“Turning around Thames will take time,” said Cathryn Ross and Alastair Cochran, interim chief executives of England’s largest water company. This plea for understanding would sound more convincing if their two predecessors had not said the same thing on many occasions since about 2016. The deep crisis at Thames is not new. Declarations of fresh starts arrive as regularly as the pollution incidents (up from 217 to 257 in Tuesday’s half-year numbers). Delivering on the good intentions – the only bit that matters – is where the company consistently falls short.
On the plus side, the Ross/Cochran plan envisages a shorter time span to demonstrate progress on leaks, pollution, complaints and more – three years, whereas Sarah Bentley, the previous boss, talked about eight and departed after two. At this late stage, though, customers are entitled to believe it when they see it.
The same comment – critically – can also be made about the shareholders’ promises to provide more capital to support greater investment. There has been an entertaining row in recent days over whether the £500m of new “equity” this year is really debt (answer: since the regulated entity isn’t on the hook to repay, it’s probably equity for practical purposes but the parent still looks grossly overborrowed). But the £500m is not the main event. Nothing like.
For starters, another £750m is due from shareholders, mostly a crew of pension and sovereign wealth funds, within the current regulatory period that ends in March 2025. And the main course is the £2.5bn earmarked for the next five-year regulatory period starting in 2025, for which all water companies recently made submissions for bills, allowed returns, capital spending and so on.
Note, though, the enormous conditionality that Thames’ shareholders attached in July’s announcement: “The nature and level of such medium-term support will depend on the finalisation of the business plan and the regulatory framework that will apply to the AMP8 period.”
The first condition – a business plan – now seems to have been satisfied. But regulator Ofwat’s view of what Thames should achieve in 2025-30, and the financial arrangements that should underpin a proposed overall £18.7bn programme, was always going to be the stiffer obstacle.
The regulator will opine on all water companies’ submissions next spring but Thames’s plan, including 40% increases in bills, does not look a slam-dunk, regulatory-wise. Martin Young, Investec’s analyst, pored over the industry’s dense submissions and concluded in October that: “Thames Water, seeking higher returns, downside protection, and scaling back ambition, is clearly a problem.”
You bet. Apart from a higher cost of capital, Thames seems to want company-specific targets and restrictions on fines that reflect the hole it is in. One could argue, as Thames does, that incentivising realistic goals is the surest way to ensure new infrastructure is built. Yet setting excessively soft performance targets – compared with other water companies’ – would look suspiciously like Ofwat letting Thames’ owners off the hook for past failures, which is not how the system is meant to work. Yes, the regulator is obliged to ensure a company’s plans can be financed; but there also has to be a cost to the owners for running a water company badly.
We won’t get a proper glimpse of the tension over the business plan until Ofwat speaks in the spring. But Tuesday’s mini-drama on dividends perhaps offered a clue to current relations. Thames’s half-year numbers mentioned a post-period dividend of £37.5m to an entity within the group’s elaborate corporate structure, but Ofwat demanded to see the justification. Quite right too: since May, the regulator has had the power to stop dividends, even those used to service debt, if performance for customers or the environment is not up to scratch. Thames’s payment looks a clear case for investigation.
If this minor standoff heralds a bigger showdown on the financing of the 2025-30 plans, there is trouble ahead. Thames’s owners want regulatory “comfort” that they can earn a decent return on investment, but there is surely a limit to what Ofwat can credibly offer without rewarding failure. Until the shareholders commit financially, Thames’s future is murky.