Private capital in utility and other public services

Last year The Times did a series of exceptional essays highlighting the shocking effects from the increased role of private equity firms in the US in offering regular public services and the scale of asset stripping to benefit PE executives. PE firms have been investors in businesses that cover areas like emergency services, acquiring foreclosed homes and renting them as well as offering mortgage collection services, and public utility services.

In this context, FT has an article on Thames Water, which manages a third of sewage and water systems in UK. The article's findings only raise more questions about UK's 1980s privatisation of public utilities,

It paid £1.16bn in dividends between 2006 and 2015... a return that equates to about half of the £2.3bn of equity paid to buy Thames Water by the Australian infrastructure bank Macquarie in 2006-07. The paydays for the investors who control Thames Water coincided with a period when the company often paid no corporation tax, paid executives massive remuneration packages and doubled its debt — all while neglecting its environmental responsibilities on several occasions due to a failure that Judge Francis Sheridan, who presided over the pollution case at Aylesbury Crown Court this year, described as “borderline deliberate”... Thames Water was fined a record £20.3m in March for dumping 4.2bn litres — the equivalent of more than 1,700 Olympic swimming pools — into the river Thames and river Thame over three years between 2012 and 2014. The incident, one of several involving Thames Water, raises questions as to whether England’s unusual decision to allow private players to run the public water system for profit is working, just as other countries such as Brazil are trying to emulate it.  

Like with the PE firms in the US, since it was delisted in 2006, large private investors have controlled Thames Water through highly opaque cross-holdings.

The private nature of the firm also means that there is limited oversight on issues like executive compensation, leveraging, and profit retention. The National Audit Office has found that while the quality of service has improved post privatisation, very little of the profits have been passed on to consumers.

Thames Water’s long-term borrowings — some of which have been used to repay its shareholders who underwrote the acquisition of Thames Water in 2006/07 with debt — have more than doubled from £3.6bn in 2007 to more than £10bn in 2016. Just under £5.3bn of this long-term debt is funded through Thames Water’s Cayman Islands subsidiary... At the same time Thames Water’s pensions liabilities swung from a £26.1m surplus in 2008 to deficits of £65m in 2009 and £260m in 2016, potentially leaving employees exposed in the event of a crisis.

All this naturally raises questions about the appropriateness of such unlisted private companies to manage monopoly public services. It assumes significance given the significant role that infrastructure funds play in long-term infrastructure concessions. These form part of the second generation issues of infrastructure PPPs that have not received the level of attention it deserves.

Update 1 (07.06.2017)

Quoting at length on this from another excellent article in FT,

The University of Greenwich researchers argue that public ownership would cut the companies’ costs by at least £2.3bn per year by eliminating the payment of dividends and reducing the cost of interest payments. They say that if the government had to pay compensation of £20bn to investors, the annual savings would provide taxpayers with an annual return of more than 10 per cent on the investment... The nine English regional water and sewerage companies — three of which are listed on the stock market and six of which are owned privately — have invested no significant new shareholder equity but extracted nearly all of their post-tax profit as dividends, according to the Greenwich university report, which calculated the cost of privatisation to each household as over £100 a year. At the same time, the companies have built up a growing pile of debt to finance investments over the 28 years since the industry was privatised... England is the only country to have fully privatised its water and sewerage system, with ownership transferred from the state to large regional monopolies in 1989. Investors paid £7.6bn for the water and sewerage companies in 1989 but the UK government took on the sector’s entire £4.9bn in debts and gave the new private corporations £1.5bn of public funds...

The owners of the nine companies — many of which are overseas investors, including sovereign wealth funds — paid out £18.1bn in dividends in the 10 years to 2016, even though post-tax profits amounted to £18.8bn during the decade, according to the researchers’ analysis of their financial reports. Three companies — Anglian Water Group, Severn Trent Water and Yorkshire Water Services — have paid out more in dividends than their total pre-tax profits over the past decade... Greenwich researchers said the cost of maintaining and improving water and sewer infrastructure has been paid for almost entirely by an increase in debt, which has risen from almost zero at the time of privatisation to nearly £40bn in 2016. The interest payments on the debt are higher than what would be paid by the public sector, which can borrow more cheaply. Together, the £1.8bn in dividends and the extra £500m of debt interest payments each year pushed up bills for each of England’s 23m households by about £100 a year...

Across Europe, there has been a wave of renationalisations as cities including Paris and Berlin have taken water and sewer systems back under local authority control as outsourcing contracts come to an end. A comprehensive study of water supply services by economists at the Paris-Sorbonne University in France — where about three-quarters of water and sewage services are delivered by the private sector through concessions or lease contracts — found that the price of water provided by private companies in 2004 was 16.6 per cent higher than in areas where municipalities provide the service.