Labour has water in its sights

Last week Labour drew the water sector into its affordability narrative, threatening licence changes if necessary. Is this bluster, or should water companies be afraid? Mathew Beech reports.

It was only a matter of time. Energy companies have spent the past year being battered by politicians and the press, ever since Labour leader Ed Miliband promised an energy price freeze if elected, in September 2013. Water companies knew their turn was coming – and their fears proved true when Labour’s shadow environment minister, Maria Eagle, took to the stage at the party conference in Manchester last week.

She made big promises. The first was: “We will reform the industry, creating a national affordability scheme – compulsory for all water companies.” This pledge to mandate social tariffs builds on a long-­standing Labour policy – the party campaigned unsuccessfully to have social tariffs included in the Water Bill last year.

More mysteriously, Eagle made a second promise: “We’ll give the regulator new powers to modify the terms of water company licences.” This is a pledge to strike fear into the heart of any water sector boss. The last time Ofwat attempted to modify water companies’ licences (the Section 13 debacle of 2012) there was nearly all-out war. The implications of new powers to modify company licences are potentially huge, but Labour is tight-lipped on the details.

First, the social tariffs. Labour has been banging this drum since last year when it sought an amendment to the Water Bill requiring all companies to introduce a national affordability scheme, or social tariff. The government, on the grounds that most water companies were in the process of introducing social tariffs anyway, and were best placed to decide how to do so. Speaking in the House of Commons in January, water minister Dan Rogerson said: “The biggest thing we can do is to ensure we bear down on charges for everybody… Ofwat has been clear in the way it has entered into the price review period and companies are now responding.”

Indeed, most water companies now have a social tariff or are introducing one. However, some have faced customer opposition in doing so, because social tariffs subsidise the poorest by driving up overall charges. The national affordability scheme proposed by Labour would override such objections.

Eagle’s second pledge was potentially even more significant. Changing water company licences is an extremely sensitive process. When Ofwat last attempted to do so in 2012, there was an outcry from the companies that almost saw the sector referred to the then Competition Commission. The crisis was averted at the 11th hour when ex-Anglian Water chief executive Jonson Cox joined the regulator as chairman and brokered a deal which effectively saw Ofwat back down. Chief executive Regina Finn left the organisation a few months later.

Given the background, Eagle’s words take on particular weight. Labour is refusing to provide any details, keeping its powder dry for the election campaign. Perhaps a hint can be found in a comment Eagle made during last year’s debate on the Water Bill: “Labour would be taking tough action to bring the rising cost of water under control. We would strengthen Ofwat’s power to reopen price settlements to cut bills where companies are making excessive profits.”

Indeed, Eagle made her concern at water company profits clear in her conference speech, claiming money was being “siphoned off” to shareholders and private owners. She cited £1.8 billion paid to shareholders and only £74 million paid in tax in 2013.

Regulatory uncertainty spooks markets, and the listed water company share prices juddered on Eagle’s speech. Severn Trent’s share price opened at 1,937p on the day of Eagle’s speech (Tuesday 23 September) and fell to 1,880p by the close of trading. Pennon started the day at 781p and ended it at 766.50p (although it picked up in the following days to close at 789.5p). United Utilities saw its share price fall from 842p to 815p on 23 September.

However, analysts remain relatively sanguine. Martin Brough, utilities equity analyst at Deutsche Bank, says the comments from Eagle were “unhelpful” and that her hints at a change to licence conditions will “reduce regulatory certainty”. But he does not expect significant alterations to the regulatory regime.  “The completion of the [price] review in December 2014 should provide five years of pricing visibility,” he says.

Indeed, the price review, now reaching its conclusions, pre-empts many of Labour’s concerns. Unlike their cousins at Ofgem, Ofwat’s managers read the political mood on affordability in good time, and have been using the review to drive down water bills. Under pressure from the regulator, most water companies did not take the price rises they would have been allowed this year. Ofwat is also focused on fair profits, with a number of significant changes to how companies are governed, how shareholder interests are represented, and how they are recompensed, already under way.

Chief among these is the cut in shareholder returns, from 5.1 per cent in the previous price review period, to a projected 3.85 per cent for PR14, which the regulator has said could be lowered still further.

Brough says this should help to “diffuse apparent political pressures” on the sector in the event that Labour goes beyond “political posturing” and makes significant regulatory changes. Stephen Hunt, analyst at UBS, agrees that Eagle is trying to “score some political points” by “drawing a parallel” with the party’s proposed energy price freeze.

He adds that the water sector, with the change of approach by Ofwat to the PR14 price review, has “just been though a big change in licences and a change in regulatory methodology”. Hunt says the water industry is in a “very sensible position now” and that the risk to investors and companies is “pretty limited”.

Water UK says Labour’s concern “has registered” but it needs to see the detail. Neil Dhot, head of corporate affairs at Water UK, adds: “We need to discuss it with Labour. It could be significant but we don’t know yet. The devil will be in the detail but there is no detail about it [the licence change].”

That detail will not be forthcoming until the election, if then. In the meantime, the water sector must hope that it is doing enough to relieve the political pressure.