New CEO at Severn Trent signals change

Photo: Liv Garfield leaves BT to join Severn Trent 
Severn Trent has appointed Liv Garfield to its new Chief Executive. Her appointment boosts the number of female FTSE100 bosses to four. She will also be one of the youngest FTSE chief executives. 

Her background is certainly not in water, she read languages at Cambridge before starting her career by joining Accenture as a management consultant. Ms Garfield joined BT in 2003 and has been credited with delivery of the £2.5bn roll-out of fibre broadband which was running 18 months ahead of schedule. She was named in September as one of the top 10 young high flyers in Fortune magasine's annual 40 under 40 list making her the highest ranking Brit in the table.

In the view of the blog this is exactly the sort of imaginative appointment the water industry needs. Its absolutely vital the industry attacks bright, young graduates and especially female staff. Currently the water industry lags far behind many sectors in the number of female staff employed especially in senior positions. Admittedly its not just the water sector that struggles to attract the best graduates. Engineering generally has a huge mountain to climb before it becomes the first choice of graduates male and female. 

The water sector is facing huge challenges with climate change and the conflict between the desire of customers to see bills reduce and the need to invest heavily to renew ageing assets. Its only by getting some fresh thinking and the very best joining the industry that a way will be found to resolve these dilemmas.  

What is holding back innovation in the water sector?

The industry is currently driven by environmental legislation. But these same regulations can restrict innovation when compliance is needed 24/7. These tighter environmental standards get even tighter as the mitigate down the supply chain to sub-contractors who understandable want to impose a safety margin to avoid liquidated damages for performance failure.

There is innovation happening in unexpected places. Fat from restaurants and build-ups in drains is set to power Britain’s largest sewage works at Beckton. Certainly over the next 10 years the rate of change will be unprecedented. But utility management is about evolution not revolution due to the need to avoid taking massive risks.

Customers certainly do not want risk. Many prefer the predictability of a fixed water bill, especially having been stung with unexpected changes in electricity bills. Who wants a different colour of water out of the tap? 

How are long term targets such as CO2 reduction to be achieved if the rules are changed. Money is spent on carbon reduction projects then the rules affecting their financing get changed. It is not an incentive to innovate instead it pushes unrealistically short term paybacks. 

Fair return in the water industry

What is a fair return for investors in the water industry? The recent announcement that water bills are going up again at above inflation rates for many water companies, brings into stark relief what is a reasonable rate of return for investors?

This is no doubt that massive investment will continue to be needed in the water industry and that if water companies are to continue to invest they need to be rewarded. But is the balance right between investors and customers? Perhaps the best way to judge this is whether the water companies are having difficulty in raising funds or attracting investors.

The water industry offers some unique benefits, it is inherently an extremely low risk business with no chance of losing its customers. Each water company is still a monopoly. The probability of customers in say the London area ceasing to want water is zero. In fact it is quite the opposite, demand is steadily growing driven by population growth and changing lifestyles. They are not many businesses that have guaranteed sales. 

The water industry is very predictable. With the Ofwat regulatory regime prices and incomes are fixed for 5 year periods totally independent of what might be happening in the wider economy. Secondly the industry is driven by legislation and this is visible many years ahead. So water offers a very low risk investment with predictable and steady income. Its not surprising that there is such demand from pension funds and infrastructure investment companies to invest in the sector.

Every time a water company ownership changes the previous owners walk away with a windfall, just look at Thames and the money RWE made from their investment. With the recent divestment by Veolia Central, there were a large number of potential bidders, This does suggest that returns on investment may still be too high. 

Building on flood plains makes no sense

As every school child knows there is a very good reason why flood plains are called flood plains. So news that a new estate in Ruthin built on a flood plain – the Glasdir estate had flooded despite residents being told the chance of flooding was less than 1 in a thousand years is disturbing. The industry depends on trust, incidents like this put this reputation at risk and do harm to everyone in the industry.

An inquiry has been announced, real questions now need to be asked of the Welsh Development Authority who actively promoted building on the land, Denbeighshire County Council who gave planning permission, the Environment Agency who presumably agreed the risk was negligible and the builders Taylor Woodrow who apparently gave reassurances to homeowners. 

The obvious concern is that commercial pressures outweighed common sense. It is made all the worse in that this is a brand new housing estate with building work not yet finished. It suggests the lessons of Tewkesbury from 2007 have not been learnt.  How depressing!

Ofwat urged to act sustainably

Photo source: Thames Water

At the All Party Parliamentary Water Group House of Commons reception on Monday night it was fascinating to hear Ann McIntosh’s views on innovation in the water industry. Surprisingly she was highly critical of Ofwat and said she though Ofwat were jumping the gun in pushing for licence changes with the water companies.

It is clear that Ofwat’s request to change the license terms to promote retail competition is causing real concern. Water company share prices have dropped significantly over the last two weeks as investors take fright. Now 17 of the water companies have apparently rejected Ofwat’s license changes.

Water UK reported: “Companies have considered these proposals carefully. Companies want to maintain investor confidence and the low cost of financing that the sector enjoys, which keeps customers' bills as low as possible - an objective which is shared by the Government.

The majority of companies have been unable to accept Ofwat's proposals in their current form due to widespread concern within the industry about their potential impact on investor confidence”. 

Water demand to outstrip supply by 2030

Photo source: Thames Water

Fourty per cent of senior executives in the water industry across the world believe that by 2030 national water demand will outstrip supply. The results are part of a fascinating survey by the Economist Intelligence Unit sponsored by Oracle Utilities called “Water for All”.

The biggest barrier ahead is seen as wasteful consumer behaviour. Across much of the world water flows out of our taps at almost no cost to the consumer. As such it is not surprising that consumers, business and farmers have little incentive to curb usage.

Israel has been one of the most innovative countries in tackling water issues with almost 70% of wastewater recycled and world leading technology for irrigating crops, (farming is the biggest user of water in most countries). But most countries do not have such a severe water crisis or the strong political will to tackle the issue.

Encouraging consumers to use less water is very difficult apart from the obvious win of installing water meters. In many countries consumption of water per head is increasing as lifestyles change. Equally imposing a significant cost for water is also extremely difficult to achieve – just look at Northern Ireland.

There is no simple answer. The risk of drought and water pollution is increasing as the world becomes more urban and the impact of climate change continues to evolve. There is a lot that can be done from reducing leakage to making better use of recycled water. The technology exists, the problem is getting the financial incentives right to drive investment. With the current world economic recession stifling public sector investment this blog is pessimistic and believes the situation is likely to get worse before action is taken.

Cost of capital in water industry

Farmoor Reservoir photo courtesy of Thames Water

Will the draft water bill help to solve the key issues facing the UK water industry, like flooding, water abstraction and major projects like the Thames Tideway Tunnel?

The draft water bill is based on the premise that increasing competition in water is the answer. Yet as every householder knows competition in railways and especially the energy market has not worked as intended. Indeed some would argue it has made the situation worse. Now Ofwat is consulting on proposals to alter water company’s license to operate to start moving towards what is proposed in the draft water bill. This sounds arcane but these so called ‘section 13’ modifications has the potential to increase the cost of capital and hence raise water bills for everyone – the opposite of what is intended.

Why? The reason is uncertainty. Many of the water companies now have pension companies as their main investors. Pension companies do not like risk and need certainty in investment returns. The proposals by Ofwat increase the risk and take away the certainty. No one knows how Ofwat will use the enabling powers and discretion it is seeking in the future.

The concerns of investors have already forced the inclusion of this statement in the white paper: We do not want to take risks with a successful model given the challenges we face in building the resilience of the sector. The water and sewerage sector has proved attractive to investors looking for reliable low risk returns, with its stable regulatory system a key factor in building confidence”.

Dieter Helm has written an excellent critique of the draft water bill - its well worth reading. 

The cost of capital in the water industry is remarkably low and rivals that of governments – to put it at risk would be a major mistake.