Thames Water is in trouble

If you wanted a business with a very good chance of making a big long-term profit then it may well be in water supply. Setting up a domestic water supply business means a massive initial investment in capital in the form of reservoirs, piping, sewage management, and water treatment but once it is set up you have a product that everyone needs and there are no real substitutes. This is a classic natural monopoly situation that looks like the producer can only make a profit.

But the UK’s biggest water company, Thames Water with 15 million customers and annual revenue of $2.5 billion faces collapse. Thames lost nearly $300m last year and it has a debt of $18 billion which is nearly 80 per cent of its asset value.

How did we get here

UK water companies were publicly owned until 1989 when the UK government privatised the water industry by selling shares in a number of regional water companies. Thames Water was one of the regional water companies that was floated on the London Stock Exchange and investors bought shares in the newly formed private company.

One of the challenges water companies have is the cost of investment in water infrastructure. The pipe system used by Thames Water is 150 years old and it suffers from serious leaks which need to be fixed. UK water companies have also suffered from well-publicised sewage leaks which will require significant investment to prevent from happening.

But the most significant increase in cost facing Thames Water is the cost of servicing its huge debt. Much of the debt Thames has is index-linked which means its interest payment rises with inflation and as inflation has increased so has Thames’ interest cost.

As a private monopoly, Thames would like to increase the price it charges to customers to cover this increase in its costs. But it cannot because Thames’ price is controlled by the UK’s water regulator Ofwat. As a vital necessity for households, Ofwat does not allow water companies to increase their prices in the way they might want to cover rising costs.

This is Thames Water's problem. It has suffered from a huge increase in cost and cannot increase prices to cover this and this leads to losses. Thames is under the threat of business failure and this means it would be renationalised and go back into public ownership.

Some possible points to discuss with a class

1. Why is Thames Water considered to be a natural monopoly?

2. What are the barriers to entry that exist in the domestic water market?

3. What type of profit might you expect Thames Water to earn?

4. Do you think it is important for the price of water to be controlled by Ofwat?

5. Discuss the advantages and disadvantages for Thames Water of being a state-owned business.