UK: BIM Sounding Board - Floating in a sea of troubles.

UK: BIM Sounding Board - Floating in a sea of troubles. - Water companies are seen as profiteers, wasting customers' money on unsuitable diversifications. David Jeffrey attempts to put the record straight.

Last Updated: 31 Aug 2010

Water companies are seen as profiteers, wasting customers' money on unsuitable diversifications. David Jeffrey attempts to put the record straight.

There is no close season for comment in the media about the former nationalised utilities. Pricing, profits and service all attract attention. The water industry with the added ingredient of environmental concern is no exception.

The Government was lucky to come up with privatisation of the water industry when it did. Up till then no price tag had been put on the costs of meeting the vast range of the then still emerging, EC directed improvements to quality in the water cycle. What a shock it would have been to have to find some £1 billion extra each year within the public sector borrowing requirement.

The new companies' balance sheets could be restructured by debt write-off and cash injection and a price increase formula introduced to meet the cost of borrowing to carry out the vast capital programme. Was there another way? Perhaps the entrenched Treasury rules for accounting for public corporations could have been changed; but no government has managed this in the past and the neglect of capital investment on water industry assets resulted.

The boards of the new water service plcs, too, welcomed throwing off the yoke of Whitehall rule and breaking out of the frustration of under investment. As plcs with strong balance sheets, properly planned income streams, and with clear service and environmental objectives, they would be free to act like any other private sector companies. They accepted that control by a director-general of water services n charges and levels of service to curb the monopoly position seemed only fair to customers who would have little choice as to their water services supplier. With a single bound they were free - or nearly.

The Government chose regulation based on a "price cap." There would be defined levels of service and specified levels of capital investment at prices fixed for at least five and possibly 10 years. There was a mechanism for what is commonly called "cost pass through" to apply for increased charges to recover unforeseen expenditure such as the imposition of new EC standards on pesticides. The Government could have chosen other regulatory regimes; they could have chosen the rate of return system used for utility companies in the US; they could have chosen the dividend control system used for the 30 or so existing statutory water companies. Neither method would have generated efficiency; the judgement was that, because they both tend to featherbed the utility company, they would tend towards higher and not lower water charges.

The chosen "price cap" method would encourage a water company to seek efficiency savings, the proceeds of which could be enjoyed, initially, by the shareholders, and eventually, shared by customers and shareholders after a five or 10-year charges review.

The reader could be forgiven if he perceived the water companies to be polluters of the water environment, purveyors of unfit drinking water, greedy profiteers and arrogant spenders of customers' money on unsuitable and unnecessary diversifications and acquisitions. Politicians in opposition parties - with no stake in the success of water privatisation - and environmental campaigners and lobbyists provide ample material to keep these perceptions before the reader. In truth, decades of under investment are now being followed by investment in the environment and water services. The last full year before privatisation saw the water authorities between them invest £1.2 billion (1988/89); the first full year after privatisation saw them spend £2.3 billion (in 1990/91). Bathing water is getting cleaner, rivers are being less polluted from sewage treatment works and drinking water is getting purer. This investment pattern will continue to the end of the century and beyond. Levels of customer service are carefully monitored and reported and they are improving.

the new companies have proved to be very profitable relative to the forecasts at the time of flotation. Total profits for the 10 water plcs in 1990/91 were £13 billion. The common question which underlies the basic unpopularity of the water industry's privatisation is, "How can this be justified when water is essentially free?" One problem is that the price rises to finance the capital programme come through, by way of big profits. The public tend to see these profits as something taken out of the company. They are oblivious to the relative smallness of the part of the profit paid out as dividends to shareholders. What they don't see is the greater part of profit which is investment for improvements.

Then there is the industry's regulator, OFWAT. Its director, Ian Byatt, is not impervious to the political and media pressures which flow from less than fully satisfied customers. He has already put downward pressure on company profits and dividends and diversification ambitions. He sees the water industry as a low-risk business which justifies appropriately low returns to investors. Industry chiefs point to the inherently risky capital investment programme, the vulnerability to downward movement in sales (without corresponding cost reduction) and, not least, to the regulatory risk associated with Byatt himself and possible changes of government.

Perhaps the industry could now be allowed to get on with what it has contracted to do without the diversion which tampering with its regulatory structure so early in its life would bring. It is certainly a structure that is allowing more to be spent on the water environment and water services than at any time in our history. All should be thankful for that.

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