2019 06 – private utility monopolies

Extracts from a Financial Times article on private utility monopolies
by Jonathan Ford

English water companies have built up £51bn in debt (from zero at privatisation), a staggering sum that customers will have to service and pay off over many years.

Between privatisation in 1989 and last year, English water companies were permitted by the regulator to generate operating cash flows totalling £159bn in 2017-18 money; easily more than the £123bn they spent on fixed assets such as new pipes and infrastructure.

How come? Embedded in the answer is the reason why private monopolies such as water and energy distribution networks have become so controversial, and why the Labour party’s attempt to nationalise them cannot be dismissed as a paleo-socialist blast from the past.

The answer is private investment returns. On top of all the money they invested in their businesses, those water companies paid out £56bn in dividends, and debt interest costs on their growing pile of borrowings.

Electricity companies have been no slouches too, with listed transmission owner National Grid delivering total returns of 12 per cent annually since privatisation. Dividends are usually seen as a return for equity investors bearing the risk, but the risk in these natural monopolies was minimal. Not only do customers have to buy the product; the regulator has a duty not simply to set prices to protect the public but also to ensure the businesses are financeable. That in turn is why they were able to borrow so much.

Now few would argue that private owners should be able to extract such outsize returns from private monopolies. It is what has spurred the interest in renationalisation.

If you do not trust private owners to exercise control, it is hard to see why that business should be in private hands. So it is hard not to share the analysis that more than well-meaning tweaks are needed. There are broadly two ways to solve the problem of private monopoly.

One is the solution the Labour opposition favours, which is to eliminate it by putting the companies into “not for dividend” public hands. Then you can set whatever social objectives you choose. Eliminating dividends certainly dissolves the conflicts of  private ownership.

The Welsh and Scottish water companies both have this model-and the latter has not suffered a notable penalty in efficiency versus the English companies, according to the Regulator.

The other approach is to foster more competition so that if risk returns have to happen, they should at least be more tolerable. In his 2017 Cost of Energy Review, the economist Dieter Helm suggested this could be achieved if the UK adopted a new approach to overseeing utilities, with regulators setting the desired outputs and then opening them up to completive tender from anyone-private or even state sources.

Water may be a relatively simple business but it is affected by climatic change. Britain’s energy systems face a period of upheaval as they are reconfigured to deal with the challenge of decarbonisation. A new approach might achieve this shift more flexibly, and align returns a little better with the real risk taken. Britain’s existing model ought to change.