What’s really wrong with Thames Water? | OilPrice.com

Thameswater again? We are not concerned with water. But this story has a moral, so read on. There are many reasons for the current dire situation in the UK water supply sector. This situation is like one of those detective stories where almost everyone is a suspect. The victim, of course, is the British public who are suffering from boil water warnings and dealing with increasingly polluted beaches, lakes and rivers. But who is to blame? The question itself is complex and difficult to answer. Every day another news article appears expressing outrage over excessive management compensation, misallocation of capital, or regulatory violations, while ending with a somber note about rising pollution in a local lake or stream. Making these problems seem too complex and difficult to solve has a numbing effect on the audience and promotes a kind of learned helplessness. This also gives politicians the opportunity to avoid responsibility for the mess they or their predecessors have created.

But let’s get back to Thames Water. Their obvious problem is water pollution. The equally obvious solution is a much higher level of capital expenditure on sewage treatment and related facilities. And that’s where the easy answers end. Why? First, because no one trusts that the existing management and board of directors, who are ultimately responsible for the dire state of the business community, will properly oversee the billions in necessary recovery investments. Secondly, no one trusts the supervisor. Ofwat has shown a profound indifference to its public responsibilities, while at the same time allowing grotesque over-leverage on its utilities. This excessive debt has financially crippled these once solid investment-grade companies. Addressing this excessive debt is a big part of what needs to be solved. Bankruptcy of the Kemble holding company and all associated non-operational entities would be the simplest option. But there is still a problem. Finally, the public appears to have lost confidence in the private sector’s ability to deal with this, but it is even less clear how a renationalization of this industry would take place. That is why these water supply problems are difficult. At the same time, we have problems with misguided management still focused on capital extraction, wildly incompetent regulators and a public increasingly convinced that privatization was a big mistake and that renationalisation of these industries is the best outcome. And all these issues are connected.


Of all the institutional failures here, Ofwat’s apparent abandonment of even rudimentary regulation of the capital structure is the most baffling to us. As we’ve written before, the water industry is one of the safest and least risky types of utilities. Everyone needs their product and demand is predictable. But from an analytical perspective, low business risk implies the ability to exert greater financial influence, and vice versa. High-risk companies should have very little or no leverage. In other words, business risk and financial risk are inverse correlates. It seems that Thames Water management has taken this idea of ​​a low-risk water company and pushed it to the extreme that can provide logical, leverage. And now they, and the British public, are stuck.

Finally, the problem facing regulators is one of public trust, or lack thereof. Why should the people of Britain trust themselves to properly oversee a major restoration program to improve water quality, when they have effectively ignored any semblance of regulatory decency in the past? For us, that is the true appeal of renationalization. It bypasses a dysfunctional British regulatory body.


This is the lesson for us. Years of neglect of public services, allowed by a permissive regulator, eventually reached the point where even politicians took notice and denounced the market-wide scheme they had previously championed. Who loses? Probably the utility company owners. Now imagine that across the pond, American electricity customers are left without service for days in sweltering heat or severe cold, and that continues to happen as regulators helplessly watch. Can the public trust regulators or management to correct the situation? Perhaps the most important lesson from the Thatcher era of utility privatization is simply that private enterprise cannot provide public services. Or at least not without vigilant supervisors. These deregulated utilities continue to fail and it continues to happen. When does an enterprising politician make this an election issue? Not yet. But summer hasn’t started yet. Perhaps Thames Water should be a case study at an Edison Electric Institute management retreat. Learn what not to do.




By Leonard Hyman and William Tilles for Oilprice.com

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