Why Thames Water is drowning in debt

When we think about companies that might go bankrupt, we don’t often think of water companies. With simple business models, monopolistic market positioning, and the essential nature of their service, it is easy to think that water companies are some of the safest investments out there. As the UK’s biggest water supplier, Thames Water seems no different.

This was the rationale of some of the world’s largest international investors that poured money into the company. Now the company is drowning in debt, at 80% of the value of the company. What happened?

To give some background, the UK water industry was nationalised in 1973. The industry’s cost and a series of pollution proceedings from our friend, the EU, led to privatisation in 1989. 10 regional private companies were created, including Thames Water, to own and operate water infrastructure. Alongside this, The Office of Water Services (Ofwat) was created to serve as the economic regulator of these local monopolies, setting limits on water prices amongst other things.

Thames Water’s private owners have changed over time – ranging from German energy company, RWE, to Australian bank, Macquarie. Whilst these owners did invest billions into Thames, a lot of it was financed through raising debt (with net debt currently over £16 billion). This debt has helped Thames pay out over £7 billion in dividends to these shareholders since 1990.

The point is that regulation drives the UK water sector

The regulatory aspect of this watery tale is crucial. At a basic level, Ofwat tries to keep bills low whilst also making water companies investable to fund infrastructure. Price limits are set every five years using regulatory capital value (RCV), which is Ofwat’s measure of a water company’s market value. From RCV, Ofwat calculates regulatory gearing, the ratio of a company’s net debt to its RCV, to inform its approval of water company business plans. It also stipulates that all water companies must have a minimum of two BBB-credit ratings to keep their water licence and avoid fines. Finally, Ofwat allows water companies to undergo “securitisation”, creating holding companies outside the regulatory ringfence to issue more debt and receive dividends, taking money out of the sector.

The point is that regulation drives the UK water sector. Thames has the highest RCV and regulatory gearing, and now has a “junk” (below BBB-) credit rating from both S&P and Moody’s, putting it at risk of losing its operating license. Thames also has a holding company, called Kemble Water, to which it pays dividends and issues debt to fund infrastructure improvements.

Water companies would love to invest instead of paying dividends, as this will increase their RCV and therefore prices they can charge. The problem is that Ofwat is torn between keeping consumer costs down and keeping water companies profitable. It has set limits on water company infrastructure investment at sub-optimal levels to keep bills low. The dividend conversation has largely damaged Thames’ reputation only, since Ofwat regulates dividend levels too.

Thames failed to complete 108 upgrade projects to reduce sewage spills

Since 2022, ageing infrastructure has led to high depreciation costs and a series of fines for sewage spills, reducing cash available to service debt. With over 50% of Thames’ debt being index-linked, the recent inflation surge did not help. Even when Ofwat approved investment, Thames failed to complete 108 upgrade projects to reduce sewage spills, demonstrating a failure of company management.

In 2024, Ofwat watered down Thames’ 2030 plans to raise bills by 52% and reduced proposed expenditure. Company CEO Chris Weston says this will prevent “the turnaround and recovery of the company”. Without price increases being approved, current and potential investors are not keen to inject more cash before Thames runs out of it next year.

Where does this leave us? We have a punitive regulator preventing price increases, limiting Thames’ ability to finance debt and attract investors. We have failed owners, who increased net debt and failed to finish approved infrastructure projects. We also have a negative PR environment as anger mounts about sewage spills, scaring investors and increasing fines. Together, this leaves Thames in its current near-underwater situation, with its future likely to involve temporary nationalisation or a listing on the stock market.