Thames Water standoff: A game-changer for water privatisation in the UK
Thames Water Ltd.'s shareholders just played a game of chicken with regulators, choosing to walk away from a $6 billion asset rather than accept regulatory constraints. Seeking higher customer bills and reduced penalties, they gambled on funding infrastructure upgrades. But the standoff signals a messy aftermath, with bonds already signalling default. Amidst public outrage over sewage spills, the event may mark the end of water privatisation, prompting a rethink on regulatory frameworks and ownership models.
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By Matthew Brooker
One way to win a game of chicken is to keep going straight over the cliff edge, like James Dean's opponent in Rebel Without a Cause. That's effectively what shareholders of Thames Water Ltd. just did in serving notice of default and walking away from an asset that was valued at $6 billion not so long ago. The owners, who said the regulator's proposals had rendered Britain's largest water utility "uninvestible," can no longer be regarded as bluffing. As in the film, the aftermath is likely to be messy.
In the end, the gap between what the shareholders wanted and what the Water Services Regulation Authority, or Ofwat, was willing to permit was too wide. The investors, a group of mostly international pension and wealth funds including Ontario Municipal Employees Retirement System and China Investment Corp., sought a 40% increase in customer bills and reduced penalties for poor performance. This, in their view, was what was needed for Thames Water to fund an £18.7 billion ($23.7 billion) upgrade of its aging infrastructure while still producing acceptable investment returns. Absent that agreement, they decided that it made no sense to keep putting in more money.
Might there yet be a way back for the current shareholders? Never say never, but it would be a brave bet. Bonds of Thames Water (Kemble) Finance Plc, part of the holding company structure through which the investor consortium controls Thames Water, were already signaling the likelihood of default months ago, and are now trading at just 15% of face value.
The regulator's refusal to buckle might be counted a surprise. The government can hardly welcome turmoil at the country's largest water company, supplier to 16 million people in London and the southeast of England, in an election year. The Conservative chair of parliament's Environment, Food and Rural Affairs Select Committee suggested in a February letter to David Black, the New Zealander who took over as Ofwat's chief executive two years ago, that the regulator might go a little easier. The watchdog has faced criticism in the past for lax oversight and a revolving door of officials departing to higher-paid jobs in the private utility sector. It stood firm nonetheless.
In this case, Ofwat is showing the more astute reading of the public mood. Britain's water companies are targets of outrage for their habit of spilling sewage into the country's rivers and coastal waters hundreds of thousands of times a year. Thames Water is the worst of a bad bunch: the largest, most indebted and poorest-performing (on Ofwat's rankings) of the 17 utilities. Even if the regulator had been inclined to give ground, it would have been inviting a public backlash.
That's what makes this such a seminal moment. The default by Thames Water's holding company came just a few days after the Boat Race, a historic annual contest between Oxford and Cambridge universities on the River Thames in London, was overshadowed by warnings over dangerous levels of sewage. Crews were told not to swallow water splashed up during the contest or swim in the river because of high levels of E. coli bacteria; one member of the Oxford team told the BBC he had been vomiting before the race, saying "it would be a lot nicer if there wasn't as much poo in the water."
The financial failure of Thames Water's holding company coupled with the Boat Race debacle constitute what may come to be seen as a symbolic epitaph for the privatization era started by Margaret Thatcher — in the same way that rubbish piled in the streets during the 1978-1979 Winter of Discontent brought home visually the breakdown of the statist industrial model and helped bring her to power. Opinion surveys already show more than two-thirds of people favor bringing water companies back into public ownership. The confluence of these two events will add force to the prevailing current.
Whether the travails of Thames and other water suppliers really show the failure of the privatization model is a murkier question. Clearly, the results have been suboptimal, given persistent underinvestment in the UK's crumbling Victorian-era pipes and sewers. This, though, is less a reflection of the nature of private capital and more a discrete problem of regulation and corporate management — driven ultimately by political decisions. In short, Britain decided that its priority was in keeping customer bills low rather than having state-of-the-art infrastructure. It is now dealing with the consequences of that policy.
Macquarie Group Ltd. has attracted much opprobrium for its ownership of Thames Water between 2006 and 2017, when it added billions of pounds in debt and extracted billions more in dividends. The Australian investment bank, famously known as the "millionaires' factory," may have been opportunistic in its financial engineering, but the system allowed it to do what it did. The regulator sets the rules of the game; investors who have accepted the bargain can be expected to exploit them to their advantage if they're able. (It's worth noting that utility regulation models can encourage overinvestment as well as underinvestment.) If you don't like the results, design different incentives.
The question now is whether Ofwat has swung too far the other way and is setting conditions that are too onerous for private investors, even in the low-risk, low-return world of utility services. If so, this could rebound to the detriment of Britain's ability to attract future investment at an acceptable cost. This is a complex matter of competing economic models but it could be settled in one simple way: by seeing whether any new investor sees value in buying Kemble from the creditors who will now take control of the holding company.
In the meantime, Thames Water's customers can be sure of one thing: Bills will be going up.
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