Ofwat’s chief executive has admitted that the regulator should have intervened in 2006 to prevent water companies becoming loaded with debt.
David Black told a House of Lords inquiry that light touch approaches to regulation in the early 2000s had given private equity a route into the sector, but that Ofwat was now using “every tool” to bring high gearing levels down.
“We should have stepped in in 2006 to stop companies gearing up,” Black told the inquiry. “We are stepping in now but did not have the powers to do so at the time.”
The water sector’s total debt is £60.6 billion; while Thames’ debt pile stands at £14.3 billion.
It is geared at 80.6%, compared to a notional gearing level of 60% that Ofwat set at the start of the current price review. It began incentivising organisations to bring their gearing down to ensure they can be resilient to shocks. At PR24 Ofwat confirmed it will reduce the notional gearing again, this time to 55%.
Responding to questions sparked by the current situation at Thames Water, Black and chair Iain Coucher appeared before Peers as a follow-on evidence session to the Industry and Regulator Committee’s investigation into water regulation.
Black said the problem of high gearing was “most acute” at Thames due to it having the highest gearing in the sector, coupled with the lowest performance record. “If it was poor performance alone they could weather it, but its consistently poor performance with high gearing.”
Black added that Yorkshire and Southern have successfully raised equity and anticipates more will announce the same to bring gearing down in the coming months.
The committee asked why Ofwat had failed to intervene sooner, to which Black said it was necessary to go back to the early 2000s to identify when action should have been taken.
Back then, Black argued the private equity model was less well understood and regulators tended to have a light touch approach. He described a “more relaxed approach to levels of debt” prior to 2015.
The chief executive stressed that since 2015, the regulator has been pushing companies to bring down their gearing levels, but faced resistance from shareholders and companies.
He said powers granted to Ofwat in the 2021 Environment Act have let Ofwat change licence conditions without universal support from all companies. This has been used to add conditions around performance-related pay,
“It’s a potential negative from an equity investor perspective,” Black told the committee but pointed to listed companies with levels of gearing in line with Ofwat’s view.
“There are current investors in the sector who do not have the appetite to invest in these terms, so some may have to leave and new investors come in.”
Asked if “investor flight was keeping him awake at the moment”, Black said the water sector remained attractive to investors as a lower risk option that offers protection against inflation protection.
However, Black warned: “We need to get the balance right to keep it attractive to global international capital to choose where it goes into the UK water sector.”