Harder to swallow

The UK water industry has found itself running for cover after several prominent politicians and newspapers rained fire on the sector over recent weeks.

After several articles painting water companies as a cartel of tax-dodging pillagers, content to gear public assets to the hilt in the interest of paying large dividends to investors, the industry emerges sporting a black eye and a limp.

The Observer aimed a choice barb at Thames Water’s owners, an investor consortium led by Macquarie: “Macquarie is the bank that makes Mitt Romney’s Bain Capital look saintly,” it wrote. Cue widespread grimacing at Macquarie headquarters.

Eye of the storm  

That Thames Water is in the eye of the storm is unsurprising: there is a £4.1 billion (€5.1 billion; $6.5 billion) sewer tunnel to be built under the River Thames and someone will have to foot the bill. 

But under 2010 legislation, that someone won’t be Thames Water, as the project was deemed too risky for a traditional water company and will instead be built by a ring-fenced special purpose vehicle.

Critics disagree with this decision, arguing Thames Water should have set aside the money to build the project. They suggest the company didn’t because it was too busy paying excessive dividends to its owners via a tax-dodging holding company. 

The row is, clearly, ideological. Yes, Thames Water’s owners make a profit out of it, but that profit is not illegal and is regulated by Ofwat. And yes, the consortium that owns Thames Water is located in Luxembourg – as are many similar structures. Rightly or wrongly – but again legally – this allows foreign investors to avoid double taxation. 

Thames Water is also eligible for capital allowances and tax deferrals on the £1 billion-a-year it spends on maintenance and improvements. But as a Thames Water spokesman put it: “Corporation tax deferrals – that is tax delayed not avoided.” If there’s any malfeasance, it has yet to be proven.

It’s beyond disingenuous to argue the private sector should invest charitably in these assets: the fight here is about what return it should be allowed to earn.

Coincidentally, this very public row erupted with the industry and Ofwat already at loggerheads. As Moody’s recently highlighted, Ofwat is seeking unprecedented flexibility over the sector, including the ability “to move activities accounting for up to 40 percent of companies’ total revenues outside of the established price control framework”. It also wants to end the current five-yearly price review.

Water companies were given until November 23 to agree or disagree with the proposed changes. If they disagreed, Ofwat said it may refer the matter to the Competition Commission in December. The next price review is in 2014.

All of this can be immensely frustrating, especially considering the £100 billion in institutional capital the industry has attracted over the last 20 years – capital the government now wants to attract for other infrastructure sectors.

But there’s no such thing as a free lunch – or a free glass of water. Regulatory risk is the price to pay for the relative stability of investing in public monopolies like water companies. 

As cash-strapped as governments may be, investors should not kid themselves: with gilts in perceived safe havens yielding close to nothing, governments know investors have to park their money somewhere. And next to zero, public assets yielding even a lowly 5 percent can start to look very attractive indeed.