The reputation of water companies has taken a beating in recent years due to poor environmental performance and historic underinvestment in the aging infrastructure. Despite the urgent need for water companies to upgrade their Victoria-era resources, it’s perhaps no wonder that investors are reluctant to support through investment.
Since privatisation, substantial dividends have been paid out by water companies. The combination of these dividends as well as pressure from the industry regulator Ofwat to keep bills low over the past few decades has exacerbated the issue of underinvestment. It also means bill increases are now landing at a time when consumer budgets are challenged.
While a significant amount of spending is necessary given the state and age of the infrastructure in the UK, consumers are understandably sceptical about whether increased bills will deliver the promised improvements, especially in the context of the cost of living crisis.
Attracting investment is also becoming difficult. Markets are crowded as utility companies look to raise money for the sustainable transition. Investors are looking at water companies elsewhere in Europe and America, where the allowed returns are higher and public perception is better. The table below also shows how trust in water companies is falling among the public.
Trust in water companies’ ability
Figure 1: Source: Ofwat, February 2023
The table above shows that while most consumers believe there is decent service and water quality, trust has fallen over sewer inflows and insufficient investment in the aging network.
The water utilities sector needs to focus on improving its environmental performance before expecting public perception to improve. We want to see deliverable plans for the next five years. Companies must ensure that supply chains are healthy and set up to deal with increased capital expenditure. Improvements must be affordable to the consumer, especially considering the tougher economic backdrop. Balancing long-term needs with immediate affordability is crucial. The most vulnerable customers need support as well, and we would support a national scheme that standardises measures across different companies and increases accessibility.
Engagement with water utility companies within the Sustainable Future range
With this in mind, we met with each of our UK water utility holdings across the Sustainable Future fixed income and managed funds, following our initial engagement exercise with them in 2022. This time around, we focused on assessing their plans for the next regulatory period and further out, and how credible hitting their targets would be.
Severn Trent remains one of the top performers from our perspective. It described to us its work worldwide with both water and non-water companies to determine best practice for its operations, and how it shares this with peers at home. The company has invested a lot into obtaining the correct expertise for each of the issues it faces. The company’s ambitions extend to emissions as well, developing the world’s first carbon neutral wastewater hub which is to be operational this year.
Anglian Water, with middle of the table environmental performance, mentioned it was in the process of revoking overflow permits for allowed combined sewer overflow (CSO) usage, which it will do as it creates additional capacity to render storm overflows permanently inactive. This is to show commitment to its zero spillages target, with the plan prioritising sensitive sites, like a Special Site of Scientific Interest or chalk stream. Efforts such as these, eliminating the legal ability to use overflows altogether, and beyond what the regulators are calling for, can be the first steps to restoring credibility in the sector.
Yorkshire Water informed us of its nature first initiative which means it looks at these solutions first before any other. These can be cheaper and more environmentally friendly, and the company is currently working on building them up to use on a larger scale.
Executive pay has been at the forefront of media attention. We challenge businesses we are invested in to make stronger links between environmental performance and pay throughout the organisation, as we believe this creates the right incentives for better operational performance. Incentives for executives need to be aligned with consumer needs, especially around an essential right like access to water, and we will continue to encourage and monitor this.
Are things getting better?
The sector will invest a record £96 billion in the next regulatory period, with goals on improving both pollution incidents and increasing water resilience. Improvements have already started, with monitoring of overflows in England and Wales now at a level that will capture nearly every discharge. Companies can now use vast amounts of data to better target the worst CSOs first. While we are encouraged by the step change in the plans to address these issues, there are still a huge amount of investment and operational improvements to be implemented before we see meaningful change.
Water utility assets have existed for 125 years and there has been chronic underinvestment during this time. While there have been failures in every stage of the ownership cycle, the responsibility lies with current owners and the regulators to define and action a clear pathway to improvements. As investors to these companies, we believe there is a route to better outcomes. We believe in the benefits the sector can provide as a job creator and driver of economic growth, alongside facilitating the sustainable transition while upgrading our water infrastructure for the benefit of all stakeholders.
Deepesh Marwaha, Investment Analyst, Sustainable Investment Fixed Income team
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