30/09/2011

ITT spins off water business Xylem

It is ironic when all the concern is over high levels of debt that ITT is to split out its water business into a new company called Xylem. It then plans to raise $1.2 billion in debt to pay off the parent company. Xylem’s 2010 revenue was $3.2 billion but most of its income comes from pumps (87%),  brands like Flygt and Lowara.

This financial engineering may make sense to the money markets but the concern has to be whether it diverts attention from its customers and its core business. The water sector is in for a turbulent few years as it can not escape the ramifications of the Euro crisis and drive by Europe and America to reduce debt. This potentially has a big impact on future water investment as funding from the state for water infrastructure projects is bound to get reduced.

Xylem may be insulated to an extent as much of the market for pumps is of course replacement of worn out assets. The concern has to be whether its really healthy for companies like Xylem to have so much debt or will they suffer the same fate as Southern Cross?  

23/09/2011

Capex bias in the water sector

Ofwat’s discussion paper on Capex bias clearly outlines the drivers for Capex bias but is silent on what it intends to do. Water companies in their evidence to Ofwat indicated that earning a return on capital is a key driver of Capex bias. This is compounded by the financial ownership structure with many water company boards having performance targets to increase their Regulated Capital Value and hence return to its shareholders.

This was starkly highlighted by BBC Panorama this week (report on water abstraction). The example quoted was Thames Water’s focus on a new £1bn reservoir at Abington. The Public Enquiry early this year comprehensively rejected Thames Water’s proposals and said it had not adequately examined the alternatives.

This is important as innovation is vital to the water industry if it is to meet the challenges ahead. A financial system that rules out operating cost solutions is not in the best interests of the industry or its customers. Lets hope the forthcoming Water Bill and Ofwat in their “future regulation’ review take ‘decisive action’.

19/09/2011

Shrinking rivers

Photo: Hobson's Conduit
This year has been unusual yet again. While Scotland may have been deluged many parts of England have had some of the driest weather in 100 years. In Cambridge they have had the driest spring in 98 years. A 400 year old historic watercourse – Hobson’s Conduit – is drying up. Is this just normal variation in weather patterns or are rising population, increasing demand for water and concreting over of countryside equally important causes?

About a quarter of rivers are classified by the Environment Agency as being in danger or “over-abstracted”. The Kennet in Wiltshire is among the worst affected yet over 9.6 bn gallons a year of water are being abstracted. It is perhaps not surprising that the forthcoming water bill is likely to propose increasing the cost of abstraction licences and perhaps make them tradable.

The new planning framework so hotly debated at the moment talks about the need for all new development to be sustainable. Does this mean that it will not be possible for there to be any development in Wiltshire given the perilous state of the Kennet which is clearly not sustainable? Unfortunately the new planning framework does not define sustainable leaving the way open for a lawyer’s paradise.

What is clear is that a holistic approach that really values water and the environment is essential. It is no good just reducing extraction – instead its vital to look at the demand side as well, is 20% leakage really the economic level? Will Metering help? Should building regulations be tightened further to reduce water demand from new properties, should development be restricted in water scarce areas? 

These are not easy questions but the trend is clear low river water flows are an increasing problem and the current position is not sustainable. 

12/09/2011

Water bill still on track

Water Minister Richard Benyon confirmed last week that publication of the Governments’ water bill is still on track for December 2011. MPs debated water legislation and flood management in Parliament last week.

The elephant in the room is the rising levels of bad debt in the water industry and increasing concerns over affordability. With the current economic gloom and rising water bills and now the additional cost of transferring private sewers it’s a problem that will only get worse. It is particularly acute in the South West with SWW water having some of the highest water bills but in a relatively poor area.

Changing the structure of the industry and introducing further competition is unlikely to make a significant difference, in deed in the view of this blog restructuring would only make matters worse. Ofwat has just published a report on ‘vertical integration or seperating the companies by discrete function e.g. sales or supply. The conclusion will not come as a surprise to those with long experience in the industry – there is no evidence that either is better.

The water industry needs to focus even more on ensuring it prioritises investment where it will make the biggest difference and delivering schemes as cost effectively as possible. Huge strides have been made on this since privatisation but its clear there is still scope to do better.  Just look at the cost penalty British Water has identified that comes from the 5 year regulatory cycle and loss of experienced people at the end of each AMP period. The forthcoming water white paper is the opportunity to take action and address the elephant in the room.

06/09/2011

Adapting to climate change in the water sector


Ofwat’s “adapting to climate change report” is another step forward to ensuring the water industry changes to cope with climate change. It’s a huge challenge for the industry against a backdrop of uncertainty in the science and difficulty in predicting what the impact will be. Will summers really get hotter and dryer as some forecasts suggest – hard to believe given the wet August?
What does seem certain is that there will be more extreme events. The cost implications for the water sector are huge. Just look at the vulnerability of many sewage treatment and water treatment sites to flooding. The big stumbling block is gaining political acceptance for increasing bills to pay for the investment. Certainly in PR09 that was a step too far and now with the more challenging economic climate it is even more difficult.
Ofwat rightly aims to encourage more innovation. Anglian Water’s success so far in meeting its target to half its embodied carbon in the building of new assets shows what can be done when there is a real commitment to act. They are on track to meet the goal and do it within the tight price limits. The passion inherent in the Anglian Water Love Every Drop campaign needs to spread across the industry.
With the dark evenings approaching the books to read are Taleb’s Black Swan (The impact of the highly improbable) and Fooled by Randomness. 

02/09/2011

Water sector - August a bad month for investors


August has not been a good month for investors in the water sector. It started with the news that Veolia’s first half results were much worse than expected. Veolia shares are down to about $13.4 from their 2007 peak of $65.65. The London-listed Aqua Resources Fund had to announce its net asset value per share had dropped 8.27% in 6 months.

While no one doubts that demand for water is increasing with the rapid urbanisation of the world, increasing population and threats from climate change. This combined with the rise in environmental regulations and increasing scarcity of water resources will require massive investment. The problem is who pays for the investment?

The current debt crisis means that Western Countries cannot take on ever more debt to fund investment, raising prices is an option for those that charge for water but politically very difficult.  But in many of the countries were the need for investment is highest, there is no history of charging for water.

Introducing water charging is extremely difficult as the Government has found in Northern Ireland. Many countries just don’t have the systems to collect tax let alone establishing water charging when the infrastructure is in a state of disrepair or non-existent. Politically its extremely difficult, not only is it highly unpopular but also it tends to hit the poorest in society hardest, the very people who need clean water and wastewater the most.

Until there is confidence that the funding mechanisms for investment are realistic the water sector is likely to remain an sector with great promise and need but with significant risk for investors. The key is to look at the specifics of each country and to understand the regulatory and political environment in that country.