Dieter Helm’s water diagnosis

Leading economist Professor Sir Dieter Helm has published two papers that feed directly into the Independent Water Commission’s call for evidence and provide interesting points of consideration – some evolutionary, others revolutionary.

From the unsustainable to the sustainable

Helm remains convinced that the current water industry structure is unsustainable.

One contention is that capital maintenance should be funded from current bills as operating expenditure, not debt-financed and spread onto future bills. Customers are therefore now burdened with more interest payments than they should be, but have not paid what they should have done to maintain the assets. “It is the customers that have ultimately connived in the great debt explosion,” he contends. Only enhancement capex should be debt-funded, in his view.

Another diagnosis is that polluters – farmers, road users and developers – are not paying for the pollution they create. Helm calls for catchment regulation of all polluters. Natural capital assets such as floodplains should be regulated as assets in perpetuity. All water assets should be similarly considered so should not be depreciated. Helm proposes a catchment regulator, with more information to be made available on users, assets and flood defences. This would bring farmers and other stakeholders into the cost equation, not just water companies and the Environment Agency.

Helm wants to scrap Ofwat and therefore the next price review (PR29) and move to catchment regulators.

He is also critical about the treatment of Thames. He states that the current financial engineering for Thames has delivered investment manager PIMCO a 17% return on its emergency loans and that offers for Thames of £4bn represent a substantial discount based on its £20bn Regulatory Capital Value (RCV). His remedy includes taking Thames into special administration. He does not believe that the current market solutions deliver a long-term future for the company.

More widely, he contends that the privatisation model has not delivered more efficient water management compared to government-owned utilities in Europe. He discusses his preference for public ownership.

However he conflates the creation of catchment regulators with re-nationalisation, whereas the arguments for both are quite distinct. Although he states that the nationalisation model “worked in the past”, he fails to recognise that the reason it failed and the industry was privatised in 1989 was because of underinvestment in capital and maintenance. Water bills were too low then as now. 

His views on the use of catchment regulators, however, has some validity as an alternative to the current fragmented approach by Ofwat, DWI, local authorities and the EA.

No regret water reforms

Helm’s second paper sets out a list of ‘No regret water reforms.’ He is convinced that splitting water assets and regulation from sewerage is needed as the risk and investment profile, as he sees it, is different. This might have been the case up until now with substantial investment needed since privatisation to comply with the EU Water Framework Directive and for PR24 to reduce combined sewer overflows. However, as resilience in water provision is an acute challenge, perhaps not as yet appreciated by politicians and the public, now is the time for substantial investment in new reservoirs and water transfer schemes, not all of which will be suitable for project finance. This means that water and sewerage assets will need to attract new capital.

On the cost of capital, Helm agrees with many commentators that setting a weighted average cost of capital has meant equity investors have been over-rewarded in a climate of falling interest rates, as the cost of debt was set at too low a level for several price reviews. Now the corollary is that the cost of equity is too low given the accelerated investment, and requires a risk premium spread above the cost of debt. This was allowed by the Competition and Markets Authority at the previous price review for companies that appealed, but not by Ofwat. In line with US utilities, Helm is in favour of setting allowed returns for the proportion of debt and equity in the balance sheet.

He is in favour of public listing (even though he seems also to want re-nationalisation). He also reiterates his support for the digitising of catchments expounded in his previous paper.

Food for thought

These two papers feed into the Water Commission’s call for evidence. From the questionnaire to stakeholders, it seems clear that the Commission is looking seriously at some form of local regulation and Helm’s proposals will provide food for thought.

But other more radical suggestions such as splitting the RCV and unifying regulation locally (so scrapping price reviews) may be a regulatory upheaval too far.