By George Hay and Neil Unmack
LONDON (Reuters Breakingviews) - Should Jeremy Corbyn win Britain’s next election, his Labour Party has said it will end private sector ownership of natural monopolies like water companies. The received wisdom is that returning utilities to the public sector will be exorbitantly expensive. But that depends how it’s done.
If a Corbyn government decided to buy out the UK water sector at current valuations, it would indeed have to pay up. The 2017 aggregate value of the 16 English water companies’ equity and debt is 80 billion pounds, according to the Social Market Foundation, a think tank. Stumping up for this would add 5 percentage points of GDP to the UK’s gross national debt.
Labour finance chief John McDonnell is okay with this, arguing that the companies’ cash flow would cover the additional interest on the government bonds issued to pay for nationalisation. But that might not remain the case if investors demanded higher yields on the rest of Britain’s debt, which is already at 90 percent of GDP. Besides, water companies might become less efficient if they were once again run by bureaucrats rather than profit-oriented managers. They are also expensive. The privatised groups typically trade at a premium to the value of their capital set by regulators, because yield-hungry investors are attracted to their stable cash flows.
To make his water grab more affordable, Corbyn could do two things. One option is to reduce the value of the sector’s equity, which the SMF currently puts at 34 billion pounds. The other is for the buying to be done by mutual or not-for-profit entities, which do not appear on the government’s balance sheet.
To achieve the first outcome the UK regulator, Ofwat, could lower the returns it allows water companies to make from charging customers. At the same time, the government could slap a windfall tax on utilities, for example those that have paid big dividends to their shareholders. There are precedents for both actions. In its last few price reviews, Ofwat has reduced the return on regulated capital water companies can earn. The fact that investors are still willing to pay a premium suggests those returns are still too high. Back in 1997, the Labour government led by Tony Blair imposed a windfall tax on utilities.
Britain also has examples of utilities being taken over by their customers. Welsh Water, which is owned by a not-for-profit company called Glas Cymru, has no shareholders and reinvests any surplus it earns in capital investment or lowering water bills. It last changed hands in the early 2000s, after a harsh regulatory review and a windfall tax eroded the price of water company equity, enabling it to be acquired for just one pound, with the rest funded by debt.
Imagine an onslaught from the regulator and Corbyn’s government knocked the UK water industry’s equity value to less than 15 billion pounds. A group of, say, 10 not-for-profit entities could then each borrow around 1.5 billion pounds to buy the equity of their local utility – just as Glas Cymru did – and assume its liabilities. A company funded with 100 percent debt may sound risky, but bond investors are already willing to lend more than 90 percent of British water groups’ regulatory capital value. Freed from the need to pay dividends to shareholders, not-for-profit buyers could deleverage. Welsh Water’s debt as a proportion of its regulatory capital value has dropped from 93 percent in 2001 to 56 percent in 2017.
A Corbyn government would still face opposition. Current water company shareholders – which include UK pension funds – would protest their losses. Bond investors might try to trigger early repayment of the existing debt. Meanwhile, the government would need the confidence of financial markets to attract fresh funding. That would be tricky, given that the state would just have just undermined that credibility.
The regulator could start by picking on the worst-run companies. The process of unwinding an entire privatised industry would still be risky and uncertain. And the whole enterprise would be easy to critique as driven by ideology rather than customer care. But when Corbyn talks about low-cost nationalisation, it’s not all hot air.
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