Thames Water is in trouble: short of cash, struggling to control sewage outflows and water leaks, and without the storage capacity to cope with hot-weather shortages.
Concerns over the future of Britain’s biggest water supplier peaked this week as investors refused to inject £3 billion of much-needed capital, despite almost a year of negotiations with the water regulator , Ofwat.
Thames Water, the Government and Ofwat are now rushing to find a solution.
The stakes are high: for consumers who will have to pay higher bills; for investors, including pension funds that could suffer large losses; and for the government, which may be forced to assume responsibility for providing around a quarter of the population’s water and sanitation supplies.
Will Thames Water be renationalised?
The Government and Ofwat are determined not to bring Thames Water back into state control, not least because this will increase pressure ahead of the general election later this year.
There may be no choice. The company needs £3 billion of equity capital by 2030 just to pay staff and suppliers and to pay for maintenance and infrastructure improvements.
The nine existing shareholders in Thames Water’s parent company Kemble – which include pension funds Omers and USS – injected £500m of capital last year in the form of a loan at 8% interest.
But they are unwilling to invest more unless Ofwat gives in to demands for higher bills, dividends to allow them to pay debts and some easing of regulatory sanctions. This includes the £500 million due by the end of March that investors promised under certain conditions last year.
While neither Labor nor the Conservatives are calling for renationalisation, there is growing public pressure, as 69% of people believe water companies should be nationalised, according to a YouGov poll from June last year.
If the government were forced to renationalise, the closest parallel might be Railtrack, the rail infrastructure company. This faced similar public disapproval over safety issues and was eventually placed into special administration in 2002. The government eventually paid £500 million to shareholders and renationalised the business as Network Rail.
What are the other options?
Ofwat and the Government are keen to find new investors for Thames Water, but there are several potential obstacles.
Regulatory uncertainty combined with years of underinvestment do not make Thames Water an attractive opportunity.
Potential new investors will have to wait for the outcome of Ofwat’s draft findings in mid-June, which will set out the extent to which Thames Water can increase customer bills over the next five years.
Before then, £190m of debt at Thames Water’s parent company Kemble will come due on April 30, which the company says is unlikely to be repaid without new equity coming in. This could trigger a disorderly debt restructuring or insolvency of this holding company.
Bondholders and banks could theoretically push to take control of the company through a debt-for-equity swap.
But it is far from clear whether they would want to own a struggling company which needs billions of pounds of investment and which has attracted public anger over sewage outflows.
Why did Thames Water get into so much debt?
When former Prime Minister Margaret Thatcher privatized the water monopolies in 1989, she wrote off their debt. Since then, Thames Water Group’s borrowings have grown to £18.3 billion as the company went from owner to owner.
In 2006, when Australian asset management firm Macquarie bought Thames Water from German utilities group RWE, the water company had debts of £3.4 billion.
By the time Macquarie sold its final stake in Thames Water in 2017, the company had spent £11 billion from customer bills on infrastructure. But far from injecting new capital into the business – one of the original justifications for privatization – £2.7 billion was taken out in dividends and £2.2 billion in loans.
Meanwhile, the pension deficit has grown from £18 million in 2006 to £380 million in 2017. Thames Water’s debt has also soared from £3.4 billion in 2007 to £10.8 billion at the point sale.
Now Thames Water says it will not be able to deliver on its recovery plan unless it receives more cash from shareholders.
According to ratings agency S&P, more than half of Thames Water’s debt is index-linked, saddling it with higher interest repayments due to soaring inflation over the past 18 months.
The company could also face large fines as part of the Environment Agency’s criminal investigation into alleged failings in its wastewater treatment works.
What operational challenges does Thames Water face?
Thames Water has admitted that aging infrastructure, such as water mains and wastewater treatment plants, is increasingly vulnerable. It’s about having to spend more on repairs, leaving less money for improvements.
Households across London and the south east have been without water for several days on at least two occasions in recent months, mainly due to faults at pumping stations.
In London the average water pipe, some of which is large enough to require scuba divers to repair, is more than a century old.
An additional problem is that some pipes are made of asbestos and lead, which should be replaced. However, Thames Water’s historic pipe replacement rate of just 0.5% per year since 2015 means not only that it would take 2,000 years to replace the capital’s entire network, but also that it is well within below international standards.
There is also widespread anger over wastewater pollution. According to Environment Agency figures this week, 47 overflows on Thames Water properties discharged raw sewage more than 100 times last year.
The annual university boat race will take place this weekend despite warnings about high levels of “dangerous” pollution caused by sewage in the River Thames.
What is the political fallout?
Thames Water is politically controversial for two reasons. Firstly, it is part of a hugely unpopular industry that regularly dumps sewage onto Britain’s beaches and rivers. Second, critics see the highly indebted giant as proof that water privatization was a huge mistake.
Michael Gove, the levelling-up secretary, sought to tap into that zeitgeist on Thursday by calling Thames Water’s management a “disgrace”. Gove said the company had been taking profits and not investing, adding that the answer was “not to hit consumers”.
Yet Gove’s performance is at odds with the government’s approach behind the scenes over the past year.
While there is no evidence that ministers pressured Ofwat into meeting the company’s demands, they privately hoped that this would enable various “regulatory easements” such as reduced fines and higher bills to keep shareholders on board.
The regulator does not.
“Ofwat is full of people who are almost zealous about the purity of their econometric models, the problem is that this means they think struggling companies should be punished further,” said a person close to the talks. “Their belief in moral hazard means they are perhaps unaware of what the consequences of the failure of a major water company would be, for the water industry generally and for the economy.”
Ofwat declined to comment.
The regulator’s apparent refusal to relent represents a political problem for whichever party is in power should Thames Water eventually collapse.
“If it fails, let’s hope it happens before the general election,” said a senior Labor figure, mindful of wider concerns about other highly indebted water companies.
Similarly, a Conservative government aide said he hoped Thames Water would continue to struggle into next year: “No one wants to be the person who commits billions to an unpopular industry when utilities are asking for money,” they said.