‘A ridiculous return’: South West Water and the cost of water

3 min read

Devon resident Stan Beale considers the excessive prices charged by South West Water and questions the regulatory regime that allows them to keep going up.

The water companies of England and Wales have largely escaped the considerable criticism there has been recently of the excessive prices charged by the privatised utility companies, in particular for gas and electricity.

But consider South West Water, which supplies Devon and Cornwall. Its excessive household charges since flotation in 1989 have been mainly attributed to the huge capital investment programme (called ‘Clean Sweep’) necessary to install sewage treatment works around the peninsular coastline in order to minimise the discharge of raw sewage into the sea. There has also been some criticism of the Conservative government for the provision of an inadequate “initial cash injection”, the so called Green Dowry. This Government contribution totalled £365 million and comprised debt forgiveness of £129 million, plus £266 million in cash.

However, any shortfall in the Green Dowry seems to have been put right by Ofwat, the regulator, in the price determinations for the first five years of private ownership. From 1990 to 1995, the price increases awarded to South West Water by Ofwat were 6.5%, 6.5%, 11.5%, 11% and 11% – a cumulative price increase of nearly 60% (plus RPI [inflation] increases). In the 1994 Price Review, Ofwat was less generous and awarded South West Water only a 1.5% increase for 1995-96, with 1% increases for the subsequent 4 years. The company complained to the Director General of Ofwat who referred the matter to the Monopolies and Mergers Commission, which reported:

“South West Water told us that the funding provided by the Director’s determination would not enable it to finance the proper carrying out of its functions as a water and sewerage undertaker. Specifically it said that the capital expenditure levels upon which the Director had based his determination would not allow (the company) to meet its legal obligations, its regulatory and operational commitments, and the proper expectations of its customers.”

However, the MMC concluded that the South West Water complaint was unwarranted and that the price increase of 1.5% for 1995-96 was excessive and should be reduced to 1%. When you think that at about this time (1994-97), South West Water profits were running at more than 40%, you must wonder what the detailed financial considerations were that justified any further price increases at all.

Not that the excessive water charges went entirely unnoticed. One of the first actions by Gordon Brown on being installed as Chancellor of the Exchequer in 1997, was to declare the water companies of England and Wales “awash with cash” and to impose a windfall tax of £1.69 billion, based on excessive industry profits over the previous four years. The South West Water share of this was £102 million, which represented an average charge of about £150 per customer household – among the highest in the country.

The recognition that water customers were being charged far more than was necessary for the companies to finance their functions prompted remarkably little media comment. There was no apparent pressure from the Government to encourage Ofwat to correct the over-generous revenues of the water companies and certainly no action by Ofwat to reduce the profits to a more sensible level.

The average South West Water household bill remains the highest in England and Wales. South West Water continues to be given the most generous profit provision. A 2009 Ofwat report included projections for “Return on capital” and “Taxation” to total £728 million of the five year total revenue of £2 billion – a projected profit before tax of 35%.

The Department of the Environment and Ofwat insist that these generous profits are essential in order that investors (the shareholders) can be properly rewarded. As implied, the profit is calculated mainly on the capital value of the company with emphasis on capital investment since flotation which, for South West Water, will obviously reflect the cost of Clean Sweep.

The irony here is that South West Water customers are being charged a second time on the basis of the Clean Sweep investment in order to reward shareholders who made virtually no contribution at all to the capital investment programme on which the return is based.

The problem for customers of the private water companies of England and Wales is that there is no independent watchdog to speak on their behalf. A major executive decision of the water companies is the setting of the budgets on which prices can be determined with sufficient precision to ensure that companies are able to finance their functions and receive a reasonable profit. These budgets are in fact set by Ofwat’s Director General of Water Services. Not only do water customers therefore get no support in their complaints about excessive prices but they are also unfortunate that Ofwat is so concerned that shareholders should receive a generous return on capital they did not finance. The England and Wales industry average profit for water and sewerage services through 2010-15 is no less than 30% – surely a ridiculous return for such low risk monopolies with stable customer bases and assured revenues.