Will Labour’s nationalisation plans solve the water industry ‘trilemma’ of affordability, population growth and environmental pressures? Burges Salmon’s Noel Beale considers the issues.

The Labour Party's stated intention to nationalise the water sector (along with other public services) has caused considerable consternation in the industry and for many of its stakeholders.  

One of the key drivers for the policy appears to be the profits which water companies have been able to make over the last 15+ years by relying on the unexpectedly cheap cost of debt rather than equity investment through ‘financial engineering’. This is something Ofwat has its eye on as part of its 2019 price review intending that financing risks/rewards will be shared with customers. However, this could ultimately be both good and bad for customers.

It is difficult to square the suggestion of nationalisation with one of the other key drivers in the water sector at the moment which is the need for long-term investment in infrastructure. Indeed, the lack of long-term infrastructure investment pre-privatisation was one of the key drivers for privatisation. And since privatisation, approximately £130bn has been invested into the water and wastewater sector resulting in significant improvements in quality. It is generally recognised that more long-term investment is required as the sector faces the 'trilemma' of affordability, population growth and demand (particularly in the south east) and growing environmental pressures as a result of climate change.  

The Labour Party’s exact intentions are unclear. The talk is of putting public services irreversibly in the hands of workers so that they could never be taken away again. Moreover, it is about everyone having and ‘feeling’ ownership of the services rather than the services being in the hands of a ‘remote’ bureaucracy.  However, what this actually means in terms of ownership models is unclear. 

The Labour Party's publication on Alternative Models of Ownership from 2017 considers cooperative ownership, municipal ownership and national ownership but there are no conclusions about a preferred model to replace the current model of ownership and regulation. Labour’s shadow chancellor John McDonnell claims that bringing services into public ownership will cost “absolutely nothing”. However, it is likely that a Labour government would need to compensate current owners for a number of reasons. 

First, the market value of the English companies is estimated to be around £83bn (Welsh Water is already a company limited by guarantee). This is on the basis that the combined regulatory capital values (RCV) of the English water and sewerage companies come to about £64bn and, where companies have changed hands in recent years, the valuation has generally been of the order of 1.3 times the RCV. However, others argue that these were at the top of the market (driven by financial engineering by the companies) and that the acquirers generally overpaid.

A new Labour government might be tempted to see if it can pay less than the above figures. However, there would be very likely to be significant legal challenges to this based on human rights arguments and the terms of various bilateral investment treaties and free trade agreements which protect investors. In addition, such an approach would fundamentally undermine investor confidence in the UK which would have far reaching effects.  

While large international investors, and some UK pension funds, might be impacted, such an approach would also impact employees at companies such as South West Water, Severn Trent and United Utilities, where many staff own shares through employee share schemes.

Labour argues that this (and future investment) can all be financed with government debt, which is cheaper than private water companies can achieve. The reality in the current climate is that there is not a lot of difference. Moreover, public ownership means the public taking on the risks of ownership which can be significant for large water companies.

Finally, the real question is whether a change in ownership would in fact bring about the increases in long-term investment, changes in consumer behaviour and decreases in costs which are required to solve the water sector ‘trilemma’. The reality is that there is little or no evidence either way.

Noel Beale is a director in the competition team at the law firm Burges Salmon.