Helm: Breaking up Thames would be a good start

Ofwat should have showed its strength by threatening to revoke the licences of beleaguered Southern and Thames, according to economist Dieter Helm, who has also proposed dismantling the latter to improve its management.

The sector’s long-term critic has suggested dividing the existing organisation into two public limited companies – Upper Thames and London Water. This, Helm said, would provide a template for other disaggregation.

“The argument that water companies need to be ever bigger has limited evidence to support it. For now, breaking up Thames would be a good start.”

Two months on from Thames’ hitting the headlines over its financial woes, Helm has written a paper examining the various options mooted for overhauling the company. In it he dispels the potential for Thames to be renationalised, citing concerns about both the competence of government to contract the necessary services from the private sector and also about how priorities would be determined. He also explores the option for local government to oversee water and sewerage services but discounts this on the basis of both experience and funding.

On the “notionally simplistic” option of taking away Thames’ licence and selling it on to “more competent management and owners”, Helm sees more missed opportunities.

He suggests Ofwat shied away from revoking Thames licence earlier this year, just as it had previously done during Southern’s nadir, because it was in “fear of the process it might struggle to control”. He puts this down both to the 25-year length of the licences and their lack of clarity.

However, he inists Ofwat was wrong not to have tried, adding it would have forced the companies to defend themselves in public and signalled Ofwat as a “serious regulator”.

He admits that the major drawback of this approach would be the impact on foreign investment in the UK, which would inevitably be restrained by fears of licences being confiscated by the government.

Practical steps

Helm lashes out at Ofwat for allowing companies to make their financial structures “amazingly complicated”, and makes the case for simplified single-company structure only providing water and wastewater services.

“At a stroke, the whole set-up would be much more transparent. Responsibilities would be clear. There would be no hiding behind groups to claim, for example, that they are paying the salaries and not the water entity. It is a fiction anyway: it is the ownership of the water company and its profits that pay the group’s dividends, and these are what the salaries come out of, if not directly from the customers. The job of running a water company should be full-time, full stop.”

He accuses Ofwat and the Competition and Markets Authority (CMA) of incentivising a switch from equity to debt via the use of a weighted average cost of capital (WACC) that gives an inflated return on debt and too low a return on equity.

Helm recommends splitting the regulatory asset base (RAB) debt into tradeable RABs which would further hinder attempts at playing the balance sheets. This would pave the way for Helm’s longheld vision of a catchment system regulation regime with parties able to bid on necessary works, integrated with floods and farming. This, Helm says, would be “much more efficient and effective, and Ofwat could be closed down.”

Ultimately, Helm shows little confidence in any radical response to the Thames debacle, saying he expects “he can will be kicked down the road, and with it the dire performance may continue”.

He cites “sadly little evidence that the regulators have the stomach for a serious clash with Thames’s owners” and expects this to be reflected in PR24 negotiations, where he expects the company’s investors to try to limit future capital programmes.

He concludes: “It is even possible that Thames limping on might bring down the rest of the industry with it. This is what they all fear and why they all want to claim that the problems are unique to Thames (which many of them are not). Limping on might be worse for Thames’s owners, too, who may find that they can exist only at a bargain basement price. Most likely all of this will happen, and the industry will find several of the companies gradually collapsing into not-for-dividend companies, like Railtrack and Welsh Water did, or, worse still, nationalised industries under the control of the Treasury.

“It would take political and regulatory courage to sort out Thames, to split out the companies, to bring them back as equity in the form of stand-alone public listed companies, and to break up Thames. Neither the government nor the Labour Party appears to be up for this (nor, indeed, for a catchment system regulator) and Ofwat’s past record does not encourage optimism. For those who would like to swim in the rivers and on the beaches, for those who care about the biodiversity in our rivers, and for those who want to be sure they will always get water when they turn on the taps, more of the same is probably the worst possible outcome. It is not sustainable and therefore it will not be sustained.”