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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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Thames Water Debacle: A Lesson in Regulation and Utility Mismanagement

  • Thames Water, the biggest water utility in the UK, was privatized in the last days of the Thatcher regime.
  • Thames Water fell into the hands of private equity investors who borrowed heavily to buy Thames.
  • At the most basic level, a utility has to do three things: raise money at reasonable rates, build large public-serving projects and lastly, to operate these projects effectively.
UK houses

The big Cambridge-Oxford boat race on the Thames is the posh British equivalent of March Madness. But there was a big problem this year. The Thames is polluted. The oarsmen had to propel themselves in a sea of e. coli. Unlike the citizens of Flint, MI, who had to face years of polluted water, the oarsmen had a choice. They didn’t have to row. But we are not writing about water equity. This is about utility regulation, and how Americans got something right.

Thames Water, the biggest water utility in the UK, was privatized in the last days of the Thatcher regime. The water utilities in the UK at that time faced enormous capital expenditures to bring water supply and waterway pollution up to European standards. The Thatcherites felt it was better to put this financial burden on private suppliers and consumers rather than on the government. These newly privatized utilities would be expected to run more efficiently anyway, and a competitive water market would develop to discipline prices—at least that was the theory. The privatizers ignored a key aspect of the water business. Like other utilities it is extremely capital intensive. This means that cost of capital, largely variable rate interest expense on a highly leveraged capital structure, is one of the biggest items in the water company budget. When they were first privatized this interest expense number that has cannibalized the expense structure was zero. And private investor capital for what is basically a non-investment grade credit costs a lot more than relatively risk free government bond money.  But that’s not our topic either. Related: Who Is Behind Iran-Backed Houthi Threats To Attack Saudi Arabia?

Thames Water fell into the hands of private equity investors who borrowed heavily to buy Thames. They subsequently paid themselves billions in dividends (effectively as repayment and profit) despite Thames Water’s enormous capital spending needs. Those investors now refuse to put more equity into the utility, which may have to declare bankruptcy (whatever the British equivalent). Or heaven forbid, be renationalized. Where were the British regulators during this debacle? We get the impression that they didn’t think it was cricket to interfere in the private business affairs of the owners. American regulators tend to meddle, however, making it difficult to extract too much from the utility. US regulators take the view that the utility needs to stay healthy, financially, in order to serve the public. And they don’t like to leave that to chance. An ailing (or greedy) corporate parent of an otherwise solid utility will look for ways to extract cash. Don’t make it too easy.

At the most basic level, a utility has to do three things: raise money at reasonable rates, build large public-serving projects and lastly, to operate these projects effectively. The inability to do any of these three things is or should be disqualifying to a franchise holder. Thames Water says it cannot raise money at reasonable terms, and one might ask if it has built the necessary projects or managed effectively what it operates. One might even argue that Thames is a “dead man walking”, having mismanaged a relatively low risk business to a point apparently beyond financial repair.

One of these days, Thames Water will be taught as a case study in schools of business and public administration— a lesson in dogmatism, light-handed regulation, and lack of common sense. Maybe we should be grateful for our clunky US regulators and seemingly inefficient government utilities for plodding along and doing their jobs. Remember, the tortoise won the race.

By Leonard Hyman and William Tilles for Oilprice.com

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