Thames Water
the limits of privatisation and a new
interventionist model
Steve Wardlaw, April 2024
It seems that the mess of Thames Water has presaged across the board agreement as to next steps - Libby Purves in the Times newspaper, left wing commentators and even Jacob Rees-Mogg are in agreement that Thames Water should be allowed to fail. That famous Corbynista Jacob Rees-Mogg has gone on record as follows:
“Thames Water ought to be allowed to go bankrupt. It would continue to be run by an administrator, the shareholders would lose their equity but they took too much cash out so deserve no sympathy and the bond holders would face a partial loss. This is capitalism, it won’t affect the water supply.”
This is an amazing statement from an ex-asset manager, and deserved more attention that it got. Interestingly, it is a statement that suits both the right and the left. If you are a free-market capitalist, then this is the logical consequence of market risk, and if you are on the left, then this is punishment for failing to meet societal objectives.
Looking from any angle, one would struggle to defend Thames Water. The asset stripping, the eye-watering sums paid back to shareholders, and then the chutzpah of asking to raise future investment sums from consumers have become the stuff of cartoon-caricature capitalist legend. However, looking at this extreme example should cause us to cast a more detailed eye over the whole privatisation ‘experiment’.
It is now clear that privatisation has ‘failed’ in a number of areas. But how should we judge success or failure?
Well, what was privatisation trying to achieve? At its purest level, there was a claim that the private sector can run a business better than the public sector. But within that there was a series of alleged sub-benefits:
It took future investment off the books and would not cost the government more
Expansion could be done without need for government intervention
The market will set a market price for consumers which will maximise efficiency
Consumers will have greater choice
Well, it is clear that some of those worked, or at least some of those worked to start with.
However, there are some issues with this selection of benefits. The first is that market efficiencies and market marginal pricing are great concepts in a truly elastic market. They work less well with a ‘must-buy’ commodity, or in a monopolistic situation. (That was the reason behind a regulatory regime, of which more later.)
The second issue is that the dogma of unfettered privatisation was applied to too wide a series of industries. Clearly there are benefits in bringing competition into telecoms, and maybe energy (more re electricity than gas) but most people struggle to see the benefits in rail and water. Indeed, rail privatisation has resulted in higher real-term subsidies then when the railways were in public ownership. And the water sector is, well, shit. Literally.
I used the word ‘dogma’ in the previous paragraph deliberately. It didn’t need to be that way. We can see far more successful models in continental Europe where re-energised public ownership has generated better service, investment and income for the state.
Much has also been written about the failings of regulation. There is fair critique, but regulation was put in place with the best of intentions. As I have referenced in previous articles, the initial model of regulation worked well initially when the various new companies had all come from a single pie that had been divided up – an “all pals together” model where industry specialists took over running of a previously public department sector or company.
The failings arose later, but arose big. This model of regulation has proven to be woefully inadequate – under both Labour and Conservative – when it comes to Macquarie, Vampire squids, Rees-Mogg himself, and others. Regulation was never really designed to deal with financial engineering, or profiteering. It was looking only at price regulation and driving down consumer costs with its RPI-X formula.
It is clear that the owners of Thames Water were simply happy to take profits without looking to build a longer term future. And why should they do otherwise? They are companies that look naturally to maximise shareholder return over a short cycle.
But being wrongly regulated and reaping market rewards has its converse side. If you are happy to bear shareholder rewards, then you must simply bear the risk to being a shareholder. It is not the state’s job to bail out venture capital and private equity outfits. If there is a lesson here for the coat-tailing pension funds, it’s that they should pick their bedfellows more carefully.
We have talked before about a more interventionist regulatory model. That would involve two particular ideas. The first would be specific targets for investment and capital injections. This could be done by a beefed up super regulator, whose job is to set out investment plans over the next 10 years for the country’s ailing utilities. The second is to cap returns on investment. This may have an effect of deterring vampire squids, but may also prove an attractive gilt edged investment asset for pension funds (as the government would then give some guarantees on return), and others who should be looking for a more stable return on their capital
Remember, at the time of privatisation, we gave away ‘gold plated’ assets (ie systems that were built totally around resilience and not around value or cost) and allowed the private sector to strip them out/run them down. Was that always going to happen? With hindsight, perhaps. The government thinking at privatisation was that a utility was a service and people would accept different levels of service at different price points. However, what has happened is that the public expected a must run service which is simply not on offer from private enterprise. And private enterprise does not want to be a supplier of last resort, subject to commercial constraints.
How do we fix it?
Well it’s going to cost money. But most of it doesn’t have to be state money. Pivoting the structure of utilities to provide a fixed if unspectacular state-guaranteed rate of return on capital spent will attract a number of investors, just not those after a quick turn. If the regulator then agrees capital investment plans, it can direct the redevelopment of system resilience (storage, better transmission links, increased green power). Resilience will mitigate energy shocks but many of our assets that helped resilience (eg the Rough gas storage field) were sold off to traders. That was an error that should not happen again.
How do we start?
The first step is to show determination Thames Water should be allowed to fail. The government should start taking back licenses without question and without hesitation where banks and other investors start playing like naughty school children. These are not currencies, other shares, or crypto. These are utilities. The government should introduce legislation to require an immediate upgrade in utilities. For the water sector, that means in terms of metering, sewage, outlet, and water quality. if companies feel that that is too much for them, then they are free to bear the risk of handing back the keys.
All companies when negotiating with governments are brilliant, almost Oscar winning, at playing the hardship card when a commercial deal is set out. Yet amazingly, they all want to continue in the play. This needs to stop. The government should simply cap the returns on utilities and return them to being a public good in two ways - a public good for the people who use utilities, but also a public good as a gilt edged stable investment for our pension funds and others.
This is a good example of a virtuous circle, where creating stable if uninteresting returns will attract for those who need stable, uninteresting returns for investors, increasing capital and allowing the government to direct the investment.
Libby Purves in the Times was right on the difficulties in managing the interface between utilities and investor greed. We simply deal with that by restructuring the sector and its funding to attract a different and more long-term investor. This is something that the Labour party, should it get in, must make one of its top priorities.
Cover: stock