The body regulating the water industry has finally had enough. After decades of mild rebukes and even milder punishments for misbehaviour, the Water Services Regulation Authority, best known as Ofwat, has imposed heavy fines totalling £168 million on three big water companies for pollution.
Thames Water faces the biggest fine
The worst hit is Thames Water, already the most vulnerable in the industry to financial collapse because of the high debt racked up by its owners, current and previous. Its fine is £104 million, announced in December and now confirmed. The fine, as the BBC piece points out, is at the top end of what Ofwat could impose and reflects the severity of the many examples of sewage spillage into rivers and the sea by Thames.
Another eight water and wastewater companies in England and Wales are still under investigation, including Anglian Water, and it is highly likely further fines will follow.
I wrote here a year ago about how Thames got itself into this mess, those huge debts, far higher than the regulator would want, and the possibility public funds would be needed to rescue it.
I also pointed out that Anglian is much less heavily borrowed and in much less danger of running out of money. The company described its finances to me as “robust”.
Potential outcomes if Thames Water goes bust
But what of Thames, needing to find another £100 million or so to pay the fine? At least it will have known the fine was coming. The company has already been raising fresh debt to plug the hole in its finances, which one might think is a sign of desperation and the last thing it needs. The company, as the Guardian piece makes clear, says it only has cash to last until sometime next year.
If Thames goes bust, someone will have to step in to ensure the country’s biggest water company continues to deliver water and sewerage services to its 16 million customers. That somebody, under a Labour government, is almost certainly us, the taxpayer. Thames will have to be renationalised.
Financial implications of renationalisation
The company has a regulated capital value of about £19 billion, according to Ofwat. This is what it is worth, and what the state would have to pay to take it into public ownership.
That figure, just short of £19.4 billion, is listed as the value of “property, plant and equipment” in the company’s last financial statement, as at end-March this year. It is a huge sum for the new Labour government to find. But there is a way of funding some of it and keeping it off the public debt. We should raise capital against future water revenues on the bond market.
One of the reasons why seven out of ten water companies in England and Wales privatised in 1989 fell into the ownership of a range of overseas financial institutions – Thames is part-owned by a huge Ontario pension fund, the body that pays the pensions of some UK academics and the Chinese Sovereign Wealth Fund, among others – is that water companies are amazingly robust businesses financially.
They are monopolies, so there is no competition. Unlike, say, tech companies or engineers, no one is ever going to invent anything better than their core product. Their customers will always need it. They have assured revenues going forward, potentially, for as long as human civilisation exists.
You can’t lose money running a water company – unless you borrow huge amounts and then get caught out by rising interest rates, as Thames did.
The potential for water revenue bonds
This makes bonds issued, with the interest on them to be funded from those future revenues, potentially enormously attractive to financial investors in the City. A bond is a loan to the issuer which pays a fixed rate of interest – the technical term is a coupon.
This is how the UK state has long funded some of its financial needs, by the issue of government bonds, called gilts, which over a fixed period pay that fixed interest payment, or coupon. The sum then has to be repaid.
The soaring rise of funding new government debt after the Truss-Kwarteng Budget was one reason it all fell apart, and rising interest rates triggered then have increased the cost of new issues.
A recent gilt issue went out offering a bit more than 4% a year, significantly higher than in previous years when interest rates were practically zero.
Evaluating the potential of water bonds
There is no reason why bonds issued against Thames Water revenues could not go out at a similar rate of interest. Or possibly a touch less – the risk of default on such a bond before it has to be repaid is, potentially, less than the risk of default by any future government, of whatever persuasion. True, I am afraid.
When the repayment falls due, this can be funded by the issue of further Thames Water bonds. This is how the gilts market works, a rolling programme of issuance, redemption and further issuance. It is how it has worked since 1694, when the first gilt was issued to fund war with France.
It is hard to say just how much could be raised from bonds linked to future Thames revenues. But the company announced operating profits of £444.5 million in the last financial year. On a very crude calculation, if that profit goes to fund a 4% coupon on those bonds, you can reach a sum of £11 billion that, potentially, could be raised. This would defray a large chunk of that £19.4 billion cost.
The symmetry of nationalisation and privatisation
There is an elegant symmetry about all this. Thames is renationalised, control of a vital part of our economy passing to the state.
It is then in effect part re-privatised, by the sale of those bonds to City institutions. Yet that control remains with the state. It creates an asset class that would be safe and immensely useful to those institutions, who look after our pensions.
I would rather my pension be invested in safe-as-houses Thames bonds than some US tech company that might not be here in ten years’ time.
A model for future troubled water companies
It is a model that could be used with other water companies that get into trouble. Or held over them as a threat against future misbehaviour.
