Defra and the £100bn

The People’s Commission challenges DEFRA’s methodology published on the 16th September which is behind the government’s repeated claims it will cost £100bn to bring the water industry back into public ownership.  

DEFRAs calculations are based on the companies’ Regulatory Capital Value (RCV) which was first calculated in 1989, based on market value and adjusted each year by capital spending and depreciation. RCV is a pricing mechanism and has no relation to the actual market value of water companies. [1]

We disagree with DEFRA’s valuation in three main respects:

• First, using RCV as a proxy for market value is flawed. DEFRA uses RCV as a proxy for the water companies’ debt and equity, which is supposed to indicate what has been spent on investment. This approach does not reflect the £83bn that firms have taken out of the water companies  in dividends. Defra does not need to use a proxy for debt and equity, as spending as net debt is readily known (£70bn in March 24 detailed in Ofwat’s Financial Resilience Report )  and equity spending has been next to nothing. Shareholders have actually invested very little (People’s Commission Report p104).

• Second it is meaningless to value a company in terms of how much is spent on infrastructure without including the current condition of that infrastructure.

• Third, we disagree that this figure reflects the value of the companies. Three of the water companies are publicly traded and currently the stock market valuation is considerably lower than RCV. DEFRA refers to the average market value over the last 30 years. Current market values would be a more relevant comparator. Using DEFRA’s methodology, Thames Water has a RCV of £21bn (which is the figure for Thames built into the Defra £100bn costs) but earlier this year could not even attract £4bn investment.

Both RCV and Enterprise Value are artificially high and should not be used to assess the costs of re-nationalisation.

With nationalisation, compensation (the cost of nationalisation) would be a matter for courts and valuation would be on the basis of an independent fair value assessment. When the dividends withdrawn and the costs required to rectify years of underinvestment are taken into account, the fair value could likely be closer to zero than £100bn (People’s Commission p 13).

We conclude that the motivation for this £100bn valuation is to protect the status quo and eliminate discussion of policy alternatives, especially public ownership which is normal in the rest of the world.

Our report sets out our recommendation to take struggling Thames Water into public ownership, as should be the case in light of the company’s persistent licence breaches. From here lessons could be learned before moving to other companies. (People’s Commission Report, Recommendation 2, p11)

In the long term, public ownership would increase transparency, reduce the costs of borrowing, reduce project costs, and allow surplus funds to be reinvested rather than paid to shareholders and provide cheaper borrowing. These gains would offset the costs of nationalisation and need to come into a valuation assessment.

[1] this is fully explained in our Report on page 30

Dr Kate Bayliss, Prof Frances Cleaver, Prof Becky Malby