling-up secretary, sought to tap into that zeitgeist on Thursday as he called Thames Water’s management a “disgrace”. Gove said the company had been taking out profits and failing to invest, adding that answer was “not to hit the consumers”.
Yet Gove’s grandstanding is at odds with the government’s approach behind the scenes over the past year.
Although there is no evidence that ministers put pressure on Ofwat to meet the company’s demands, they were privately hoping it would allow various “regulatory easements” such as reduced fines and higher bills to keep shareholders on board.
The regulator did not.
“Ofwat is full of people who are almost zealous about the purity of their econometric models, the problem is that this means that they think struggling companies should be further punished,” said one person close to the talks. “Their belief in moral hazard means that perhaps they are oblivious to what the consequences would be of a major water company going under, for the wider water industry and the economy.”
Ofwat declined to comment.
The regulator’s apparent refusal to give in represents a political problem for whichever party is in power if Thames Water finally collapses.
“If it is going to go under, let’s hope it’s before the general election,” said one senior Labour figure, mindful of wider concerns about other highly geared water companies.
Likewise, a Conservative government aide said they hoped Thames Water would continue to struggle on until next year: “No one wants to be the person who commits billions to an unpopular industry when public services are crying out for cash,” they said.