Water Industry: Financial Resilience

Commons Urgent Question

The following Answer to an Urgent Question was given in the House of Commons on Wednesday 28 June.

“Water is what makes life possible on our planet, and it is essential for our health and well-being, as well as for our economy, including the production of food and clean energy. The Government are taking significant steps to ensure that the water industry is delivering the outcomes that bill payers expect and deserve. Water companies have invested £190 billion since privatisation in 1989. In April, the Government published the Plan for Water, bringing together more investment, stronger regulation and tougher enforcement capacity for regulators in relation to those who pollute.

Ofwat and the Government take the financial resilience of the water sector very seriously. Ofwat is the independent economic regulator for the water sector and has responsibility for its financial resilience. The sector as a whole is financially resilient. Ofwat continues to monitor the financial position of all the key water and waste water companies. Ofwat reports annually on the sector’s financial resilience, and Ofwat’s latest annual monitoring financial resilience report shows that the water sector is financially resilient.

Market confidence in the sector is demonstrated by new acquisitions, such as Pennon’s purchase of Bristol Water, and by shareholders being willing to inject new capital. Ofwat has taken steps in recent years to strengthen the sector’s position. That includes action to update the ring-fencing provisions in water company licences to better safeguard the interests of customers, and barring water companies from making payouts to shareholders and removing money or assets from the business if they lose their investment-grade credit rating. Ofwat has outlined that water companies must be transparent about how executive pay and dividends align with the delivery of services to customers, including environmental performance. Since privatisation, total capital investment has outstripped dividends by 250%.

On 20 March 2023, Ofwat announced new powers that will enable it to take enforcement action against water companies that do not link dividend payments to performance for both customers and the environment. In December 2022, Ofwat strengthened its powers on executive pay awards by setting out that shareholders, and not customers, will fund pay awards where companies do not demonstrate that their decisions or pay awards reflect overall performance. We support Ofwat’s work, and we urge all water companies to take this opportunity to review their policies.

The scale of the Government’s commitment to the water industry is highlighted by the integrated plan for water, and by our commitment to the financial resilience of the sector in delivering for customers and the environment.”

My Lords, back in December last year, Ofwat outlined concerns about the financial resilience of several water companies, and now we see that the ratings agency S&P has negative outlooks for two-thirds of the UK water companies that it rates because they are overleveraged and beholden to too much debt that was taken on in an era of low interest. How does the Government’s assessment of the overall resilience of water companies compare with that analysis? Have the Government looked at the impact on customers of these financial deficits, and how will they encourage investment into much-needed infrastructure in order to secure reliable and sustainable water supplies for the future?

I thank the noble Baroness for her questions. First, this will not impact on customers. Their bills are regulated by agreement with the regulator, Ofwat, and we do not expect any reduction in service—that is also strictly monitored. We think that investment by water companies into our water sector infrastructure is important, which is why we have agreed that there will be the largest-ever investment—£56 billion—to see our infrastructure further improve.

Since privatisation, £190 billion of capital investment has been made. In real terms, that is twice what was happening at the same rate prior to privatisation. We have also seen improvements in the provision of water for customers, and we want to see that continue. We look very carefully at, and work with, Ofwat and the water sector on concerns about leverage—I share the noble Baroness’s concern about some of the companies’ degree of leverage. It is interesting that the level dropped last year from 72%, where it was in 2021, to 68%, which was roughly the same as it was in 2005, having risen from 37% when the previous Government were in position. However, Thames Water in particular has a much higher leverage rate, which has rightly caused concern for the Government and the regulator. That is why we are working with it to make sure that it is viable. We believe that with £4.4 billion of liquidity in its business, it can trade through this.

My Lords, Thames Water is not the only company causing concern: Southern Water, Yorkshire Water and South West Water were mentioned in the other place. Last year, £1.4 billion was paid out in dividends. Meanwhile, sewage poured into waterways, flooding affected many areas, and others had their water delivered in bottles. Ofwat cannot solve these problems. Surely it is time for the Government to take back control and sort out this essential service.

We think that the model that operates at the moment is the right one. We have seen more investment, but if the Government took back control, that would, in effect, put the onus back on the taxpayer. That would mean that I or the Secretary of State would have to get in the queue behind the health service, pensions, and all other areas of government spending to get the right levels of capital investment we need in the water industry.

We think that the £56 billion can be afforded at a relatively modest increase of around £12 per household. For roughly £1.20 a day, households receive the water they need and sewage and dirty water are removed from their homes, and there has been a massive increase in spending on the infrastructure we need, some of which is still in need of changes. Through this model, we have delivered a better outcome for the consumer and for the taxpayer. We have concerns, and I share the noble Baroness’s concerns, certainly about the issues relating to Thames Water and one or two other companies. Ofwat has been proactive in trying to resolve the concerns with those companies, and we are watching the situation very closely.

My Lords, I declare my interest as co-chair of the APPG on Water. My noble friend will recall that alarm bells rang some years ago when a number of water companies were based offshore in places such as the Cayman Islands, which seems singularly inappropriate. I congratulate my noble friend on putting in the statutory and legal effect that dividends and bonuses must now be linked to environmental performance. Does he imagine that that will have an immediate effect or will it take some weeks and years before it comes into force?

I welcome the fact that overseas investors want to invest in our regulated utilities sector. We must remember that actions that Governments take on one element of the regulated utilities sector can have impacts right across it, but I appreciate the comments from my noble friend. We have introduced new legislation to support our ambitions to bring into force stronger powers for our regulators to tackle pollution and improve transparency with the public so we can hold water companies and polluters to account. Through the Environment Act 2021, we have also introduced a statutory duty for water companies to achieve a progressive reduction in the adverse impacts of discharges from storm overflows. This is in addition to new, legally binding targets to significantly reduce pollution from farming, wastewater and abandoned metal mines; and the water demand target to reduce leakage, increase the resilience of supplies and leave more water in the environment.

My Lords, I should be grateful if the Minister can clarify two points for me. In the other place, the Minister mentioned £190 billion of investment by water companies. That does not seem right, because it appears to me that companies are capitalising repair and maintenance costs, which is contrary to good accounting practice. Could the Minister check on that? Secondly, looking at the last two years’ accounts of Thames Water Utilities’ holding company, I see dividends of £70 million, plus £452 million interest paid on loans from other group undertakings. That sounds incredibly suspicious and is a form of profit-shifting and tax abuse. Please can the Minister get his colleagues, or his own department, to look at those things and report to the House.

The £190 billion is the amount water companies, with regulator approval, have invested in our water infrastructure. Thames Water has not paid out any dividends to its investors, but it has paid out dividends to its holding company to finance its borrowings. In 2017-18, it was £55 million; in 2021-22, it was £37 million; and it has since been, roughly speaking, around and between that. The figure is lower this year than it has been in the past. It has also recently secured from investors a further £500 million, and, as I said earlier, its liquidity, at about £4.4 billion, means that it is a viable trading company.

My Lords, it seems to me that there is a real cultural arrogance within the management of water companies, and a feeling that however fast and loose they play with financial engineering, they are too important to fail. Does the Minister agree?

I can speak only across the whole range, and there are some very good, well-run water companies and some to which, in the past, I would have applied some of the words that the noble Lord used. I think the message has really come home to roost, not least from this place and the other place, but also from a general feeling of anger among the wider population about the degree of pollution. One reason for that anger is that we have provided the public with the information, and I am extremely proud that we did. We used to know about 5% of the sewage outflows; we now know about nearly 95%, and by the end of this year it will be 100%. We have made that information public—you can see it on Twitter almost every day—and I am really pleased that people can hold their water companies to account. I have certainly questioned some of the practices of certain water companies, but I think the model is right and we need to get behind it, as did the previous Labour Government. I hope that all future Governments of any persuasion will recognise that this is the best way to get significant investment into protecting our environment for the future.