Utility Week - authoritative, impartial and essential reading for senior people within utilities, regulators and government
Issue link: https://fhpublishing.uberflip.com/i/449717
20 | 23rd - 29Th JanUarY 2015 | UTILITY WEEK Finance & Investment Market view T he UK has led the way in the denation- alisation of its critical infrastructure and our openness has meant most of our water and electricity assets are now owned by a wide range of international investors of various flavours. Whether this is a problem or not very much depends on the investors' objectives and how they go about pursuing them. Unfortunately, in some cases, it has become a problem, and poten- tially a time-bomb. Utility investors range from possibly the most famous global investor of all, Berkshire Hathaway, to various consortia of banks and private equity houses and even, in a few cases, public shareholders. Diverse ownership, such as exists in publicly floated companies, has a number of helpful characteristics, generally driving moderation, via diverse interests, and trans- parency. Conversely, concentrated owner- ship has advantages that are the opposite: the ability to become more focused on a more narrow set of objectives and less need for transparency or accountability. However, this should not matter. Running the firm is the job of the management, and sharehold- ers' ability to interfere is limited to appoint- ing (or de-appointing) the board. However, this separation is not always as pure as theory would have it, least of all when ownership becomes concentrated into the hands of a powerful majority. Public ownership enforces a transparency and accountability, the absence of which allows private owners to exploit more risky and "efficient" funding models – more effi- cient in this case generally meaning more debt accumulated, less tax paid and more profit returned to shareholders. While these perils exist for any type of organisation, the natural forces that keep them in check do not exist with a privately owned but government-backed monopoly business, and the ultimate conclusion of this could be potentially devastating. Back in the late 1980s our utilities needed investment and our government needed money. Privatisation provided an elegant solution to both problems by releasing a windfall for the government and simultane- ously enabling the newly created companies to access cheap borrowing in order to fund necessary investments. Though a bit short- term, this was a pragmatic solution, if care- fully managed. Getting geared up So, what happened? The government got its windfall and the newly created companies were bought and resold as successive inves- tors realised what a great deal they were. The other thing that happened was debt – lots of it. Thames Water is the poster child here. Its sale originally raised the govern- ment around £1 billion and in the time since, its debt has climbed from almost nothing to something in the order of £8 billion. Today, Thames Water cannot easily bor- row the money required to fund the Thames Tideway Tunnel, and the regulator has to allow the additional money to be included in customers' bills. This is not an investment need that appeared from nowhere. It has been over a decade in conception – a decade during which Thames Water delivered great share- holder performance, paid very little tax (none at all in 2012) and, it appears to the casual observer, failed to save up for a criti- cal investment it knew had to be made.* Thames Water is not alone in this. At pri- vatisation, the government wrote off debts, meaning that our water companies began with only circa 5 per cent gearing (borrow- ing). By the mid-1990s this had increased to 25 per cent, which at the time was average. However, the market decided that an asset-backed monopoly business could prob- ably sustain higher gearing. So, onwards the market has pushed and will keep on pushing until something stops it. Some of the pos- sibilities for that end are far less palatable than others but the potential for catastrophe is huge. So how big is the problem? Thames, Anglian, Southern and Yorkshire represent a good slug of the UK's water industry, and are all owned by various combinations of private investor. In our electricity networks the pic- ture is similar: the only remaining electricity network that is publicly traded is SSE. Interestingly and by way of contrast, the big six energy suppliers – of which SSE is one – are publicly traded. The energy retail market, like supermarkets or banks, is domi- nated in the UK by a small number of players that control most of the market. But despite their state-owned origins and the tough rap they get for energy prices, they are not monopolies. So, in theory, they have market competition as well as public investor scru- tiny to keep them honest. Neither of these natural controls exist for a water or electricity network business that is privately held – these businesses are monop- olies and private ownership creates the nec- essary opacity for this to be fully exploited for the benefit of shareholders. So the time-bomb is this: if an energy sup- plier goes bust and cannot fund its ongoing operations, its investors will be the biggest losers (along with its employees). Neither its customers nor the general public would expect to pay extra as a result and nor would they have to. Investors take this risk and the returns they get are their reward for doing so. If, on the other hand, a privately owned utility business fails, its investors will gener- ally lose relatively little (having made quite a bit already and organised things such that their risk is minimised). However, somebody would need to step in to keep the lights on or the water running. This would be the state and we, the taxpayers, would ultimately foot the bill – not only for keeping things going but also for any investments that had been deferred. Worse still, we would all have to swallow this knowing that some clever finan- cial engineering had made a tidy profit out of our previous bills. The analogy with the banking crisis is striking – if you think we need banks too much to let them fail, what do you think about water? The reduced reporting burden that is afforded to a privately owned firm, combined with the "efficiency" of not having to rec- oncile numerous interests, creates the abil- ity for great focus on the singular objective The utility time-bomb The banks were too big to fail and the taxpayer had to bail them out, but might the same thing not be true of privately owned monopoly networks businesses? Toby Ashong fears it is.