Select Committee on Environment, Transport and Regional Affairs Memoranda

Memorandum by Kelda Group plc (DWB 15)

  May Kelda Group offer its support for the Sub-Committee initiative in setting up a pre-legislative inquiry into the draft Water Bill, and moreover welcomes the opportunity to make input in that process.

  Kelda's basic contention is that there is a need for a Strategic Review of the UK water industry aimed at achieving more balanced and cohesive relations with all financial stakeholders, customers, regulators and the community.

  The water industry is now facing the need to respond to strong external pressures particularly:

    —  The need to raise large sums of capital at low cost.

    —  The certainty that equity markets will not provide additional funds for water or waste water investment.

    —  The need to generate efficiencies through competitive forces in a way that does not put at risk the safety of drinking water supplies.

  The fundamental issue to address is long-term funding of investment and the need to find a structure going forward which provides the maximum possible capital at the lowest cost. On current plans, the water industry needs to finance investment of £16 billion over the next five years. This is in a period where quality and environmental obligations are rightly increasing but average bills have more recently declined by 12 per cent in real terms.

  The regulatory price cut has dented investor and lender confidence in the industry. Although equity prices have to an extent recovered, having fallen by more than 50 per cent early last year, providers of private capital upon whom the industry will rely for all future investment are still reluctant to lend money to the industry. In the meantime the major credit rating agencies have downgraded their assessment of the industry.

  This investment issue and consequent pressure has resulted in a number of companies making proposals for re-structuring.

  Although Kelda's first proposals for restructuring its water business into separate asset and operating companies did not meet regulatory approval, they helped increase the focus on longer term issues in the water industry, particularly the need to raise the significant capital sums required at the lowest cost of borrowing. The recently announced "Not for Profit" ownership structure in Welsh Water, Glas Cymru, is similar to the proposals made by Kelda.

  Further evidence of the need to change was given by Thames, who opted to sell itself to a major overseas company. Such companies have the benefits, outside the UK, of a more stable long-term commercial environment, are allowed more attractive rates of return, can more easily finance investment and have the financial strength to take a longer term strategic view.

  There is increasing recognition that the combination of historic privatisation structures, inappropriate "one size fits all" models of competition and a punitive interventionist regulatory approach does not, in the long term, best serve the interests of the consumer, the industry or the wider environment and the community. This is particularly true where long-term capital expenditure is necessary. Recent events in other industries have helped reinforce this general point. There is now more regulatory sensitivity to and acceptance of the dynamics of the linkage between capital markets and equity markets in the UK.

  The water industry in general and Kelda in particular has made substantial progress on many fronts, such as cost reductions, water quality and service delivery improvements. We look forward to a greater recognition of these achievements, and believe now is the time for an overall review of all options open to the industry, with a new regulator, and opportunity for a more balanced regulatory approach.

  We would wish to explore with the Committee two of the above issues in particular, namely the need for a Strategic Review and the means by which the lowest cost of capital can be secured for the industry.

  It is against this backdrop that we reiterate our support for the Sub-Committee initiative, and if invited, would be delighted to make an oral submission to the process through our Executive Chairman, John Napier.

January 2001

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