Sunday 25 February 2024

Cleaning Up The Water

Prem Sikka writes:

England’s water and sewage industry epitomises all that is wrong with our country and should be a major issue for the forthcoming general election. This publicly-owned monopoly was privatised in 1989 for just £6.1bn. It has ever since been inflicting harms on society, with the full approval of the regulator and privatisation obsessed government. Its shareholders and directors are the biggest winners.

Directors of water companies have been incentivised to inflict five broad harms on all, with the aim of securing bigger profits and pay-packets.

Firstly, there is the problem of leakage due to lack of investment and repair and maintenance expenditure. Over a trillion litres of water a year is lost in leaks from crumbling infrastructure. Rather than investing to increase water security, companies tell customers to curb usage.

Secondly, companies boost profits by dumping tons of sewage in river and seas. Between 2020 and 2022, companies were responsible for over 1 million sewage spills for over 7.4 million hours. More recent estimates are 399,000 times a year, equivalent to about 1,090 times a day, posing threat to human health, marine life and biodiversity. Only 14% of rivers in England have a good ecological status, and no rivers in England have a good chemical status.

Thirdly, companies exploit customers. Water companies have operating profit margin of 35% which is extremely high for an industry with captive customers and no competition. Water bills have risen by 363% since privatization, which is around 40% in real terms. However, there has been no commensurate increase in the quality of water security or waste water disposal.

Fourthly, despite high customer bills the investment in infrastructure has been low. No new reservoir has been built in England since 1989. Industry boasts that by 2023 it invested £190bn in infrastructure. However, this number is inflated by creative accounting practices. Water companies capitalise a portion of interest payments and repair and maintenance expenditure which in their view enhances the assets. A 2023 House of Lords report estimated that by 2050 the industry needs to invest between £240bn and £260bn, or over £10bn a year, to control sewage dumping, but the government claims that the current level of investment is around £5bn a year. Clearly, there are major problems ahead.

Fifthly, water companies are serial tax dodgers. In 2018, Michael Gove, the Environment Secretary said: “Last year Anglian, Southern and Thames paid no corporation tax. Indeed Thames has paid no corporation tax for a decade. Ten years of shareholders getting millions, the chief executive getting hundreds of thousands, and the public purse getting nothing”. Much of it is due to financial engineering by private equity owners of companies, very adept at shifting profits to low/no tax jurisdictions. Little has changed. Water companies paid no corporation tax in 2022-23.

The above are major components of profiteering by water companies.

The government’s traditional response is that executive remuneration and investment is a matter for shareholders, albeit under some oversight from the ineffective Water Services Regulation Authority (OFWAT). Water management can’t be left to the private sector as it is a vital resource for life. In any case, shareholders are focused on short-term private returns and neglect broader social concerns. England’s nine major water and sewage companies are more than 90% owned by overseas investors scattered across China, Hong Kong, Singapore, Caymans, Qatar, UAE and elsewhere. They have little or no physical contact with polluted rivers and crumbling infrastructure and have not curbed undeserved executive pay, tax dodges and other abuses.

Shareholders have done extremely well out of water companies. Since privatisation, around £75bn has been siphoned-off in dividends, funded by high debt and squeeze on investment. The cost of servicing the £60.3bn debt pile is passed to customers in higher bills. Out of the operating profit margin of 35%, an average of 20% is used to pay interest and most of the remainder has been siphoned off in dividends, leaving little for investment, which then is inevitably funded with debt. Inevitably, there is a financial crisis and customer bills are hiked. Up to 28% of the customer charges cover the interest cost.

The companies are highly leveraged and are struggling. Thames Water, the UK’s largest water company has debt of £19bn and wants to increase customer bills by 40% or more by 2030. It is now saying that without a substantial increase in customer bills, it will not make the required investment in infrastructure. Water company demands are novel in that companies raise capital from customers, whilst shareholders own the resulting assets and receive the dividend streams.

Water companies have a history of violating environmental rules. Here is a small sample. Since 2010, Anglian Water has been sanctioned 74 times and fined £6.2 million; Thames Water 98 times and fined £175 million; Yorkshire Water 94 times and fined £109 million; Severn Trent 82 times, fined £5.8m; and United Utilities 215 times, fined £6.6m. Directors do not face any personal fines or prosecutions. The puny fines have not deterred and have become just another cost of doing business.

In most other walks of life, habitual offenders would face effective penalties. But in the water industry, directors are rewarded by shareholders with bigger pay-packets. For the years 2021, 2022 and 2023, directors of water companies in England collected remuneration of £70m, including £40.4m in bonuses. It is hard to think of any justification for payment of any bonus to directors engaged in socially harmful practices.

Most people are concerned about the exploitative practices. So, periodically the government soothes public anxieties with promise of reforms. The most recent suggestion is that bonuses for directors may be banned “if a company has committed serious criminal breaches … That could include successful prosecution for a Category 1 or 2 pollution incident – such as causing significant pollution at a bathing site or conservation area – or where a company has been found guilty of serious management failings”. Note the vague words like “could” and emphasis on multiple breaches and failings.

OFWAT has presided over degradation of water and sewage services, but the government expects it to curb bonuses. There isn’t much chance of that as OFWAT is conflicted. Two-thirds of England’s biggest water companies employ key executives who had previously worked at OFWAT. The Environment, Food and Rural Affairs Committee is concerned that OFWAT cannot exercise its full range of powers in case that affects the stability of the sector and water companies refuse to invest i.e. OFWAT is being held to ransom by water companies.

The problems of the water industry can’t be effectively addressed within private ownership or a shareholder–centric model of corporate governance. Here are some alternatives.

  • The government needs to enforce the full environmental duties on water companies. This will reduce their profitability and quite likely make them financially bankrupt.
  • This would be an opportunity for the state to reacquire them at a knockdown price. They should be run as arm’s length not-for-profit organisations with professional management.
  • The government could also adopt a private equity model i.e. the cost of purchase could be loaded on to the entities, similar to private equity acquisition of Asda and Morrisons.
  • The profits and dividends currently siphoned off by shareholders would go into investment in infrastructure. Additional investment can be funded by borrowing.
  • Whether in public or private ownership, at least 50% of the board members must be directly elected by employees and customers to ensure that diverse voices are heard at the board level.
  • Executive remuneration contracts of water company directors should be publicly available so that everyone knows what they are getting. The sanitised snippets in annual company accounts are often economical with information and rarely mention that chauffeur driven cars, private school and medical fees are part of executive pay packages.
  • Employees and customers must be empowered to vote on executive pay, with 51% approval carrying the day. Thus, directors exploiting customers and employees; dumping sewage, neglecting flood defences, dodging taxes and not plugging leaks will experience difficulty in securing high pay. Democracy and people power will act as a pressure point, keeping directors on the straight and narrow path of good practices.
  • If bonuses are to be paid for extraordinary performance, they ought to be paid after extraordinary scrutiny. So, approval of 90% of stakeholders would be required.

The above is not a panacea but will go some way toward increasing investment, improving the environment and empowering people to end abuses in the water industry.