The future of the UK water sector needs to be changed

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The regulator, Ofwat, has been wading through a torrent of controversy to determine future price increases in the water sector. Thursday’s draft ruling will not resolve the crisis at the weakest firms, notably Thames Water. But the regulator has probably done enough to balance the needs of consumers, investors and the environment, safeguarding the current operating model for the water industry for now.

Debt-ridden Thames Water, which must now try to raise new capital, will move into a special “turnaround supervisory regime”. The regulator says it is not a precursor to the special administration regime (Sar), essentially a form of nationalisation.

But Ofwat is considering appointing an independent monitor to examine the company’s performance. That could facilitate a move to SAR if necessary – which is still very much possible. It could also give the regulator some influence over the company’s long-term future: among other options, Ofwat has suggested splitting Thames into two or more licensed entities. Cutting out its complex structure would have significant benefits.

Thames, which will run out of money by spring unless it finds new investors, said it needed a 5.7 per cent return to attract new capital investment. It’s not happening. Of course, Ofwat has increased the allowable return on equity beyond the 4.1 per cent it suggested at the end of 2022. But so far it has only reached 4.8 per cent. It may need to be raised, according to consultant Martin Young, given the global scramble for infrastructure capital. Barclays research suggests investors may be asking for more than 5 per cent.

But the reaction from public markets suggests Ofwat’s plan was well thought out. For example, Pennon and Severn Trent’s share prices rose by 10 per cent and 4 per cent after their business plans were hailed as outstanding.

It is no accident that listed companies are at the top of their class. Listings provide transparency in corporate governance, accounting and performance. They ensure that rights issues are open to all investors and allow for cleaner investor exits. Companies owned by a consortium have difficulty raising new capital if the interests of their investors are not aligned.

Listed companies are also – crucially – typically less indebted than their peers. This chimes with Ofwat’s new preference for a larger capital buffer to improve resilience: the theoretical debt in its calculations has fallen by 5 percentage points to 55 per cent since the last analysis.

After the embarrassment of a total crisis at the country’s largest water company – drained of funds under its former private equity owners – Ofwat is now pushing companies towards the stock market. It is considering a write-off for the costs of relisting, a small but useful contribution to the chaotic task of putting the regulated sector on a stronger footing.

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