How bad is the crisis at Thames Water?

Thames Water is in trouble.

Britain’s biggest water utility, which provides essential water and sewerage services to around a quarter of the population in England, says it does not have enough cash to last the next 12 months.

And there is no guarantee it will be able to raise more. The regulator put it into special measures on Thursday.

South East Water also said this week that it needs cash from shareholders to stay afloat, while the regulator said it is keeping a close watch on Southern Water, which also has strained finances and failing infrastructure — including sewage outflows at popular seaside resorts.

The water monopolies’ ability to raise cash from investors depends on bill increases being approved by the regulator.

Consumer bills pay for the utilities’ operations, infrastructure improvements — and more controversially, for executive pay, bonuses, debt interest and dividends.

But in a draft ruling on Thursday, Ofwat proposed water bill increases of around a fifth: far short of the average 33 per cent requested by UK water companies.

This could still be insufficient to persuade investors to inject equity into some of these most troubled companies, especially given the public opprobrium over sewage pollution.

That could lead to the collapse of one or more of the utilities into the government’s special administration process, 35 years after the state-owned regional water monopolies were privatised and just as the new Labour government seeks to promote the UK to foreign investors.

How bad are Thames Water’s finances?

Thames Water is burning through cash. The company’s net cash fell from £1.83bn to £1.15bn over the 12 months to the end of March.

The company also said it had “fully drawn” £2.2bn in revolving credit facilities and term loans.

Ofwat may force it over the medium term to break itself up or publicly list as part of the regulator’s special turnaround regime for the company.

Meanwhile debt in the part of its byzantine structure regulated by Ofwat has grown to £16.2bn, up from £14bn the previous year. There are also more than £1bn of loans that need refinancing by the end of December, only some of which can be rolled over, according to the financial statements released earlier this week.

The precarious finances mean Thames Water is vulnerable to a “trigger” event, which could tip it into insolvency. This could be anything from a fine, a further credit rating downgrade or an unforeseen water supply outage.

The company’s reputation has not been helped by its insistence on paying bonuses, including a £195,000 bonus for Chris Weston, who only joined as chief executive in January.

That gave Weston £437,000 for just three months work during a period when Britain’s largest water utility has been battling to avoid nationalisation.

On Thursday Ofwat said it was bringing the company under its new “turnaround oversight” regime, which would be “more stick than carrot”.

That requires a more detailed business plan and closer monitoring, probably from an independent inspector, who will report back to the regulator.

There is also another £1.3bn of debt sitting at parent company Kemble. It has no other interests outside Thames Water and relies on dividends for its survival.

Thames Water will not be allowed to pay any more dividends, Ofwat says, and the company may still be fined for payouts so far.

What are the options for Thames?

Ofwat’s draft ruling provides little clarity for the business.

If Thames Water is to maintain the status quo it needs to convince investors to inject cash, ensuring that bondholders do not take a haircut and the company delivers its turnaround programme.

This would protect the “regulated capital value” model that underpins water, energy and airports in the UK as well the planned new nuclear power stations.

But raising equity from investors is looking problematic.

Ofwat’s consideration of a listing or break-up of Thames Water may slow its ability to raise fresh equity, which it is planning to try in the autumn, analysts said. The company needs £750mn from investors by April and £2.5bn by 2030.

Its existing nine shareholders — the Abu Dhabi and Chinese sovereign wealth funds and pension funds USS and Omers — have already said the company is “uninvestable”, and are refusing to inject any cash.

Tim Short, a former investment banker at Credit Suisse First Boston and water industry specialist, said new investors could potentially come forward but “it’s the sort of people who will shoot you in the face as soon as look at you”.

“Investors would likely be deterred by the poor and deteriorating credit ratings, the reluctance of the regulator to support the company’s infrastructure investment proposals, the newly hostile litigation environment and the catastrophic PR position,” he added.

What is the special administration regime?

If any of the troubled companies struggle to raise fresh equity they will be placed under the government’s special administration regime; a form of temporary nationalisation.

This is different to the turnaround regime that Ofwat is placing Thames Water into. Under an SAR, a failing water company would be run by an insolvency practitioner who would restructure the debt to make the business more appealing to investors.

Creditors may be required to swallow losses so that new investors could come in — though the bigger the haircut, the more reticent they may be.

This “nationalisation-lite” option may be preferred by the new Labour government, not least because it does not require the Treasury to find the cash to redress the years of under-investment in the industry.

It also ensures the monopolies remain in the private sector, giving the government some cover if their turnaround programmes are not fully successful.

But the regime may not work if investors fail to gain confidence in the company or regulator, meaning the company could stay in special administration for years or be permanently renationalised. 

In the meantime, the government is drawing up legislation that would put the entire water industry into “special measures”, with a ban on bonuses for executives of heavily polluting companies, criminal charges for the worst lawbreakers, and closer monitoring of sewage outflows.

That could all deter investor support for Thames Water and other companies.

What is the effect on taxpayers and customers?

Almost all households across England and Wales will face bill increases, in part because of the rise in inflation, which has pushed up labour, chemicals and energy costs.

But Thursday saw merely Ofwat’s draft decision: the final bills will not be known until early next year, and even then companies may appeal to the Competition and Markets Authority.

Lawyers say there should be no impact on customers and no reason for the government to want to take on the companies’ debt if any of the utilities are put into special administration — and probably even if they are renationalised.

The businesses should ideally have sufficient cash from customer bills to survive and deliver infrastructure improvements.

Either way, the government, regulators and water monopolies are keen to reassure investors and customers that staff will continue to be employed, and that the taps will continue to flow. Most days at least.