Thames Water has a problem: cash-strapped, struggling to control sewage flows and water leaks, and without the storage capacity to cope with shortages during hot weather.
Concerns about the future of Britain's largest water provider came to a head this week when investors refused to inject a much-needed £3bn of equity, despite nearly a year of negotiations with the water industry regulator, Ofwat.
Thames Water, the government and Ofwat are now rushing to find a solution.
The risks are high: for consumers who will have to pay higher bills; For investors, including pension funds, who may experience significant losses; As for the government, which may find itself having to bear responsibility for delivering about a quarter of the population's water and sanitation supplies.
Will Thames Water be re-nationalized?
The government and Ofwat are determined not to return Thames Water to government control, not least because it will increase pressure ahead of the general election later this year.
There may not be a choice. The company needs £3bn of equity by 2030 just to pay its staff and suppliers, and to pay for maintenance and infrastructure improvements.
The group's nine shareholders – including pension funds OMERS and USS – last year injected shares worth £500m in the form of a loan, via Thames Water Kemble's parent company, at 8 per cent interest.
But they are unwilling to invest more unless Offwat makes way to demand higher bills, dividends to allow them to pay down debt, and some relief from regulatory fines. This includes £500m due by the end of March, which investors conditionally pledged last year.
Although Labor and the Conservatives have not called for renationalisation, there is increasing pressure from the public, with 69 per cent of people believing water companies should be nationalized, according to a YouGov poll in June last year.
If the government is forced to renationalise, the closest example might be Railtrack, the rail infrastructure company. This faced similar public disapproval over safety issues, and was eventually taken into private management in 2002. The government eventually paid £500 million to shareholders and re-nationalized the company under the name Network Rail.
What are the other options?
Ofwat and the government are keen to find new investors for Thames Water, but there are several potential hurdles.
Regulatory uncertainty combined with years of underinvestment does not make Thames Water an attractive prospect.
Potential new investors will need to wait for the outcome of Ofwat's draft findings in mid-June, which will determine how much Thames Water can increase customer bills over the next five years.
Before that, £190m of debt at Kemble was due to be repaid on April 30, which the company said was unlikely to be repaid without the arrival of new shares. This could lead to a chaotic debt restructuring or the bankruptcy of this holding company.
In theory, bondholders and banks could lobby for control of the company by swapping debt for equity.
But it is not at all clear whether they want to own a troubled company that needs billions of pounds of investment and which has sparked public outrage over its sewage outflows.
How did Thames water become so urban?
When former Prime Minister Margaret Thatcher privatized the water monopolies in 1989, she canceled their debts. Since then, Thames Water Group's loans have increased to £18.3bn as the company moves from owner to owner.
By 2006, when Australian asset manager Macquarie bought Thames Water from German utility group RWE, the water company had £3.4bn of debt.
By the time Macquarie sold its final stake in Thames Water in 2017, the company had spent £11bn of customer bills on infrastructure. But far from injecting any new capital into the business – one of the original justifications for privatization – £2.7bn was taken in profits and £2.2bn in loans, according to research by the Financial Times.
Meanwhile, the pension deficit rose from £18 million in 2006 to £380 million in 2017. Thames Water's debt also increased sharply from £3.4 billion in 2007 to £10.8 billion at the point of sale. .
Now Thames Water says it will not be able to deliver on its turnaround plan if it does not get more money from shareholders.
More than half of Thames Water's debt is index-linked, according to ratings agency Standard & Poor's, burdening it with higher interest payments as inflation has risen over the past 18 months.
The facility could also face significant fines as part of the Environment Agency's criminal investigation into alleged failings at its wastewater treatment works.
What operational challenges does Thames Water face?
Thames Water has admitted that aging infrastructure, such as water pipes and wastewater treatment plants, is becoming increasingly vulnerable. They have to spend more on repairs, leaving less money for improvements.
Households across London and the south-east have been left without water for days on at least two occasions in recent months, mostly as a result of failures at pumping stations.
The average lifespan of water main pipelines – some of which are large enough to require divers to repair – is more than a century in London.
An additional problem is that some pipes are made of asbestos and lead, and must be replaced. However, Thames Water's historic pipe replacement rate of just 0.5 per cent per year since 2015 means not only would it take 2,000 years to replace the capital's entire network, but also that it is well below international standards.
There is also widespread anger over sewage pollution. According to data from the Environment Agency this week, 47 overflows owned by Thames Water discharged raw sewage more than 100 times last year.
The annual regatta will go ahead this weekend despite warnings about “dangerous” high levels of pollution caused by sewage on the River Thames.
What are the political ramifications?
Thames Water is politically controversial for two reasons. Firstly, it is part of an unpopular industry that regularly pumps sewage onto beaches and rivers in Britain. Second, critics see this debt-ridden giant as evidence that water privatization was a huge mistake.
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Michael Gove, the settlement minister, sought to tap into that zeitgeist on Thursday when he described Thames Water's management as a “disgrace”. Gove said the company was making profits and failing to invest, adding that the solution was “not to hit consumers”.
However, Gove's position is at odds with the approach the government has taken behind the scenes over the past year.
Although there is no evidence that ministers put pressure on Offwat to meet the company's demands, some secretly hoped that it would allow various “regulatory accommodations”, such as reduced fines and higher bills, to keep shareholders in the company.
The regulator did not do this.
“Ofwat is full of people who are almost overzealous about the purity of their econometric models, and the problem is that this means they think troubled companies should be punished more,” said one person close to the talks. “Their belief in moral hazard means they may be oblivious to the consequences the collapse of a major water company could have for the water industry and the wider economy.”
Ofwat declined to comment.
The regulator's apparent refusal to give in poses a political problem for whichever party is in power if Thames Water eventually collapses.
“If they are going to collapse, let's hope it will be before the general election,” said one senior Labor figure, aware of wider concerns about other highly equipped water companies.
Likewise, a Tory government aide said they hoped Thames Water would continue to struggle into next year: “No one wants to be the person who commits billions to an unpopular industry when public services are screaming for money.”
