Water bills in England and Wales were always going to rise massively. The question was the degree. Ofwat has landed on figures that, for about three-quarters of the companies, represent roughly what they wanted in order to fund regular operations and build new projects.
The response in the share prices of the few firms that remain on the stock market always offers the best instant guide to these hellishly complicated five-yearly regulatory determinations. On a bad day in the wider market, Severn Trent and United Utilities were two of best performers in the FTSE 100 index; Pennon, owner of South West Water, was in step in the FTSE 250.
That reaction is understandable when you look at how far the economic regulator has shifted between July’s draft version and Thursday’s final one. The total expenditure allowances for the sector – to be funded from bills – has climbed from £88bn to £104bn over the next five years.
About £7bn of the difference is explained by post-May demands from the Environment Agency that specific extra projects be added – Ofwat had no choice but to grant funding for those. The rest relates to matters of judgment on, for example, companies’ cost of capital, where Ofwat said it is “conforming to market expectations” by nudging upwards. That is a “positive” outcome for the listed trio, analysts at Barclays and Jefferies agree.
The government will be delighted, one suspects. For the bulk of water companies, including most of the unquoted ones, there is no question mark over their “investability”, the word industry lobbyists deploy to try to terrify ministers and regulators. Bondholders and shareholders will not be running for hills at the likes of United Utilities, which asked for a 36% rise in bills and got 32%, or even Yorkshire, which wanted 46% and got 41%. The size of those adjustments is normal in these price exercises.
But then one comes to the dogs of the sector, Southern and Thames Water. The former, now torturing tens of thousands of its customers in Hampshire with outages, wanted a preposterous pre-inflation 83% rise in bills over five years and got 53%. Thames, simultaneously copping an £18m fine for outrageously ignoring rules of dividend payments, pitched for 53% and got 35%.
In both cases, the eventual bill rise may be slightly more – but, revealingly, only because Ofwat has so little faith in the companies’ ability to actually build certain projects that it hasn’t granted the accompanying funding upfront.
Thames and Southern, like everybody else, are free to run off to the Competition and Markets Authority to dispute Ofwat’s calculations. But both debt-ridden outliers would be well advised to think twice. On a sector-wide view, the embattled Ofwat has set bills at a level that will allow the average company to ramp up spending on, for example, storm overflows. If Southern and Thames can’t live with average expectations, their investors will just have to take more pain.
In Thames’s case, its current shareholders have already been wiped out, so we’re talking about the size of haircuts for the bondholders. The small “B” class is trading at pennies in the pound. The “A” class, representing about £15bn of debt, is at about 70p in the pound. Crunch the numbers and that implies a write-down of about £5bn. If that is still not enough to attract £3bn-plus of new equity capital, the bondholders will just have to take a bigger thump. If Thames were still a listed company, the market would have forced a financial restructuring years ago.
None of Thursday’s number-crunching will satisfy the lobby that would prefer to re-nationalise the entire sector. But the government has zero appetite for such an adventure, and is even frightened of tipping Thames into special administration, AKA temporary public ownership. So the current setup is the one we’re stuck with, at least until Sir John Cunliffe’s new Water Commission advises differently.
But this is probably the last chance for the sector to regain a semblance of trust with the public after the years of pollution scandals and dividend-gouging.
Ofwat, doing the politically expedient thing, has pushed the limit of public tolerance for bill increases. Now the investors behind Southern and Thames should stop bleating and accept the reality of haircuts and exceptional capital injections. Just get on with it.
