Two years after the cost of living crisis hit, many English households are still struggling. And while people can – and have – cut back on many things, water is not one of them.
What many bill payers may not realize is that their money doesn’t just pay for services, it also serves debt, many of which relates to dividends paid to shareholders.
Figuring out what proportion of bills goes towards servicing debt is no easy task: there is no widely agreed methodology for this calculation, and the guidelines from Ofwat, the industry regulator, are based on a theoretical company that according to experts is not real. -life business.
These companies – some of them with more than £1 billion in annual revenue – use complicated financial mechanisms that make it even harder to opt out.
One such device commonly used by some of the companies that supply our water is a derivative – a financial instrument used to mitigate the risks of fluctuations in interest rates and currency value.
The effects of such products vary significantly from year to year and between companies: in 2023 derivatives worked in favor of English water companies, but in other years derivatives were associated with high costs, raising the cost of servicing debt to 36 % of revenue across the industry in 2022.
The water companies defend their use of derivatives – indeed some argued in response to the Guardian that they protect customers and reduce bills.
Experts in the field – including Dr Kate Bayliss from the Department of Economics at Soas University of London – say derivatives, and instruments like them, “are speculative financial instruments that bring their own risks and added complexity to what is a very simple and transparent business”.
Bayliss said some water companies had previously used “financial engineering” to raise debt and pay dividends and were now using derivatives to mitigate fluctuations in financing costs.
This is a position shared by Ofwat, which says they can influence financial resilience as well as company credit ratings and power mask underlying financial weakness.
The Guardian’s methodology, which compares water companies’ net financing costs with their revenues, was developed with Bayliss and agreed by other experts.
To iron out some of the annual fluctuations caused by derivatives, the Guardian, in consultation with these experts, looked at company accounts over a five-year period.
The analysis includes the gains and losses of derivative instruments when these products affect the financing costs of debt servicing.
We used the companies’ income statements – not cash flows – as the basis of the methodology, as recommended by independent experts, who said it was more accurate and made for a more meaningful comparison to income.
Richard Murphy, one of the experts consulted, said: “Cash flow does not indicate a company’s ability to make money or its ability to survive in the long term. It is therefore a hopeless measure of the ability to meet the long-term demands of the water industry.”
Our analysis found that customer accounts account for at least 96% of water company revenue.
Some of the companies that responded to the Guardian’s request for comment – including Thames Water, Southern Water and South East Water – disputed the methodology.
According to the analysis, almost a quarter of the revenue is from Affinity Water – which operates in London, East and South East operations. England – is used on average to service debt. The company’s figure, calculated on the basis of its cash flow statements, is 11p in £1.
Affinity said: “The 11p is based on cash interest paid as a proportion of all expenditure incurred in the year up to 100p. Our total expenditure includes amounts spent on servicing debt, investment in assets, suppliers’ operational services, staff costs, and local and central government… The water industry is financed by a combination of debt and equity. This reduces costs for customers.”
Similarly, Sutton and East Surrey Water (SES) said the cash interest paid compared to income averaged 9.8% over the past three years. However, the Guardian put the five-year figure at 22%.
A spokesperson said that despite inflation and supply chain cost pressures “the business remains financially resilient. We always try to keep our charges as fair as possible for our customers and also work hard to find savings in the way we work.”
The spokesperson said most of the financing costs in 2023 were the result of the high impact of inflation. “However, this does not result in any cash payment until we repay the debt at the end of the bond term, which runs from 2027 to 2031, and therefore does not have an immediate direct impact on our customers.”
Wessex Water, which serves parts of the south west, spent an average of 19.1% of revenue servicing debt, according to the analysis.
A spokesman for the company said its debt was “in accordance with regulatory requirements and financial covenants and avoids any risk to our financial stability”.
Yorkshire Water was found to have spent an average of 16.2% paying for interest and other fees associated with borrowing money over the past five years.
The company said borrowing is only one way of financing its investments “because it ensures that we spread the cost of investment over the future life of those new assets, and therefore it is not just paid by today’s bill payers”.
The analysis found Severn Trent Water spent an average of 11.2% on debt servicing over the past five years. A spokesman for the company said the assets Severn Trent invested in were for the provision of services now and for future generations.
They added: “It is therefore appropriate to compare some of our borrowing for the investment made against the life of those assets – similar to how a mortgage is paid off. The amount of debt we hold is relative to the size of our asset base, and it is not only one of the lowest in the sector, but also in line with the level guided by the regulator for financial resilience.”
Similarly, United Utilities’ cost of debt was 11.3%, according to the analysis. The company said it can keep costs for customers as low as possible because of its “robust financing structure”.
United Utilities said it had “one of the lowest levels of leverage in the sector, enabling us to effectively raise debt to support ongoing and future capital investment and continue to pass costs on to customers over the life of the distribute assets.”
An Ofwat spokesperson said: “When we set up accounts, we take great care to ensure that customers’ contribution to companies’ cost of borrowing is fair. For the 2020-25 period we have used a method which means that, should a company choose to go beyond the levels for debt we use for our calculation, the company bears the additional cost of repaying the money paid and not the customer.”
