Financing the private water and sewerage Companies of England and Wales

Introduction

Updated to Tuesday 21 August 2010

With the transfer into private ownership in 1989, of the water and sewerage companies of England and Wales, there was general dismay at what were seen as excessive charges. We were told that household water and sewerage bills were higher than expected due to the high cost of making good 200 years of neglect as well as meeting improved standards for water quality and a clean environment. Most unfortunate were South West Water customers whose bills, from the outset, were significantly above the industry average due to the additional cost of Clean Sweep, the programme to install sewerage treatment works around the coast of the South West peninsular in place of something like 250 raw sewage sea outfalls.

More than 20 years on from privatisation and South West Water charges remain the highest in England and Wales at about 20% above the second highest (those of Wessex Water) which themselves are about 20% above the industry average. The main reason given for the inordinately high South West Water household bills - at more than 40% above the industry average - remains the high cost of the coastal clean up despite announcements to the effect that Clean Sweep is now essentially complete.

Unfortunately the Walker Review of water charges was not exactly searching but the report does include some financial information which is of interest. As detailed in Table 1 of "The Walker Report and SWW", referenced above, the projected capital expenditure for South West Water, over the 5 years 2010-15, is shown to be £558 per household compared with the industry average figure of £549. This is of course the charge on customers intended to finance the ongoing capital investment programme (including any residual Clean Sweep projects) and, at less than £2 a year above the industry average, can hardly be the reason for South West Water household bills being more than 40% out of line.

The real cause of the wide range of household charges are those levied to provide shareholders with "return on capital". These are mainly based on the regulatory capital value (RCV) of the assets accrued since flotation in 1989 and are shown in Table 2 of "The Walker Report and SWW". The RCV per household for South West Water is shown as £3,053 compared with an average industry value of £1,441. The "return on capital" charges for South West Water are therefore largely based on a capital value that is more than double the industry average. This obviously accounts for the 35% profit before tax projected for South West Water within the total 2010-15 revenue package of £2,082 million.

This is a ridiculous level of "profit" which will take more than one third from South West Water household bills for the next 5 years. Wrong-headed as this profit determination certainly is, what is to be said about a "return on capital" based on the accrued RCV and levied on the unfortunate customers who themselves financed that RCV in the first place. An unwarranted charge to provide such a huge and unwarranted benefit to shareholders is surely beyond any sensible justification.

Having financed Clean Sweep since flotation in 1989 - having essentially gifted to shareholders the bulk of the assets comprising the RCV - South West Water customers are now paying a "return" on that RCV to provide shareholders with substantial profits. It should be noted that this arrangement is not specific to South West Water and is therefore likely to be expensive for all water customers since it is a direct incentive for the companies to promote capital investment projects. For normal private companies, capital expenditure must generally be financed out of revenue against other demands, such as shareholder dividends, and any anticipated financial benefits are by no means assured. However, for regulated water companies, the benefits of capital investment projects are clearly established. Ofwat approval must of course be obtained but this done it is gravy all the way. The projects will be generously financed by increased Ofwat price determinations and in due course, as projects are completed and the investment is accounted as RCV, shareholders can begin to enjoy the regulatory "return on capital", again financed by increased prices.

The figures quoted above are taken from the Walker Report and are easily verified from references given in "The Walker Report and SWW" to the report which is available on the Defra website. These figures are therefore beyond dispute in clarifying a hitherto obscure aspect of the Ofwat fixing of water and sewage charges. They also completely contradict and refute the general understanding that South West Water is a special case and that its excessive charges are attributable to the ongoing cost of keeping the beaches clean. Further problems and anomalies related to the Ofwat regulatory regime are discussed in the papers listed above. Comments will be welcome.