What is the real problem with Thames water?

Thames Water again? We are not in the water business. But there is a lesson in this story, so keep reading. There are many reasons for the current predicament of UK water services. This situation resembles one of his detective novels where almost everyone is a suspect. The victims, of course, are British citizens suffering under boil water warnings and facing increasingly polluted coasts, lakes and rivers. But who is responsible? The question itself is complex and difficult to answer. Every day, another news story expresses outrage about excessive executive compensation, capital misallocation, and regulatory malfeasance, while concluding with a dark story about worsening pollution in local lakes and rivers. . Making these problems seem overly complex and difficult to solve has a numbing effect on the public, fostering a kind of learned helplessness. This also allows politicians to avoid responsibility for the mess they and their predecessors have caused.

But back to Thames Water. Their obvious problem is water pollution. An equally obvious solution is massively increased capital spending on sewage treatment and associated facilities. And the easy answers stop there. Why? First, no one trusts that the current management and board, who are ultimately responsible for the dire state of the enterprise, can adequately oversee the billions of dollars of necessary remedial capital spending. Second, no one trusts the regulators, either. Ofwat has shown utter indifference to public responsibility while allowing the utilities to grotesquely overleverage. This excess debt has financially ruined these companies that were once solid investment grade businesses. Dealing with this excess debt is a big part of what has to be solved. It would be easiest to bankrupt the holding company, Kemble, and all the associated non-business entities. But there is another problem. Finally, the public seems to have lost faith in the private sector’s ability to cope with this, while it is even more unclear how a renationalisation of this industry would work. That’s why the water utility problem is so hard. We simultaneously have mismanagement that remains focused on capital extraction, wildly incompetent regulators, and a public that is increasingly convinced that privatization was a huge mistake and that renationalization of these industries would be the best outcome. And all of these issues are interrelated.

Of all the institutional failures here, it is most puzzling to us that Ofwat appears to have abandoned even basic capital structure regulations. As I’ve written before, the water industry is one of the safest and least risky types of utilities. Everyone needs a product, and demand is predictable. But from an analytical perspective, lower business risk means more financial leverage can be leveraged. The reverse is also true. A high-risk business should have little if any leverage. In other words, business risk and financial risk are inversely related. Thames Water’s management appears to have taken this idea of ​​a low-risk water business and pushed it to its logical and leverable limits. And now they and the British public are at an impasse.

Finally, the problem for regulators is public trust, or lack thereof. Why should the British public trust regulators to adequately oversee a major capital improvement program to improve water quality, when regulators have largely ignored the adequacy of regulations? For us, that is the real appeal of renationalization. It can bypass the UK’s dysfunctional regulatory bodies.

Here is our lesson. Years of neglect of public service functions, tolerated by tolerant regulators, have finally reached a point where even politicians are taking notice and denouncing the market-oriented regime they once defended. Who loses? Probably the owners of the utilities. Now imagine across the Atlantic, regulators standing by helplessly as American electricity customers go without power for days in sweltering heat or bitter cold. Can the public trust regulators and management to make the situation better? Perhaps the key lesson from the Thatcher-era privatization of utilities is that private companies simply cannot deliver public services. At least, not without vigilant regulators. These deregulated utilities have and will continue to malfunction. When will some enterprising politician make this an election issue? Not yet. But summer has not yet begun. Perhaps Thames Water should be a case study at an Edison Electric Institute management workshop. He learns what not to do.

By Leonard Hyman and William Tills, Oilprice.com

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