There is much discussion on the subject of the nationalisation of our water companies right now, with a lot of what is being said by Labour and commentators being close to nonsense. This thread lays out why nationalisation is the right option now, is affordable, and so is right…….
First, I should lay out my credentials for saying what follows. I am a professor of accounting practice at Sheffield University Management School. More importantly, I have been a chartered accountant for forty years and I have bought and sold a lot of companies.
This matters because a lot of what of what is being said right now about the affordability of various options when it comes to our water companies and other utilities is based on political rhetoric and not very much at all on how nationalisation works and how it can be paid for.
The other necessary preamble to this thread is to note the thread I wrote last week. In this, I explained that the English water and sewage companies do, as a whole, look to be operating on the basis of exceptional financial assumptions that threaten their viability.
These water companies are monopolies. They make strong operating profit margins that have over twenty years averaged 38 pence in every pound paid to them. But, and this is the critical point, they have spent almost all that on their funding.
20p in every pound paid to them by us, the water consumer, has gone on interest charges, and another 15p has gone on dividends. The remaining 3p has gone on tax. There has never been profit left over to invest in the new equipment the industry needs.
The scale of the new investment that is required is massive. The government says it's £56 billion. The House of Lords says it is £260bn. Either way, the water companies can only raise this by charging more, borrowing more or getting the shareholders to finally cough up more.
In fact, whatever happens, the shareholders are going to have to do that right now because these companies are losing money hand over fist at present, and that is going to continue. The loss after tax in 2022 was £2.7 billion. This might well get worse.
The worsening situation of these companies is down to their reckless use of index-linked bonds to finance their borrowing. Index-linked bonds guarantee that people lending to a company will get their money back having allowed for the impact of inflation when it is repaid.
The interest rate these bonds pay is usually quite low but people who buy them don't do so for the interest. They buy them because these bonds guarantee repayment of the original sum lent as adjusted for inflation, meaning that the value of the bond does not fall in real terms.
Let me offer a quick example. Suppose a bond is issued for £1 million with a 1% interest rate, and it is index linked. Assume inflation was nothing for 5 years. In those years the interest was £10,000 a year.
Then, though, inflation hits 10% all of a sudden. Now the cost of repaying the loan goes up by £100,000 in the year that happens. And interest is now paid on £1.1 million, the new repayment sum owing. So that year's interest costs £111,000. That's a massive increase.
If the inflation continues for a second year you can see how this might ruin the profitability of a company. If it moves into a third - as now seems possible in the UK - it could mean the end for a vulnerable company with a lot of these bonds.
UK water companies do have a lot of these bonds. Something like 65% of all their bond borrowing is index-linked. They thought they could afford this because a) inflation was not going to happen, and b) they thought they could pass the cost onto us, the customer.
But inflation has happened. And worse, their bonds seem to be linked to the retail price index, but the water regulator, Ofwat, uses the lower consumer price index. So first, they are bound to have losses and, second, we do not need to pay for all of them.
The result is that these companies might look weaker and weaker as time goes on: some of them, at least, do not have the balance sheets to absorb this scale of losses and still look like viable going concerns.
Why say all this? Because any discussion of nationalisation of the companies has to take into account the facts. And the fact is that the finances of some of these companies do not look good.
Not that you would know this from looking at the stock market performance of those amongst them that are quoted on those exchanges. They are Severn Trent, United Utilities and Pennon Group (South West Water).
These companies appear to be in rude stock market health. Take this example, of Severn Trent:
The price is down 10% in the last three months but still up significantly over time. And the current price is 44 times the earnings of the company, i.e. shareholders think it is worth paying 44 times the profit attributable to each share to buy it. They can only justify that by thinking the profit is going to rise.
United Utilities has a current share price suggesting shareholders value it at more than 30 times earnings. Pennon Group is valued at more than 90 times its earnings. Together these companies have a market value of about £14.9 billion right now.
Together these companies make up 36.1% of the English water industry in my estimation, based on weighted average assets, sales and employees. That implies that the sector as a whole in England is worth about £41bn.
On top of that the sector now has about £55bn in borrowing outstanding. So, that suggests that these companies have total funding that might require compensation if there was to be nationalisation of maybe £90bn or more.
However, I doubt this figure. First, these companies are losing money heavily and are desperate for funds for investment. So if the regulator gets heavy with them (as it should) then the shares in them are not worth anything like the sums stock markets are suggesting.
Second, if it becomes apparent that these companies are in trouble the debts that they owe will fall in market value to something well below the amount on the balance sheet. This is what happens in distressed companies.
So, how much are these companies really worth? It depends on a) how long inflation lasts, as it is ruining them with excessive loan interest costs right now b) how long it is before the government acts before nationalising them and c) who blinks first.
The last is important. There is no precise science to company valuation (whatever the textbooks say). At the end of the day it comes down to who is the more desperate to do a deal. If the shareholders panic - and they might - then all the cards are with the government. And vice versa.
Either way, by the time anyone gets near to talking nationalisation of these companies their value will have fallen considerably, is my suggestion. Nationalisation is not going to cost £96bn, in my opinion.
But whatever happens, nationalisation need never have a cash cost. Let me repeat that in another way. It is complete nonsense to suggest that so-called taxpayers' money will ever be used to pay for nationalisation of the water companies.
How can I be so sure? Three reasons. First, I have looked at the nationalisation of industries like the railways in 1947. They too were run down, under-capitalised and in dire need of investment. How did the government pay for them? With bonds.
Technically those bonds used to pay for the industry were repaid thirty years later but actually they were simply replaced with replacement bonds, and so cash has never been paid for that nationalisation as yet.
I cannot stress this point enough. Just as most company takeovers are paid for by the issue of news shares in the acquiring company, so too can any nationalisation be paid for with the issue of government bonds, which then in effect stay in issue in perpetuity.
Cash needs play no part in a nationalisation in that case. What is open to debate is what the fair compensation for shareholders and maybe bondholders might be - because this has to be paid and has been in previous nationalisations.
I argue that the English water companies are now environmentally insolvent. They are surviving in business solely on the basis that they are being permitted to pollute and not pick up the cost. That's not a great business model.
If the government through Ofwat forced the real cost of solving this issue onto the water and sewage companies they would be insolvent, in my opinion. I happen to think that is what Ofwat should do. I also think that should be the basis of the negotiation of fair value.
I would also use that basis of valuation to argue for a write down in the value of debts in issue given that I doubt these companies could service many of those issues for much longer. But I stress, these are negotiations to be had.
The outcome of those negotiations might well change the total value of new bonds to be issued, but not the cash to be paid, of which there will still be none.
So, the only cash cost to be paid is the cost of the interest on the new bonds issued to replace the bonds and share capital now in issue. Let's assume the total compensation package is £60 billion in a couple of years, by which time base interest rates will have fallen a lot.
Let's say the borrowing cost will be 4%. That's a cost of £2.4 billion per annum when the average interest and dividends paid by the companies over the last amount to £3.4bn a year. Even if £90bn compensation was paid (and that would be crazy, in my view) the cost would be £3.6bn.
In other words, this industry can pay for its own nationalisation out of its own cash flow. If it is realistically priced, there would be a significant margin to spare. So in that case to say this can't be afforded because of the cost to taxpayers is nonsense: there is none.
And in that case those politicians saying that this is not an option to consider are simply ignoring two facts. One is that nationalisation does not involve cash. The other is that the money the industry already pays to investors can pay for nationalisation.
So, might we stop the claims that nationalisation is not an option because of the cost of doing it? Nationalisation is not just an option, but at a fair market price it is a totally viable one.
But more than that, given that large-scale state investment in this industry is essential why should it be under the control of anyone but the state? Private ownership and discussions of mutual benefit companies make no sense. Now is the time for the N word to be rolled out.
And one final point, if any government says it could not afford the cost of investment to deliver us safe, pollution-free water after nationalisation then who do they think can? The market certainly could not do so.
So, any politician using this argument is actually saying that they think the state should abandon its duty to provide that most basic commodity, which is clean water. I think that should rule them out of office.
It really is time politicians stopped ducking this issue and started talking about what is possible and necessary. Only nationalisation meets that dual criteria, which is why it must be on the agenda.
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I find nothing to disagree with in this post at all. But even now, there are efforts to sub divide and further privatise the water supply through OFWAT’s New Appointments & Variations (NAVs).
https://www.ofwat.gov.uk/regulated-companies/markets/nav-market/
We’ve ran into NAVs on some new build sites and it makes basic water connection even more troublesome and hard to negotiate through. We tried to engage with a NAV about their regulations for fitting sprinkler systems and all we could find were their Chief Financial Officer details – great if you are an investor maybe but crap if you want to know how to fit domestic water supplies to what is now THEIR system.
So, the desire to continue to privatise, disaggregate and make more complex the system for the sake of ‘investment’ and ‘competition’ is very strong in this industry. The big names like Severn Trent are only a part of the problem.
I post this only so that we can see the totally misguided and atavistic culture we are up against.
There is a lot of nonsense talked about what the state can and cannot do.
The Second World War is estimated to have cost the US over $340 billion in the dollars of the time (over $4 trillion today). By 1945 the war effort was 40% of GDP. And then the Marshal Plan cost a tiny fraction of that but still over $13 billion (over $170 billion today) when the US GDP was around $250 billion.
And some how, after nearly 80 years, the GDP of the US is over $24 trillion and the cost of rebuilding Ukraine is estimated at $400 billion, yet apparently no single government can apparently afford a modern Marshall Plan for Ukraine. Yes, that is approaching two or three times the real spend, but from a GDP that has grown eightfold in real terms.
The state is not as weak as many in the right would paint it, if only it has the purpose to marshal and direct its resources. It is always about allocation and distribution.
To make this relevant to today’s 75th anniversary, can you imagine any government of any political stripe with the ambition and the drive to create the NHS, if it did not already exist.
The continued failure to take any steps to address the groaning need for social care in England demonstrates the lack of any kind of vision to improve the people’s wellbeing.
Thank goodness, in Scotland, the domestic water supply is in public ownership.
Scotland and Wales and Northern Ireland give obvious examples for different ownership models to England. It would be a shame to ignore the natural experiment. Is there any independent and reliable research to measure and judge their performance against the for-profit private bodies in England? How are they doing for customer price and satisfaction, finance cost, investment in infrastructure, sewage, etc? Is the market doing better than other ownership structures? Or is it abusing its effective monopoly power?
The Welsh issue is massive dependence on index linked bonds
Andrew, I’m in Scotland and there are differences in how water services are charged in England & Scotland. Domestic water consumption is metered in England but in Scotland it’s a flat rate charge based on a banding structure that takes into account the size of the house and its location. I’m in a Band G house (3 bedrooms, 3 public rooms, 2 bathrooms and kitchen/dining room) and our current annual charge for water consumption is £387 per year (32.25/mth). I’ve no idea how waste water is charged in England – is it metered too? – but our Band G charge is £449.70 p.a. (£387.48/mth) and covers not just our domestic waste but also our share of regional costs for roads drainage, sewage plants and systems.
For business premises in Scotland water supplies are privatised, with meterage of both water supplied and waste water removal and a regional charge for roads drainage, sewage plants and systems. All the essential supply and waste water services are provided by Scottish Water, but charges are levied by commercial firms (called Licenced (sic) Providers) and payment is made to them, not to the local authority or Scottish Water. Scottish Water is 100% owned by the Scottish Gov and is classed as a statutory corporation, so quite how the Licenced (sic) Providers can supply to businesses at a more attractive rate than would apply if supplied directly by Scottish Water isn’t clear. The history of this is here:
https://theferret.scot/scottish-water-public-ownership/
Suffice it to say that the last thing that Scottish householders would want is privitisation of domestic water or tinkering by dogma-driven politicians.
Stick with what you have Ken
Richard
Of those debts do you have an estimate of how much is owed to the various holding companies of the water companies. And how would that, if at all, affect your analysis.
From what I can gather a big amount of the debt repayment is just going to parent/holding companies, which just seems to be another vehicle for extraction of the rents.
No, not precisely
Most likely though about £10bn
Excellent post!
1typo maybe.. “right down” should perhaps be “write down”? Homophones are a scourge!
Corrected
Thanks
The trouble is, you see what you think you wrote
A very fine post indeed. My vile habit of investing on the stockmarket allows me to comment on price/earning (PE). Severn Trent 44x, United Ute 30x, Pennon 90X (I confess I started to snigger at that point). Most Renewables (which is the part of the stock markets I play in) have PEs of circa 15 through to 30. 30 is “a bit fancy” – but I think we can agree that given the rhetoric from even the UK, the sector will show very strong growth now- 2030. 20% compound is talked about. So, although dividends are meagre, growth compensates.
The very high PEs for the water industry can only be accounted for because
a) each company is a monopoly,
b) the current rating suggest that the market expects the monopolies to continue,
c) the market expects a combo of regulator and polit-sickos to allow things to continue (re money extraction) coupled to allowing large-scale investment – thus expanding the capital base & increasing returns.
I agree with nationalisation – but take the view that it should be done on the grounds of state security. I leave readers to imagine London with no running water or sewage for 1 week. Once rendered in these terms, arguably the current owners of the various companies pose a far greater and direct threat to the well being of the UK than anything else. This argument could and should be extended to the other quasi-mafiosi enterprises that operate the elec and gas networks, equally rapacious and dishonest.
Thanks
And I entirely agree on P/es – these are ludicrous
On the subject of PEs, wasn’t privatisation all about ending monopolies (as well as providing ‘more resources’).
According to Charles Buchanan’s public choice theory ONLY the public sector thinks monopolies are any good and seeks to sustain and benefit from them.
Once again, the pure bullshit of Neo-liberalism is revealed by its own greed.
I do hope the penny has dropped now with the public.
I’ve been thinking about how not to pay my water bill if it goes up? In fact a great campaign for the whole population to do that might be on the cards?
I’d cancel my direct debit, then send a cheque in at the old rate when they ask for payment (holding back additional funds just in case).
Let’s see how these money grabbing bastards would like that.
It would be wonderful if a lot of the population were to do the same.
In Ireland non-payment of water bills was massively successful – vast numbers joined in
The rational approach to problem solving is to compare all the possible options, so here’s another public ownership model from this morning’s The Conversation – https://theconversation.com/renationalising-thames-water-would-be-a-gamble-but-there-is-another-way-to-help-clean-up-the-industry-208880.
Unfortunately testing an option is not like doing science in a lab – the unintended consequences may be overlooked……. and there are always players who keep their hands well hidden……
Thanks
Geoff your argument doesn’t stack up if the United States Federal government can pump money into to help the 87% local authority owned water and sewage industries via the EPA (Environmental Protection Agency) the UK can afford to nationalise the UK industries which are close to worthless in terms of their ability to perform the tasks they were set up to implement!
https://en.wikipedia.org/wiki/State_revolving_fund
https://en.wikipedia.org/wiki/Water_supply_and_sanitation_in_the_United_States
Of course we can count on the “Witch-Finder General” Starmer not putting up any response to your arguments. Who ever dares within “his” party will be demonised! This issue of what to do with the water and sewage industry is a defining moment for the future of the UK and Starmer’s failure to grasp the nettle is why you shouldn’t be voting Labour unless it’s imperative to get rid of a Tory!
Even the organisers of the Henley Regatta are complaining about the state of the water! Can’t get more Tory than that!
“Henley regatta organisers complain of sewage pollution from Thames Water”
https://www.theguardian.com/environment/2023/jul/04/henley-regatta-organisers-complain-of-sewage-pollution-from-thames-water
Will Sir Keir be accepting Rupert Murdoch’s invitation to join him at the Regatta this year!
Henley is shit should be the call…
This in the G’ today: https://www.theguardian.com/commentisfree/2023/jul/04/crisis-regulatory-failure-thames-water
Pathetic self-serving garbage by one of Gordon Brown’s bag men. Extract:
“Many companies in the water, energy and other utility sectors are competent, are fully aware of their social and environmental responsibilities and do not exploit their consumers or use financial engineering to benefit their shareholders.”
The man is living in another world if that is what he believes. My own direct experiences with UK elec distribution companies is the polar opposite: rapacious liars and mafiosi-style operation is barely the half of it. But what would we expect from “a visiting professor at King’s College London, a former group vice-president for strategy and policy development at BP, and a former adviser to Gordon Brown” – a nice safe pair of hands, spouting staid old stuff in an attempt to ensure the comfy status quo is not disturbed.
I have met Nick Butler. He was a co-director at Cambridge Econometrics for while.
His solution is typical. let’s move the industry further from government control whilst pretending there is just a rotten apple issue.
I love one comment on that Guardian article by Nick Butler it basically says that deeply engraved on the Tory Party Coat of Arms is a Mafiosi motto:-
“Privatise the profits, socialise the costs”
Starmer’s Labour Party is well on its way to having the same!
Here’s the list of Mr U-Turn’s u-turns. Note the country can’t afford nationalisation!
https://www.theguardian.com/politics/2023/jul/04/u-turns-labour-keir-starmer-tuition-fees-income-tax
Won’t be long before he announces the country can’t afford the country’s nationalised healthcare system the NHS! Of course he won’t be saying anything about the country not being able to continue funding the the forty odd year house price bubble!
A small technical point, Richard…you say…
What is open to debate is what the fair compensation for shareholders and maybe bondholders might be – (because this has to be paid and has been in previous nationalisations.).
Should that ‘fair compensation’ be based on the value of the shares net of the returns paid? Should the taxation advantages of shareholding be accounted for?
I envisage that there will be many nationalisations in coming years, for many of the same reasons…
Fair value is based on the discounted vaue of future income streams, althohygh proxies and heuristics are often used
Those look like they wull be limited in the case of water
If the company is bought bondholders do not necessarily need to be repaid – they can move with it – it depends on the bond deed
Should shareholders get anything if it looks like the company is going bust or if technically it is bust? Usually in the stock market shareholders are the last to get anything when a PLC goes bust. I know because years ago I had a few shares in HMV – it went bust as a PLC, but it is still alive today as a private company. Shareholders got nothing, they get nothing most of the time when a PLC goes bust even if it lives on as a private company.
If the water companies need a state bailout then basically they are bust as the market is saying we will not do it. Shareholders mostly know the risk they are taking when buying shares, I don’t see why they should be compensated at all. I seriously doubt there are many “Sids” still holding shares from when they were originally privatised. I assume the only concern for water company shareholders is that they bought the company originally from the state when it was privatised? The shareholder base will have changed over the years though. Buyers of water company shares must have known the risk. Go bust you get nothing.
Unless the company has gone bust they will argue until their day in court is over that the company was worth more than its stock market value
Valuation is deeply subjective
The law requires fair value be paid and if the companies have yet to go busty there will be some
The other alternative to nationalisation I’ve seen proposed is the ‘social purpose’ (but still profit making – ???) company put forward in an e-mail from Liv Garfield (who has found that e-mail is as leaky as water mains!) – see https://www.theguardian.com/commentisfree/2023/jul/02/now-water-bosses-you-must-show-how-capitalism-must-work-for-the-common-good and https://www.standard.co.uk/business/severn-trent-thames-water-nationalisation-labour-b1091238.html .
But last led me to https://www.standard.co.uk/business/the-cost-of-nationalising-thames-water-nothing-b1091078.html : The cost of nationalising Thames Water? Nothing
I really do not buy this
Thye old needs to be swept away
This does not do that
And I canot see how they could raise the required funds without government support so nationalise them
Headlines from the Independent:-
“Thames Water fined £3.3 million after ‘millions of litres’ of sewage pumped into rivers near Gatwick”
“Thames Water had shown a ‘deliberate attempt’ to mislead the Environment Agency over the incident”
https://www.independent.co.uk/news/uk/home-news/thames-water-sewage-gatwick-fish-b2369082.html
And what do you think Therese Coffey’s response will be to this? A pathetic “The system’s working!” ???
Guess which cabinet member has the lowest rating amongst Conservative Party members. Not hard to figure out – the one in denial the water and sewage industry is environmentally insolvent despite how much stink the industry creates!
https://i.guim.co.uk/img/media/a6faee96e095289a2d27db43c65d405083a06937/0_0_952_920/master/952.jpg?width=700&quality=45&dpr=2&s=none
Thanks
Now tweeted
Brilliant stuff. Need to declare I was Senior Engineer for Sheffield Main Drainage at point of Privatisation. Least it is forgotten, all water company assets were owned by Local Authorities, who did not receive a penny in compensation when these assets were taken. Nationalisation – more Municiplisation, due to river and drainage catchments being local, not national, need to recreate local water and sewerage public authorities, with public accountability. Massive opportunities remain in huge land assets stolen at privitisation for Municipal enterprise, and maybe even solve Housing issues?
This mess can be fixed!
Thanks
Important points
Richard,
for a professor of accounting, your maths is atrocious.
“Let me offer a quick example. Suppose a bond is issued for £1 million with a 1% interest rate, and it is index linked. Assume inflation was nothing for 5 years. In those years the interest was £10,000 a year.
Then, though, inflation hits 10% all of a sudden. Now the cost of repaying the loan goes up by £100,000 in the year that happens. And interest is now paid on £1.1 million, the new repayment sum owing. So that year’s interest costs £111,000. That’s a massive increase.”
That’s… that’s just not how ILBs work.
Interest cost is still 1% of principal. Principal increased to 1.1m, yes, but interest is not 1% * 1.1m, which is far from the 111,000 you falsely throw around.
I am referring to the total accooting charge in the accounts