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Leonard Hyman & William Tilles

Leonard Hyman & William Tilles

Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and…

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What Does Renationalizing Thames Water Mean?

  • Thames Water claims it needs to spend about $23 billion in capex between now and 2030 which will increase customer bills by at least 40%.
  • The present management of Thames Water Company can no longer easily raise this money in the capital markets.
  • A real solution to Thames Water's problems may not come until after the elections in the UK.
UK Houses

For weeks, now, British editors, letter writers and resident economic thinkers in the government have been debating how to preserve Thames Water as an investor-owned entity. We might ask, “Why bother?”, but if you are a British neo-liberal intellectual, the superiority of private ownership is dogma, so don’t ask. And if you are in the energy business, you might ask why you should care? To which we would answer that some energy consumers soon may ask what advantage private ownership confers on their energy suppliers, you know, the ones whose lines fall at every storm or burn down local forests. Thames Water may be the canary in the coal mine.

Watching a large public utility struggle to provide an essential service is analogous to watching an animal rescue video. Will the “hunters” (the government) get there in time to rescue the baby deer (the public) from the icy lake (e. coli)? The situation today with Thames Water is equally compelling given the public’s desire or need for clean water is clearly not being met. And we should point out that this issue can be satisfactorily resolved with an adequate infusion of new capital investment in treatment facilities. The company claims it needs to spend about $23 billion in capex between now and 2030 which will increase customer bills by at least 40% according to the company. The good news here is that this is mostly a money problem not a technology problem. The bad news is figuring out who pays the rather large bill for all these prospective capital improvements. And as a picture of irrelevance, the present management of Thames Water company can no longer easily raise this money in the capital markets—their equity investors have already refused to put in more capital— which, as analysts everywhere will recognize, is really quite a feat. However, now there are possibly two groups of “hunters” offering the public rescue from its toxic predicament, one possibly from the private sector as well as one and one from the government. Related: Musk Lashes Out at Reuters for “Lies” Over Inexpensive EV

To be clear, if we assume that both public and privately held water corporations subscribe to the same service/quality standards or technology, then there are only two main differences between them: how they’re financed and how they’re managed. A publicly held or government owned entity finances itself exclusively with bonds or similar financial offerings, sold to investors at a relatively low interest rate approximating that of its governmental parent. In the present interest rate environment, we’d assume an overall utility capital cost of 3-4%, consisting entirely of solidly investment grade bonds of varying maturities, and no expensive equity. By contrast, a private sector utility (imitating an American utility capital structure) might be financed with 50% corporate debt and 50% shareholders equity. Both of these components are higher cost financing than the government’s debt cost—and close to 6 or 7 percentage points higher in the case of utility equity capital. But overall a typical “balanced” private sector utility capital structure carries a weighted cost of about 7-8%, or roughly 100% higher cost of money than the government financed alternative. Remember we’re assuming that both public and private utilities provide an identical commodity. A lengthy discussion of the role of risk capital in corporate finance is beyond the scope of a brief essay, but looking at shareholder owned Thames Water, it seems fair to ask what is the role or ongoing value of shareholder’s equity in this regulated utility’s capital structure?

Apart from financial structure there is another major difference between public and private sector utilities, management structure. A publicly owned utility is run as a governmental department or sub-unit like police, fire, or sanitation services with executives reporting to the mayor, county executive, or governor. Sometimes utility executives will be hired from the private sector at salaries above government pay levels, but the overall public sector compensation levels are way below that of the private sector. Private sector management, on the other hand, entails a team of highly compensated executives and a Board of Directors with varying oversight roles. The management costs of private sector, or investor owned, utilities is much higher than publicly owned alternatives but this difference is small in terms of overall cost of service. Articles about excessive executive compensation especially during periods of corporate failure can gin up outrage but the real financial difference between public and private entities remains in the cost of capital.

We stated earlier that the key question here ultimately is who pays for necessary system improvements. And that’s not quite correct. The answer is the public will always pay. The only question is to whom, how much and over what period.

The last thing missing from our discussion here is context. We believe this compelling public issue hasn’t been resolved for a simple reason: politics. Resolving this pollution problem requires large, unpopular rate increases for the public. And as politicians prepare for general elections in the UK, the last thing either party wants is to face a public irate over a large increase in its water utility bills. As a result, this issue is likely to fester unresolved unless the public health aspect becomes more compelling. Alternatively, since Thames Water is still privately held, a so-called “white knight” could emerge to provide financing and leave management largely intact. We suspect that a certain Mr. Buffett, for example, could easily finance a $20 billion capital program in return for say a 9% coupon guaranteed for twenty years plus a few board seats. He could even gradually phase in the higher costs to minimize political fallout. Either way, we would be surprised to see a real solution until after the upcoming elections.

By Leonard Hyman and William Tilles for Oilprice.com

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