The water industry is in crisis. Can it be fixed?

Our toilet flushed and water came out of the tap. In this sense, the water industry in England and Wales is efficient. In almost every other way, it’s a mess.

The most obvious sign of confusion occurs after the toilet flushes. Last year, England’s privatized water companies discharged a total of untreated sewage 3.6 million hoursmore than double the amount recorded the previous year.

Millions of customers, surfers and bathers have joined the chorus former pop star Feargal Sharkey has been singing for years – that the industry is a “chaotic chaos“.

It’s not just our rivers, lakes and coastlines. Some communities were told to boil tap water to ensure safety, while others had their water supplies cut off for days or even weeks.

Environment Secretary Steve Reed told the BBC that parts of the country could face drinking water shortages by the 2030s, with plans to build new homes hampered by water supply issues.

Confidence in these companies has never been lower, and it’s not hard to understand why.

There are some common factors that are putting pressure on the system and require radical reform to address them. The government knows this, which is why it has just announced a major new committee to conduct the biggest review of the industry since privatization 35 years ago.

The independent commission will be led by former Bank of England deputy governor Sir Jon Cunliffe and will report and make recommendations next June. Options on the table include reforming or abolishing Ofwat, the main regulator.

For critics like Sharkey, this is an admission that privatizing basic monopolies has failed. Sharkey, the former frontman of the Undertones, is now outspoken about the state of Britain’s rivers. Recently, he descriptive It was probably “the most organized act of theft ever committed against the British people”.

So how did we get here, how do we solve this problem, and what does it mean for customers and their bills?

Reflecting on water privatization in her memoirs, Margaret Thatcher wrote, “The rain may come from the Almighty, but He has not sent the pipes, pipes and works to match it”.

When her government privatized water companies in the late 1980s, they became debt-free. Today, their debts total £60bn.

There is nothing inherently wrong with debt. This can be a cost-effective way to finance investments in industries where lenders are very happy to lend to them.

It’s easy to see why they were so happy to lend it money. Water companies receive steady and growing revenue from customers who cannot go anywhere else to get what they will ever need. Regional monopolies providing basic services with a guaranteed income have always been considered a safe bet.

Another attraction for water company shareholders, as with other companies, is that repayment costs can be deducted from earnings to reduce reported profits and therefore their tax bills.

Some shareholders (not all) went too far and left the water company with too much debt. This can backfire when the cost of debt starts to rise – as we’ve seen over the past two years as interest rates rise in response to the surge in inflation starting in 2022.

For example, in the 10 years from 2007 to 2017, when Australian investment firm Macquarie was Thames Water’s largest shareholder, debt rose from £2 billion to £11 billion, during which time Macquarie and other investors did not inject any new of cash or own equity.

In five of the ten years that Macquarie became Thames Water’s majority shareholder, investors paid out more in dividends than the company earned in profits, borrowing heavily to make up the shortfall while allowing debt levels to soar.

Thames Water is now on the brink of bankruptcy with just enough cash to last until the end of the year.

Macquarie sold its stake in the company in 2017. New shareholders, including large domestic and foreign pension funds, recently canceled a £500m capital injection. They did so after learning Ofwat would not allow the bill to rise, with new shareholders insisting the bill rise was necessary if their investments were to earn a return for their own pensioners and shareholders.

A Macquarie spokesperson said in a statement: “We support Thames Water as it delivers a record level of investment that enables the company to reduce leaks and pollution incidents while improving drinking water quality and supply security upgrades. Its legacy infrastructure still needs more work, but when we sold the final stake in 2017, the company met all conditions set by regulators and had an investment-grade credit rating.”

Thames Water currently has debts of more than 16 billion pounds, and the cost of debt is rising for Britain’s largest water company, on which a quarter of the country’s people rely on for their water supply.

This is the most extreme example, but other companies, including Southern Water, face similar debt-ridden situations. Since 2021, China Southern Airlines’ largest shareholder happens to be Macquarie.

As a result of all this, there is a widespread public perception that investors and executives have siphoned money away from dividends and compensation that should be invested in improving water utility infrastructure. The Lib Dems capitalized on this perception in this year’s general election, picking up dozens of seats after making reforming the state of the industry one of their aims. key campaign promises.

According to Ofwat, water companies have paid out £52 billion in dividends since 1990 (equivalent to £78 billion today). Many believe the money could have been used to help prevent sewage leaks instead of ending up in the pockets of investors.

But over the same period, water companies invested £236 billion According to the British Water Authorityrepresenting the department.

The report added that £9.2 billion was invested in the water sector in England and Wales last year, the highest ever capital investment in a single year.

It’s important to note that not all water companies are the same.

Some companies are doing well, have manageable debt, and have made steady investments in infrastructure in the three decades since privatization while paying dividends to shareholders who provided the capital needed for the privatization model.

Regardless, lenders are now asking other water companies to raise rates as well, as the industry as a whole appears to be a riskier bet.

Regulator Ofwat has allowed this debt build-up to happen because for years it did not believe it had the necessary powers to decide how companies choose their financial structures.

Which brings us clearly to the next factor in this slow-motion car crash – poor regulation.

Ofwat has not only failed to police the levels of debt piling up on water companies’ balance sheets. It has also been accused of getting its priorities wrong by focusing on keeping bills low without doing enough to encourage investment.

Borrowing costs fell sharply in the years after the financial crisis – one reason companies borrowed heavily.

Regulators, prompted by the government, decided cash-strapped customers needed to keep their bills as low as possible. In fact, bills are rising faster than inflation – so they are getting cheaper in real terms.

But this means less money is actually invested.

John Earwaker, a water industry expert and director of consultancy First Economics, said rapidly falling financing costs could and should make room for more investment while still keeping water tariffs rising modestly.

But regulators take their cues and power from governments. Negative comparisons have been drawn between the telecoms industry and its regulator, Ofcom, which is driven by the government to ensure projects such as fast broadband receive adequate investment.

This is not just a supply issue. Demand is also an issue. As the weather becomes wetter, population size and urban concentration rise.

I recently visited London’s Finsbury Park neighborhood to see rusty pipes laid over 150 years ago during Queen Victoria’s reign that have been replaced by bright blue plastic pipes.

When the old pipeline was laid, the land above it was semi-rural. Today, water company engineers work underground in residential areas, facing disruption and expense.

In recent history, cities have become increasingly densely populated. In 1990, when water companies were privatized, 45 million people lived in urban areas. Today, that number has reached 58 million, an increase of nearly 30%.

Meanwhile, rainfall has increased by 9% in the past 30 years compared with the previous 30 years, and six of the 10 wettest years since Queen Victoria came to the throne have occurred since 1998, according to the Met Office.

Heavier rainfall floods aging infrastructure like storm drains, which then releases sewage into nearby waterways. Replacing this infrastructure requires huge investments.

As Ofwat chief executive David Black recently pointed out, many companies are often keen to blame everyone and everything but themselves for poor outcomes.

Two weeks ago, Ofwat announced fines of £168m against three water companies over a series of “failings” in operating wastewater treatment plants that resulted in excessive leaks from storm overflows.

Mr Black then told the BBC: “It’s clear the company needs to change and this has to start by addressing culture and leadership issues. Too often we hear people blaming the weather, third parties or external factors for shortcomings.”

There may be some external causes for sewage discharges, but effective monitoring, reporting, rising complaints about complaint handling and billing errors are a tough sell.

Some executives complain privately that they are in a doom loop. They can’t charge enough fees to invest the money they need, the infrastructure breaks down, and then they get fined – which leaves them with less money to invest in the things they’re fined for.

This is what Sir John Cunliffe is now responsible for. Over the next six months, he will hear evidence from customers, companies, engineers, climate scientists, environmental activists and many others.

British Water welcomed the establishment of the committee on behalf of the industry: “Our current system is not working and requires significant reform,” a spokesman said.

The environment secretary said all options were on the table, including scrapping Ofwat, which was set up by Margaret Thatcher during privatization in 1989, and replacing it with a new regulator.

That is, all alternatives to renationalization, which many are calling for. Some argue that free market competition doesn’t work when you can’t choose which pipe to get your water from.

But Environment Secretary Mr Reid insisted this was not the solution: “It will cost taxpayers billions and take years during which we will not see further investment and the problems we are seeing today are just It’s going to get worse.”

Ruling this out means that the hundreds or even hundreds of billions needed to fix our water industry and make it future-proof will have to come from private investors – who want their money back and for their own shareholders or pension funds Program membership brings rewards.

This means one thing is for sure – even if toilets continue to flush and taps continue to run, past failures will mean significantly higher bills in the future.

Asking people to pay more to flush their toilets will be a hard sell to swallow when the service is perceived to be failing.

BBC in-depth report is the new home of websites and apps delivering the best analysis and expertise from our top journalists. Under a unique new brand, we’ll bring you fresh perspectives that challenge assumptions and in-depth coverage of the biggest issues to help you make sense of a complex world. We’ll also be showcasing thought-provoking content from BBC Sounds and iPlayer. We start small but think big, and we want to know what you think – you can send us your feedback by clicking the button below.