Thames Water and its creditors poured into the High Court on Tuesday to put rival £3bn emergency financing packages in front of a judge. But the UK water regulator Ofwat faces its own trial this week — and one that could have even wider consequences.
On Thursday, Ofwat is due to publish its final determination for the next five year regulatory period, which begins on April 1.
This will set the financial and operating conditions governing water companies until 2030, including how much they must invest in upgrades, how severely they are penalised if they fail, what allowance they are given for cost of capital and how much they can charge their customers.
The determination is especially crucial for Thames Water, as it has been abandoned by its shareholders, and needs to attract new ones to drag itself out of its deep financial hole.
Thames has asked to increase bills by 50% by 2030 — if it cannot, suitors for the equity may be scarce.
In each period, Ofwat estimates the remuneration needed for water companies' capital, based on empirical evidence of funding costs and an assumed balance sheet structure. The aim is to give companies a decent chance of funding themselves, but leave it up to management to do better or worse, depending on its financing decisions.
Ofwat's estimate of the base return to capital may look particularly like a stab in the dark this time, since some companies' funding costs, including Southern Water's, are way out of kilter.
And with Thames Water having crashed from investment grade ratings to CC in just a few months this year, predicting its cost of funds is impossible.
Crunch time
The stakes are high. Thames, the UK's largest water company, is destitute, and unless new deep-pocketed backers can be found, will have to be nationalised or go through an enormous default.
The most common popular interpretation of Thames Water's problems is that Macquarie, the Australian bank and asset manager, is the cause.
During its part-ownership as leader of a consortium of private investors from 2006 to 2017 it sucked money out of the company, its accusers allege, loading it with debt while cutting corners on improving the network.
Group net debt rose from £6.2bn to £11.5bn, or 6.6 times Ebitda to 11.2 times.
Macquarie has defended its record, justifying the debt increase by the £11bn invested in Thames during its involvement, more per customer than at any other company in the sector, and more than under previous and subsequent owners.
As a result of the investment, Thames's regulated capital value rose from £6.5bn in 2006 to £12.9bn in 2017, so debt fell as a percentage.
Macquarie dismisses some of the claims against it as “mischaracterisations” and insists that it reduced leakage and pollution.
Whatever the rights and wrongs of Macquarie's tenure, one thing is certain: the shareholders did not have sole responsibility for the company, as investors in an ordinary business would.
Ofwat was in charge of the sector throughout, setting the guardrails and writing the rulebook.
If Thames has turned into a financial pigsty, the farmer must share the blame with the beasts.
Troubled waters
Thames is by far the worst off of the UK water companies, but that does not mean the others are having a peachy time.
Southern Water had to pay a nosebleed-inducing yield for a seven year bond in October, and has been downgraded by all three rating agencies, including Moody’s pushing it out of investment grade.
Having one company fighting collapse and another teetering over the junk abyss — as well as the myriad though less severe problems elsewhere in the sector — is not only a failure of the owners. It is a failure of Ofwat’s previous regulatory standards and practices.
Ofwat has many critics, but few of them envy its responsibility.
It has to try and conjure an industry that provides a good service at a fair price to consumers, protects the environment and replaces thousands of miles of Victorian pipes with new ones — all while attracting and rewarding private capital.
Scylla and Charybdis had nothing on this, yet Ofwat must try to steer a course through.
Once the regulator issues its final determination, water companies have the right to appeal to the Competition and Markets Authority if they think it is too harsh.
A handful appealed last time, and a similar number may again. But as a water analyst told GlobalCapital in October: "if the whole sector appeals, there might be questions about the effectiveness of Ofwat".
He was understating it. If the new determination does not lead to a somewhat happier and more effective water industry in the next five years, Ofwat will be wiped from the scene, and the sector will be more drastically reformed.