Water companies are struggling to hold their finances in order as interest rates rise on the huge debts they have taken on to pay dividends, according to a leading economist.
Dieter Helm, a professor of economic policy at the University of Oxford and an adviser to governments, said there were worrying signs from water companies about their financial stability as the economic crisis pushes up interest rates.
At privatisation in 1989, the nine English water companies were debt free. Between 1991 and 2019 they took on £52bn of debt, according to analysis. By last year debt had risen to £56.2bn, with Ofwat warning of concerns about the financial resilience of the sector.
Helm said rising interest rates on those huge debts now put these companies in a concerning situation. “In effect, the companies mortgaged their assets and then paid out the cash from the mortgaging in the form of dividends, share buybacks and special dividends. There followed the great financial engineering,” he said.
Last week Yorkshire Water announced an equity injection of nearly £1bn from the repayment of intragroup debt after Ofwat raised concerns over the fragility of its balance sheet and its ability to provide an essential public service. Shareholders were asked to provide an additional £100m to reduce spills from storm overflows.
Southern Water, which was fined £90m for discharging billions of litres of raw sewage into the sea, was rescued last year with a £1bn cash injection from Macquarie, the Australian asset manager.
Both companies have high levels of debt, with the ratio of company debt to equity at 77% for Yorkshire Water and 71% for Southern Water as of March 2021.
Helm said: “There are worrying signs from the companies, as they struggle to hold their finances in reasonable order as interest rates rise, and to tackle just their current obligations.
“Two – Southern Water and Yorkshire Water – have required big capital injections to keep them afloat, and Thames Water has been unable to meet its obligations satisfactorily, notwithstanding it having passed on dividend payments for several years.”
He said the water sector had reached a very unhappy and unsustainable state of affairs, of drought, sewage overflows, hosepipe bans and public outrage about executive pay. “Add in rising interest rates starting to bite into all the debt taken on by mortgaging the assets of the businesses rather than investing, and it is hard to avoid the conclusion that the wheels are beginning to fall off the original privatisation model, and that it is no longer fit for purpose,” Helm said.
The regulator has warned water companies not to pile costs on to customers, who are struggling with the cost of living. In a letter to companies on Tuesday Ofwat said they must mitigate any significant inflationary increases in customers’ bills for 2023-24.
Yorkshire Water and Thames Water are among six water firms under investigation by Ofwat, over credible evidence of potentially illegal dumping of untreated sewage into rivers and waterways.
Ofwat opened a separate enforcement case against Yorkshire Water over concerns about the fragility of its finances and whether it had the resources needed as a provider of essential public services. The Ofwat action was closed after the injection of £940m in the repayment of intragroup loans announced last week.
This summer Thames Water announced an injection of £1.5bn by shareholders into the company as it tried to reduce debt and improve its performance amid an outcry over sewage pollution.
Ofwat rules state that a company will be put into “cash lock up” and refused permission to give out dividends if it passes a certain threshold, notably if the company’s issuer credit rating (as defined by the licence) falls below investment grade, according to a freedom of information response to Ash Smith, of Windrush against Sewage.
Helm said the regulators were as responsible for the state of water companies as the firms themselves. “No amount of lobbying and buck-passing will get the industry and its regulators off the hook.”
He said a zero-tolerance approach was needed for raw sewage discharges. “No water company should be allowed to generally dispose raw sewage into rivers full stop,” Helm said. “To do so should be treated as a serious, notifiable pollution incident. On rare occasions this might happen, but it would be in genuinely very exceptional circumstances, not in the ordinary course of the water company’s activities. Backing this up would be a river monitoring system that picked up any such event.”
Analysis published last year by David Hall, of the Public Services International Research Unit (PSIRU) at the University of Greenwich, revealed that in the last 11 years, as the problems of raw sewage dumping increased, the nine English water companies paid shareholders a total of £16.9bn in dividends – an annual average of £1.4bn.
Yorkshire Water said: “We understand the importance of continuing to have robust financial structures in place and the repayment of the inter-company loans will continue our resilience into the future. We’ve agreed with Ofwat that the loans, totalling c£940m, will be repaid before end of March 2027 and this will likely include capital injections from shareholders.”
Sarah Bentley, Thames Water’s chief executive, said she had launched a turnaround plan since joining in September 2020 and that the company had made good progress in tackling structural challenges. “However, everyone at Thames is aware that we’re only at the start of our journey and there remains a huge amount to be done and delivered. We’re also aware that none of the programme can be delivered without significant capital investment. With this new, substantial equity investment programme our shareholders are both underpinning the investment vital for our improvement and also expressing their confidence in the long-term outlook for Thames Water. We warmly welcome their continued support.”
A Southern Water spokesperson said: “The vast majority of our debt is fixed, and therefore not influenced by interest rate changes.
“Thanks to our new majority shareholder’s commitment to Southern Water, following an initial injection of £1bn, we are investing £2bn between 2020 and 2025 to further improve our network. This money is being spent fixing, upgrading, and expanding our network of pipes, pumping stations and sewers that make up our extensive water and wastewater infrastructure.”
