Britain builds moat around leaky Thames Water
The author is a Reuters Breakingviews columnist. The opinions expressed are his own. Updates to add graphic.
By Neil Unmack
LONDON, July 11 (Reuters Breakingviews) -Thames Water may yet fail, but the rest of the sector should be okay. That’s one way to read the latest edict by British water regulator Ofwat. Allowing UK utilities to invest more and earn a higher return could encourage foreign investors to see Thames’ troubles as local rather than systemic.
Every five years the UK's privatised water companies say how much they plan to invest, and Ofwat then decides how much they can charge customers and thus what return shareholders can make. In 2024, customers are sick of bills and sewage leaks, but companies say they need to invest more to cope with global warming. Thames, the most indebted, has been unable to secure the equity it needs to cut debt from a toppy 80% of its 20 billion pound regulatory capital value (RCV), a theoretical estimate of its ability to generate returns.
Ofwat’s draft decision is humiliating for Thames. The regulator has deemed its business plan “inadequate” on dealing with waste, threatened it with more fines, trimmed its investment request by over 5 billion pounds, and placed it under closer monitoring. It will make the group’s shareholders, including the UK’s Universities Superannuation Scheme, even less likely to invest fresh equity.
It’s possible placing Thames on the naughty step makes it easier for the regulator to take a softer approach in future, via fewer fines or permissions to delay investment. But the company will still need to persuade new investors it can turn its business around, or else risk bondholder haircuts. The yield on Thames Water’s 2032 unsecured bonds jumped to 9.4% on Thursday, up over 200 basis points since March, a sign of rising risk of default.
Prime Minster Keir Starmer’s main concern is that a Thames implosion prevents other water companies from financing themselves. The good news is this looks increasingly less likely. On average water companies last year had debt of less than 70% of RCV. Thursday's announcement means companies can increase investment by 88 billion pounds over the next five years, and make a return on equity of 4.8% above inflation, over 60 basis points above previous expectations. Listed water companies like United Utilities UU.L or Pennon PNN.L are now trading above their regulatory capital value, a theoretical estimate of their worth according to JPMorgan estimates, suggesting the market views the returns as adequate.
The flip side is that bills will rise. UK customers will now on average pay 19 pounds more per year, after inflation, and the ensuing political heat may encourage governments and regulator to take a tougher line. For the time being, that may prevent foreign investors from venturing anywhere near Thames.
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CONTEXT NEWS
Shares in UK water companies rose on July 11 after sector regulator Ofwat allowed companies to step up investment and earn higher returns.
Ofwat’s preliminary draft determination allowed companies to invest 88 billion pounds over the five-year period between 2025 and 2030. While that was 16 billion pounds less than the level requested by companies, it is still a substantial increase from 59 billion pounds in the previous regulatory period. The average customer water bills will rise by 19 pounds per year, before factoring in inflation.
The prices will allow companies to make a return on equity of 4.8% above inflation, higher than the 4.14% estimate that had initially been suggested by the regulator.
Separately, Ofwat said that the business plan of Thames Water was inadequate because it had not justified the level of investment and costs it requested, and said the company should be subject to closer oversight. Thames will be allowed to spend 16.9 billion pounds over the 2025, 5.1 billion pounds less than the sum it had requested.
Standard & Poor’s on July 11 placed its ratings for Thames debt on credit watch negative, citing weaker liquidity.
Shares in Pennon rose as much as 7.8% on the morning of July 11, while those in United Utilities rose nearly 3%.
Thames Water's assets are older than those of UK peers Thames Water's assets are older than those of UK peers https://reut.rs/3VG7D2b
Editing by George Hay and Streisand Neto
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