I hadn’t really planned to write about the British water industry again, but the current crisis in Thames Water seems to be more than a local political difficulty. The accountant Richard Murphy has a post on his blog which looks beyond the detail of the failure of Thames Water to the wider issue of the “environmental bankruptcy” of the British water sector. The post is a summary of a longer report, called Cut The Crap, that was also published this week.

Photo: Andrew Curry, CC BY-NC-SA 4.0

There are three problems going on here at the same time. The first is that rate of financial extraction from the British water industry by its commercial owners since privatisation has been eye-watering, and has involved loading the companies with debt.

The second is that the upward tick in interest rates over the last year or so has wrecked their balance sheets, because they can no longer afford to pay for this debt.

The third is that this vast shareholder freeloading has meant that the companies have spent only a fraction of what they should have spent on repairing and rebuilding the ageing infrastructure, with the result that raw sewage is being pumped routinely in Britain’s water systems.

Financial shenanigans

So it’s worth spending a little bit of time on the two parts of this story—first, the financial shenanigans, and then how to invest in rebuilding the sewage infrastructure.

To analyse the first part of this, Murphy has created a set of accounts that integrates the accounts of all of the companies that provide both water and sewage services in the England. (It includes: Thames Water, Anglian Water, Northumbrian Water, Severn Trent, South West Water, Southern Water, United Utilities, Wessex Water and Yorkshire Water.) FN The water utilities in Wales and Scotland are both publicly owned. I know accounts aren’t everyone’s idea of a good time, but some of the headlines from the analysis are worth spelling out.

  1. In the 20 years between 2003 and 2022, these companies made an operating profit of 38%, which is high. “Staggeringly high”, says Murphy. If you need a yardstick, a typical services business would make 15% operating profit, and you would expect utilities business to be a bit lower than that.
  2. Interest costs ran at 20%—so more than half of those profits were paying for the cost of debt.
  3. They paid some tax over that time, but less than you’d expect, and this left £24.8 billion in profits over 20 years. And all of that, plus a bit more, was paid out in dividends to shareholders—£26.7 billion.

Drop in the ocean

So to summarise: really high profit margins from consumer bills (despite the water sector allegedly being regulated to prevent this happening); high interest payments (because debt levels are high); and every spare bit of profit, plus a bit more, over 20 years, funnelled to shareholders.

It’s worse just linking this back to the second point above, because I’m reminded of something that the economist James Meadway said when interest rates started to increase last year. I’m not sure if it was in an article or a tweet, but he basically argued that the UK’s economic system over the last decade or more—low wage, low investment, etc—had been completely dependent on low-to-zero interest rates.

But of course, the main reason that this really matters is because England’s watercourses are being polluted with raw sewage because the companies have failed to invest enough in infrastructure. Belatedly, they have come up with a plan to invest £10 billion over seven years to improve this (which they plan to charge to their consumers), but as Murphy says, this is a drop in the ocean, perhaps literally.

The industry has offered to invest £10 billion over seven years, or £1.4 billion a year. The government has decided that £56 billion is required over 27 years, or just over £2 billion a year. The trouble is neither sum will come close to getting rid of the crap in England’s water. The House of Lords looked at this issue based on independent analysis and concluded that the most likely estimate of the cost of getting rid of allthe pollution in our water was £260 billion.

Environmentally insolvent

That’s a lot of money, and the House of Lords report, and the independent analysis translated it into the size of household bills (it’s a lot). You can save some, basically depending on how much sewage you are willing to see discharged into environmentally sensitive rivers every year.

But before we get to that, it’s worth making a more important point. On pretty much any reasonable scale of sewage reduction, as Murphy points out, the water companies are “environmentally insolvent”:

The concept of environmental insolvency applies to any business that cannot adapt to make its business environmentally friendly – as climate change and ending pollution requires – and still make a profit. What it means is that its business model is bankrupt. That is where the English water industry is now.

Sustainable cost accounting

This point is backed up by analysis in the report using an approach known as sustainable cost accounting. There’s a wider point here—that in general the private sector would never be profitable if it had to pay for the environmental capital it gets through—but it’s rare to see such a clear cut example.

It’s maybe worth just expanding on how sustainable cost accounting works: (from the report, p.9):

It requires that a company prepare a plan to show how it would manage the consequences of its pollution and environmental, climate and biodiversity change. That plan would have to state how it might remove its harmful impacts by a specified date, both within its own business and within its supply chain.

There’s a little more detail on how you assess the plan as well:

Sustainable cost accounting requires that the full cost of the changes needing to be addressed by the company should be included in its accounts… A precautionary principle would apply: in other words, the plan could only rely upon existing technologies that have been proven to work. The plan would have to be costed.

Savings for sustainability

So how do you pay for this? You certainly don’t want to load it on consumers’ bills. The companies are carrying too much debt (quite a lot of which has, basically, financed dividends to shareholders) so they can’t take it on. Murphy has quite a clever suggestion here: a bond that works as an ISA (Individual Savings Account). So, in line with the existing ISA regime, these are tax-free provided it is held for a certain period of time. Some ISAs also carry a small interest rate. The numbers here look quite interesting.

The total value of the UK ISA holdings at the end of 2020-21 stood at more than £650 billion; in that financial year (the latest for which we have data) “amounts subscribed”—new money being saved through ISAs—totalled £72 billion.

Post-carbon infrastructure

Of course, no-one is going to trust the water companies with this, even if the government does find a way to re-capitalise them and socialise their losses. Murphy thinks that we should take them back into public ownership, and that would bring England back into line with the rest of Europe, and Scotland and Wales, come to that.

But there might be other ways to do this as well. In general, we need to find innovative ways to rebuild our infrastructure so it is climate ready. The savings market is already quite strongly incentivised by governments because savings and pensions are thought to be a good thing, even if this tends to benefit the better-off.

At the moment, most of that ISA money ends up sitting in banks, which are, right now, most likely to use it on loans for property investment. (We really don’t need them to do this). I need to do some more research on this, but we could solve Perhaps the question of how to rebuild our sewage infrastructure could be a pilot for those bigger and more valuable post-carbon infrastructure investments.

Thanks to Nick Wray for the link.

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A version of this article is also published on my Just Two Things Newsletter.