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‘We need a campaign for public water’ May 3, 2012

It’s been raining for the last two weeks but parts of England and Wales are still in drought as the water companies leak 3 billion litres of water a day while managing to pay their shareholders £1.5billion in annual dividends. If this wasn’t bad enough, the regulator has announced water bills will be going up by another 6% this year. Corporate Watch spoke to David Hall, director of the Public Services International Research Unit, to find out what more than 20 years of privatisation has done to the water supply and what can be done about it.

The water companies say there simply hasn't been enough rain recently and it’s not their fault there’s a drought. Is that true?

There's a genuine problem throughout eastern and southern England of water stress – the amount of water being used isn't matched by rainfall. Despite its reputation for rain, this is actually one of the most water stressed parts of the world and there is an underlying issue that is there, regardless of private sector operation.

But the big ways of dealing with water stress are by reducing demand and by eliminating leakage. In terms of reduction of demand, that's basically a public information exercise.

In terms of reducing leakage, that is down to the companies and they don’t do it enough. Left to their own devices, private companies achieve the ‘economic’ level of leakage - they’ll reduce leakage to the point where it’s cheaper to pump up another few litres of water than to stop those litres leaking out. The marginal cost of producing an extra cubic metre of water is very low. If it all comes out of reservoirs, say, that are there anyway, you’re just raising the reservoir level by a couple of millimetres. Bang, done delivered.

Leakage rates in England and Wales vary but in London, for example, they’re around 30%. In Germany and the Netherlands, which have public water systems, we’re looking at 5-7%. So the companies could be doing a lot more.

But the regulator Ofwat (the Water Services Regulation Authority) says only six out of 21 companies in England and Wales missed their leakage targets last year.

Ofwat targets for anything are fabrications between Ofwat and the industry. The water companies have persuaded Ofwat that it’s very important they collect their leakage data at three in the morning. Why should this matter we ask ourselves? Surely water leaks out of pipes the same whether it’s three in the morning or not?

But one thing that makes a huge difference to rates of leakage is pressure in the system. Water companies are obliged to maintain levels of pressure sufficient to deliver water throughout households and it’s very obvious if they’re not doing it. However, at three in the morning, very few people are using water. So half an hour before the leakage data is collected the water pressure is reduced sharply, as a result of which the leakage falls sharply.

The companies say the system was so old and dilapidated with “worn-out Victorian pipes” when they took over in 1989, that, okay, progress may not have been as quick as people would have liked but they’ve invested a lot in it and it’s getting better. Ofwat backs that up, saying that since privatisation in 1989, “£90 billion has been invested in the water and sewerage sector across England and Wales”, which has led to “significant improvements”.

It’s perfectly true that a lot of the water system in England and Wales is old and worn-out. That’s why they’re leaking so much and that’s why we’ve got the problem. But just blaming the pipes is like blaming the weather, except, unlike the weather, we can do something about the pipes. So the question is: are they doing enough? The reason leakage is less of a problem in the Netherlands and Germany is because they’ve modernised and replaced old pipes. Again, the issue is the limitations of the economic incentives. The actual patterns of investment are based on what the regulators allow them to charge users: they’re not raising more capital from generous, philanthropic shareholders who want to invest in England and Wales’ water pipes. They’re raising money through greater surpluses from consumers. That means they invest in what’s most profitable. Blocking leaks is not very profitable.

On the other hand, you get over-investment in other areas, for example the huge new central sewer – the ‘super sewer’ – Thames Water is attempting to install in London. There’s no doubt London’s sewers need new capacity to avoid future problems of sewerage flooding but an analysis last year showed the benefits it was actually going to deliver could be delivered far more cheaply with other options. This sewer is being built because Thames Water is going to be able to charge sufficient prices to get a huge rate of return. So you get the wrong pattern of investment.

So the company will say to Ofwat it needs to raise people’s water bills to fund it?


So there’s no public subsidy?

No, there’s very little public subsidy in England and Wales. It’s paid for out of bills.

To take Thames Water as an example again, in recent years it has strongly pushed to be allowed to build a desalination plant to produce more water and to build a new reservoir in Oxfordshire. Now, again, the simple question of why a water company that’s losing a third or more of its water would be asking to build a new reservoir and a desalination plant in this, of all countries, can only really be explained by the fact that they’re assessing the rates of return there.

Who is Ofwat?

There was a House of Lords committee investigation into exactly that question. The investigation decided that, in terms of public administration, Ofwat could be most accurately described as a government department without a minister. It has certain government power but is accountable to no elected person. It is an unaccountable set of bureaucrats. Ofwat asked rather anxiously if the committees of the House of Commons it is sometimes summoned to give evidence to counted. But of course it doesn’t.

Its statutory duties now include a duty to consumers, but the prime duty when it was first created in 1989, with the privatisation, was to ensure the companies made sufficient profits for them to carry out their work. That was the statutory duty of Ofwat – in fact its only statutory duty. Ofwat basically spends its time with the companies. This is its peer group. It has very little contact with anybody else.

The biggest single thing that affects water poverty is not so much the cost of supply of water, which will be quite high in that particular region because of water stress, but the charging structure. The possibility of arriving at a situation with less poverty is much greater if you have water run by a municipally owned company which has monthly discussions in public with consumers, the community; and workers. Then a political decision is being made.

Here, you have Ofwat sitting down with the companies exchanging arcane details of information, that were described even by one of the company representatives a few years ago as unintelligible to the average human being. They give no incentive whatsoever for anyone to participate. So it’s a question of probabilities, but there’s no way the UK structure could ever generate that kind of reactivity to social situations.

There have been quite intensive discussions in most European countries in recent years about developing participatory mechanisms that enable all sorts of people to participate more actively. The board of the municipal water companies in cities like Seville and Cordoba in Spain have posts for representatives of community associations, trade unions and consumer associations, for example. So every month, everything the water companies do is being discussed, in public, by a mixture of elected councillors and others.

It’s easy to criticise Thames Water – it posts huge profits, its bosses earn huge amounts of money, it’s owned by Macquarie, an Australian investment group nicknamed ‘The Millionaire Factory’. But is it typical of the other water companies around the UK? There are others that are leaking less and that have increased their prices less around the country. So, if they were the norm, wouldn’t privatisation work a lot better?

Most of the companies, most of the time, are doing an okay job because they employ workers who know what they are doing, and who would do it well under public ownership also. Water supply is not particularly rocket science. There’s not a lot of difficult stuff to do in the water sector, I think it’s fair to say. It’s very capital intensive, so it’s basically maintaining a system in working order and monitoring it. The worst things from privatisation in England and Wales are at the margins, in terms of what they are screwing out of users, by exploiting every possible way of getting prices higher.

An actually criminal example of that was five years ago when Severn Trent lied to Ofwat about the number of customer complaints that were being dealt with. It’s a ludicrous thing to be lying about, except that, with the regulatory system, how you scored on that affected how much you could charge your customers.

The ownership of the water companies is quite interesting. When water was first privatised all the companies were floated on the stock market and various institutions and members of the public bought shares. Now it’s a real mixture. There are still three companies that are classic stock exchange companies, or are parts of classic stock exchange companies, such as United Utilities or Severn Trent. There are others that are owned by multinational groups and subsidiaries of them. Then there are companies, of which Thames Water is one, which are owned, in effect, by various forms of private equity companies. The bit of Macquarie that owns Thames would technically call itself an infrastructure fund rather than private equity, but in practice there’s little significant difference.

What this means is that the dividend and profit streams are controlled by a private group of people who don’t, for example, have to produce annual reports to the stock exchange in the kind of detail that listed companies do. More relevant, the shareholding is very concentrated. Now, one thing that means is they’re in a position to structure the companies’ finances in such a way that the money taken out of the profits is also very concentrated. When this first started they called it the ‘thin equity’ model. That means the amount of shareholder capital to which the dividends go is now relatively small. From a management ownership point of view, you can control the company finances quite precisely so you can deliver dividends that, in terms of the company as a whole, are quite small because most of the capital is paid off by interest on loans. But the dividends are actually a very high return to the little amount of equity left.

When the companies were first privatised they had no debt whatsoever, because Thatcher wrote off £4 billion debt and created debt free companies. Another hand we gave them, apart from writing off debt, was a tax holiday for a few years. Since then, many of the companies have systematically borrowed, borrowed, borrowed, so now they are overwhelmingly debt-financed.

And they’ll still be as careful to avoid tax as anybody else. With Macquarie, for example, when it took over Thames, it restructured the financing of the whole operation. It paid all the previous debt off by issuing huge, new, 50 year index-linked bonds, at quite low interest. This is legitimate, and is actually a sensible way of financing utilities, but they issued them in the Cayman Islands [a tax haven].

Okay, but in the UK, if the water supply was renationalised now it would be done so by a government that is committed to cutting investment in public services as much as it can. So, okay, Thames Water has issued this bond from the Cayman Islands and other companies are taking huge profits, but at least they are getting some investment into the system.

There’s relatively little subsidy going into the industry and that was true before privatisation. These were stand alone, self-financing state-owned companies, financed by people’s water bills. The majority of people are still charged an annual fee, regardless of consumption, based on their house value (there’s a much higher percentage of metering now but it’s still a minority). In economic terms this is a tax. It’s a relatively progressive tax because it’s based on the size and value of a property. So if it were in public ownership the funding structure could in principle stay exactly the same.

But the private sector certainly is not the most efficient way of financing investment. One reason is very simply the cost of private rates of return. If it was still under public ownership, the cost of the capital involved would be much less because state or government entities can always raise funding cheaper than the private sector. You can see this with the railway network. Network Rail is kind of a limbo organisation, but it issues bonds that are 100% guaranteed by the government with very low interest rates.

Now, the gap between what the state and private sector pay in interest has recently been estimated in the context of the Private Finance Initiative as about 2%. Data from the water sector suggests that’s a reasonable long term level. A couple of years ago, using that figure, we estimated that if the water sector was in public ownership, with the same level of investment and financing as now, we would be paying £1bn a year less in water charges than at present. That’s around 12-15% less.

So how do you think a public water supply system in the UK should be organised?

There are different arguments. If you went back to the public sector you could either take it back in its current form, which is in effect a small set of national companies with regional monopolies.

But, interestingly, there is no evidence that it is less efficient to run water companies on a smaller scale. You don’t improve the efficiencies of water companies by lumping smaller companies into one big one. The main reason for that is probably just because the operations are so tied to the shape of the land. There’re no synergies to be had there and there are managerial problems across multiple basins. So you could reassign them at a municipal level, as they were organised until the 1974 reorganisation.

Operationally, and in terms of finance, that would mean breaking the companies up into much smaller units. The big advantage of doing that with water, or any other service, is local accountability and local sensitivity to environmental and social factors. The disadvantage is financial. People living where costs are higher would find themselves having to pay higher. The overall cost of running a water system will vary from river basin to river basin, because the available water, the length of distance you have to transport it, and so on, differ. The cheapest water system to operate is where you’re living at the bottom of a mountain covered in glaciers and snow, and it literally falls off the mountain as pure as anything (which is why companies particularly like concessions in towns at the foot of the Alps – it’s easy money). But it’s entirely political whether you make the inhabitants of each region carry the cost of those differences or whether you average them out across the whole country so everybody shares the worst costs.

There’s also the question of compensation. In the UK, when the water companies were privatised in 1989 they were sold - pipes, reservoirs, land and all - to private companies. That’s an unusual form of privatisation, probably unique in the world in fact. They were all given 25 year contracts to go along with all the property. If that had remained unchanged, those 25 years would be nearly up and they would have to be put out to tender.

And it’s now we learn the one thing private companies hate more than anything else is competition. A few years ago the companies realised the potential implications of this. They asked the government, and the government asked Ofwat, to adjust their licences. So if their contracts are transferred to anybody else, they’re entitled to a 25 year notice period. It means even if the government went through a competitive tendering exercise in 2014, and if somebody other than these companies won it, they would have to wait 25 years before taking over, or they, or the government, would have to pay 25 years’ worth of profits in compensation. In Argentina, which has renationalised one of its main oil companies, for example, the share price of the Spanish multinational whose assets they are renationalising has dived to a very low level, which means the compensation it is entitled to reflects that share price.

But these questions are not impossible to deal with under a democratic system. There’s a very nice example from the Brazilian city of Porto Allegre, which is famous for its public budgeting arrangements for public sector services. The water company held public meetings all around the city explaining they were proposing to increase water prices by 18% to build new wastewater treatment plants, which would be good for the city in the long run. After doing all this consultation they went back to city hall and said to the councillor and asked for approval for the plan. The council said: “an 18% increase – you must be joking!” The water people said: “no, don’t worry, we’ve had this dialogue with citizens and everybody supports this decision. Don’t worry – this is a city of grown ups.” So democracy’s a wonderful thing like that. People are perfectly capable of debating these issues and coming to reasonable conclusions.

It seems to make sense that it would be better to have more local scrutiny and power over a local water company, but how would that work? Martin Baggs, chief executive of Thames Water, has said many customers “don’t know what goes on behind the scenes… They want to turn on the tap, flush the loo and forget about it.” That’s true isn’t it?

Perhaps, but public mechanisms are in principle and practice better at allowing citizen and public control to get things improved than any mechanism the private sector has. The private sector’s greatest incentive when confronted with any major problems is to lie. The last thing you want is to admit you’ve made a mistake and something needs to be corrected.

But it’s not only the private sector that’s guilty of that.

It’s not, but it’s a very high economic incentive in the private sector. There may be incentives to do that within the public sector, within career structures and the way things are managed, but you don’t have to manage the public sector like that. In the public sector you can have a culture of open discussions of mistakes and lessons to be learnt and so on and so forth. There is much more of a culture of that in the public than the private sector.

So for people reading this, if they’re angry at what they read, is the best thing for them to join campaigns for public water in the UK, or is it to ensure water is a central part of more broader campaigns and movements for social justice?

Both is the obvious answer. The answer to the first question – should they join campaigns for public water? – is yes but the very first important step is to create such a campaign. The UK is the only country in Europe, as far as I’m aware, that has no significant campaign over water at all. Not even just over the issue of water privatisation, but there is no national campaigning body for water justice or water rights.

Most local activity is largely on the level of consumer complaint activity, which is not unimportant, but it’s different to campaigning activity for a different system. So if anyone reads this and thinks they want to get a campaign started, great. More power to you and I’d be very happy to do everything possible I can to help.

Read more from the Public Services International Research Unit here.

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