Flickr/Patrick Brosset. Some rights reserved.
Of all the privatisations of the Thatcher government, perhaps the most controversial was the privatisation of water. Most countries in the developed world run their water on a municipal basis. In some countries, citizens don’t receive water bills but simply pay for it as part of their rates. In the UK, however, we now have a patchwork of different ways of delivering our water.
In Scotland and Northern Ireland, water is delivered by the public sector. Northern Ireland Water is a government owned corporation, accountable to the Northern Ireland Utility Regulator. Scotland has a truly public water supply. Scottish Water is a statutory organization, accountable to Scottish Parliament. In Wales a non-profit organization, set up after the failure of a private concern, supplies the water. In England ten wholly private companies provide water and waste management in ten regions. Once again, this puts England at the forefront of the privatisation drive within the UK.
Water is the very stuff of life, so it is understandable that its privatisation during the Thatcher years was controversial. So why do it? The big argument for privatisation used to be that it was cheaper. However as this turned out not to be the case—or somewhat disingenuous, depending on how you want to look at it—the new argument is that it’s more ‘effective’. We are told that, whilst private utilities may be more expensive, they are also more efficient. It turns out this might be a bit questionable.
In 2014, the Public Services Research Unit conducted a review looking at the difference in efficiency between the public and private sectors. They concluded: “The results are remarkably consistent across all sectors and all forms of privatisation: there is no empirical evidence that the private sector is intrinsically more efficient.” This finding is echoed by a whole host of studies into privatisation in both developing and developed nations, which show that the idea of greater efficiency in the private sector is a myth. This applies to water, but also equally to other utilities. A review of the experience in privatizing electricity in Norway, Canada (Alberta) and the USA (California), as well as the UK, concluded that markets did not deliver lower prices and higher efficiency because small groups of producers abuse market power. (Woo et al, 2003).
The UK’s water supply would seem particularly informative to study, due to the diversity of supply methods within one nation. At the same time this very complexity—and the information available—means the industry is very opaque and difficult to scrutinize. In a report for the New Policy Institute, the authors refer to the way the industry, particularly within England, is organised as 'very odd'.
Despite the complexities of the English water industry and its ownership model, certain trends are evident. Firstly, as recent media headlines suggest, household bills in England are increasing. Secondly, there is the clearly changing ownership profile of the privatised water companies, and the increasing presence of private equity in the mix. Thirdly, high profits and dividends for shareholders have also generated headlines. Fourthly, an increasing amount of debt is being carried by the English water companies. And finally, a run of problems and issues have faced the English water companies, including leaks and unsafe water, along with waste water incidents. Taken together these issues seem to challenge the claim by Thatcher’s government that a privatised water industry would be more efficient and less costly to run.
In England annual water bills had risen from £120 per year in 89, to £204 by 2006. If you take into account inflation, you’ve still got a rise of 39% over and above inflation.
And bills continue to rise, despite stagnating wages and a sluggish economy.
To counter the anger at climbing bills, privatisation supporters argue that the English water companies have invested more than state run entities would have. A study by Greenwich University shows that this isn’t true. Their research concluded that at least half the investment made by the water companies since privatisation was due to EU directives and regulations. That is, the companies made the investment because they had to. They didn’t do so happily either. In fact, the UK government tried to exempt the private water companies from having to make the improvements but the European Commission denied the bid.
During the early noughties Scottish Water and Northern Ireland water also had higher bills. But during this time Scottish Water invested £1.8 billion into the system, the biggest investment into the water infrastructure in Scotland ever made. Once this period of investment into a decaying water network was finished, Scottish Water began to reduce bills. Whilst Northern Ireland doesn’t currently charge domestic customers for water, it has had higher notional bills than some of the English regions. However it has, in the last few years, had the least increase to bills of all the water suppliers.
These days the difference in bills between the English water companies and Scottish Water are stark. Last year Scottish Water customers paid less than customers of all the private English and Welsh water companies. Prices across the ten English water companies vary greatly. Offwat’s estimated average bills for 2013/2014 are as follows:
South West £499
Dwr Cymru £434
United Utilities £406
Severn Trent £335
In contrast the cost for Scottish Water customers was £334. In England, the least expensive is Severn Trent, and the most costly for households is South West water, whose average bill for 2013/2014 was an astronomical £499. So high are South West’s bills that the government pays for a £50 reduction for each household! This raises the question, if the private industry needs to rely on government help for its customers – shouldn’t the government simply take over and run the concern directly?
This isn’t the only instance of the industry asking the government to help. Thames Water has long argued that they need to build a new sewer in London to update the Victorian system – a so called ‘super sewer’. The only problem is that, as Thames Water is owned by a private equity consortia and has a high ratio of debt, it can’t finance this itself. The ownership group of Thames Water includes Macquarie Infrastructure Fund (Australia). The China Investment Corporation, and Abu Dhabi Investment Authority. The result of the situation is that the British state has to come to the rescue once again as Thames Water has asked the government to guarantee the risk. This is because Thames water has run up debt since privatisation and now owes around £8 billion. All this despite being able to pay out approximately £1.4bn in dividends between 2006 and 2012. This example brings us to two of the most pressing issues facing the English water companies, the increasing amount of private equity ownership, and increasing debt profiles.
The ownership profile matters for a variety of reasons. Stock exchange listed parent companies would be subject to UK tax. Private equity companies are not open to the same scrutiny, or the same tax regime if based outside the UK. Furthermore, they do not have to comply with any of the disciplines of the UK equity market.
The water companies that are private equity owned seem to be the ones with higher debt ratios. In fact, the privatised industry as a whole now has high debt levels. You can measure a company’s debt levels by looking at what is called the gearing ratio. This is a way of looking at how highly leveraged a company is. It is measured in percentages, and it is traditionally argued that a business that has a gearing ratio of higher than 50% is highly geared, or, highly leveraged, which could be unsustainable. The average level for the water companies has risen dramatically since privatisation and stood at 70% by 2010.
Whilst higher ratios aren’t always a cause for alarm—financing through debt can be cheap—the figures for some of the water companies are worryingly high. It also matters what the money is being used for. If the money is being borrowed purely for capital investment it is different than borrowing to keep paying high dividends, which some believe utilities in general are doing. It is argued by some analysts that organisations which have to borrow to pay dividends are basically self-cannibalising.
Thames water in particular has been accused of using borrowed money to fund too high dividends for over a decade.
This need for high dividends can cause companies to experience trouble with their credit ratings. Indeed, Sir Ian Byatt, formerly of Offwat, himself makes the link between high dividends, high debt, and trouble getting finance. He states: “In practice, many companies, especially the private equity infrastructure funds, have paid out excessive dividends to their owners. In the case of Thames Water, this has damaged its credit rating, leading to requests to Government for guarantees.”
Some analysts believe the most highly leveraged water companies could be in danger of going bust if asked to pay back a significant proportion of that debt. In this sense, English households are now, often unknowingly, part of the somewhat risky financialisation of water.
Another reason for the high debt structure of these companies may be more dubious than simply wanting to finance investment cheaply. There are increasing allegations that the water companies are using debt to lower their tax obligations. Tory MP, Charlie Elphicke, claims that the water companies have used debt interest to avoid tax adding up to over a billion pounds lost to the Exchequer in just three years. He terms the avoidance “staggering”. He singled out Yorkshire Water as a particularly bad example.
Simon Hughes MP gave figures showing just how much tax Yorkshire Water has managed to avoid by using debt to offset payments. He wrote to the Public Accounts Committee back in 2012 stating: “Yorkshire Water…has seen its tax liability decline from £70m in 2009 to a tax credit of £18.9m this year after it took out £1bn from a group of finance companies it owns in the Cayman Islands."
The ownership profile of Water Yorkshire includes Deutsche Asset & Wealth Management, GIC an investment fund backed by the Singaporean government, along with Citi Infrastructure Investors (US based). So yet again we have a complex group of international finance organisations, owning a UK utility that is highly leveraged and pays little UK tax.
In sharp contrast to the complex over indebted structure of much of the English water companies. Welsh water is a non-profit organisation, under which “assets and capital investment are financed by bonds and retained financial surpluses. Financing efficiency savings to date have largely been used to build up reserves to insulate Welsh Water and its customers from any unexpected costs and also to improve credit quality so that Welsh Water’s cost of finance can be kept as low as possible in the years ahead.”
Scottish Water is a publicly owned utility, directly answerable to the Scottish Parliament. It can borrow more cheaply than the English water companies, as government debt is considered safer than private debt. It has invested record amounts of money in recent years into the infrastructure, and once the investment is finished it quickly reduced bills to levels lower than all the English companies.
Whilst analysing UK water provision is an extremely complex task, it is clear that the privatised English water companies are operating in a highly financialised environment in many instances. They stand accused of running up high debts to maintain dividends, and in some cases, such as Thames Water, this has arguably helped damaged their credit rating. They appear to be run in the interests of shareholders and not customers. Not only are English customers paying the highest bills, they also are most at risk from utility companies whose business practices may mean that when it comes to future investment the state has to step in. Indeed, it is this highly leveraged structure, and the increasing amounts of foreign ownership that are most troublesome when examining the water providers.
Water should not be a vehicle for huge, international consortia to get rich. We have two alternative examples of healthier ways to run water companies within the UK. The non-profit organisation set up in Wales, or better yet, a return to full public ownership. The case of Scottish Water shows that this would be the best outcome for English customers.
This article is part of the Modernise: de-privatise series.