Bills are rising to fund massive shareholder payouts

Water privatisation looks little more than an organised rip-off
Bills are rising to fund massive shareholder payouts

YESTERDAY
by: Jonathan Ford, FT
How hard can it be to be the chief executive of a privatised British water company? Your customers are determined by geography, your prices set by a regulator and designed to offer ample scope to fund both capital expenditure and to pay returns to your investors. Pretty much all you have to do is to make sure your sewage plants work and to keep the public waterways clear of human waste.

Yet even this bare minimum seems to have eluded Martin Baggs, the former boss of Thames Water. He, you might recall, was the man at the corporate stopcock when the utility’s malfunctioning plants spilled so much excrement into the Thames that locals in the Berkshire town of Little Marlow took to referring to the scum-covered surface as “crappucino”. The company was this year fined a record £20m for venting 4.2bn litres of raw sewage into the rivers Thames and Thame between 2012 and 2013.

Not that this escapade unduly crimped Mr Baggs’ career prospects. Despite evidence of negligence in its operations that later led a judge to brand the company’s actions “borderline deliberate”, he not only prospered after its disclosure, but received a rise of 60 per cent in 2015, taking his pay to a princely £2m. He stood down last year, showered with encomiums for his “huge contribution”.

To be fair to Mr Baggs, he is not alone. The boring job of plumbing seems almost an afterthought in determining the rewards of water supremos. Not only is pay uniformly high: Steve Mogford, chief executive of United Utilities, collected £2.8m last year, for instance. But if things go wrong, well, why should a bit of sewage stop those cheques rolling? In 2016, Yorkshire Water was fined £1.7m for polluting a lake near Wakefield and a section of the River Ouse. But that didn’t prevent it handing its boss Richard Flint £1.2m.

So what primarily drives the financial incentives offered by these businesses, if not customer service or the wider public interest? The answer is finance.

There was a reminder of this last week when it emerged that Thames Water (or rather its customers) had obligingly paid off £2bn of the £2.8bn of debt that the Australian investment bank Macquarie took on when it acquired the company in 2006, despite conditions set by the regulator that the utility’s finances would be ringfenced from the acquirer. The financing cost of this corporate transaction — from which water users derived no conceivable benefit — was simply lobbed on to their bills.

Other companies are similarly accommodating when it comes to prioritising shareholder interests. With the removal of all but three utilities from the stock market, these are now mainly international private equity firms and infrastructure funds operating through complex offshore, tax resistant structures. Over the past decade, the nine main English water companies have made £18.8bn of post-tax profits in aggregate, according to a study by Greenwich University. Of this, £18.1bn has been paid out as dividends. Consequently, almost all capital expenditure has been financed by adding to the companies’ debt piles. Collectively these now stand at a towering £42bn.

In the long run, this approach is clearly unsustainable. But Ofwat, the regulator, permits it because it takes no interest in the companies’ capital structures as long as they retain investment grade ratings. No utility, needless to say, has ever lost its licence for this reason, and the regulator has a (somewhat circular) duty to take the ability to raise finance into account when setting prices.

The result has been very juicy for private equity investors. Macquarie, for instance, received returns of between 15.9 per cent and 19 per cent during the 11 years it controlled Thames Water, according to Martin Blaiklock, an infrastructure consultant. According to him, that is twice what an investor might expect from a private utility.

But it is harder to see what is in it for the customers, who have to pay the mounting debt interest. Their bills are, in effect, rising to fund the massive shareholder payouts.

The utilities insist they are putting in investment. But it all adds up to some very costly infrastructure. Those annual interest bills might be £500m lower if the companies were still in state ownership, according to the Greenwich researchers. Customers also would not have to finance the £1.8bn in dividends. Bundle it all together and that could knock £100 off a £400 annual water bill.

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The regulator needs to look again at the generosity of its regime, and its cock-eyed governance. As things stand, water privatisation looks little more than an organised rip-off. Quite why this natural monopoly should not operate through not-for-profit, public interest companies is ever less clear.

Jonathan.Ford@ft.com