Tuesday 4 July 2023

Thames Water: catastrophic downside

Asset-stripping is hardly new: but the first really big company to be terminally hollowed out by modern financial engineering was Enron (1987-2001).  The reason why it happened there, was completely the opposite of what's taken place at Thames Water.  Enron was chronically under-capitalised for conducting the business it was (very successfully) engaged in: giga-scale market-making in the energy sector, with attendant innovation and creativity that has been much missed in the sector since 2002 (sic) but never truly replicated.   Nostalgic laments aside, what Enron absolutely needed for its business model to be workable was to maintain investment grade credit status, because long-term dealmaking was its forte, and nobody[1] will do long term deals with a shaky counterparty.  

Why was maintaining credit status a problem?  Because (a) as an inevitable structural problem, cashflow lagged profit (which can be the death of literally any business, however sound);  (b) it couldn't borrow any more, which deprived it of the traditional solution to that issue; and (c) - the real killer - it was committed to perpetual expansion, it being traded on Wall Street as a growth stock[2].

This conundrum became fully apparent (to Enron itself: the rest of the world just gawped and invested) as early as 1993, when the financial engineering started.  For a few years there was ample opportunity to do some clever but wholly prudent stuff, resulting in a balance sheet that was a marvel of precise and efficient design.  However, by the end of the '90s what could be achieved by such elegant means was pretty much exhausted, and they started resorting to some deeply imprudent expedients, designed by Enron people who really knew what they were doing - and abetted by banks who should have known better - and could therefore build it very big and very bad.  (It didn't help that one of the main architects of all this was actually on the take in the literally criminal sense.)

*  *  *  *  *

Enough of history: it suffices that some potentially very dangerous financial technology had been designed and employed, able to be abused in completely different circumstances.  Enter highly capitalised Thames Water, with physical assets and guaranteed revenue streams galore; the most fertile ground imaginable for financial engineering - and ideal circumstances for gouging out all the cash and remitting it as dividend.  And so, it seems, they have.

How dangerous is this?  One might say: who remembers Enron now?  Didn't the lights stay on, and the waters close over?  Hopefully, optimistically, that's right: HMG has quietly resolved several seemingly vast corporate problems in the past, British Energy 2003 being perhaps the best example ("Nuclear Generator In Financial Meltdown" - never a comfortable headline).  With TW there appears to have been a bit of advance warning: and maybe with the recent 'rescue' of Bulb, some sensible generic thinking has already been done in government.  Maybe.  And Thames Water is squarely based on real assets.

But on the pessimistic side:

  • how likely is sensible generic thinking, in advance, within HMG?
  • Bulb's business model was trivial compared with Thames Water
  • with British Energy, when it went under its product hadn't been forward-sold to any degree, but could be (and was[3]), for an instant and constructive boost to its finances
  • the economy was in a much better state in 2003 to be standing behind any loose ends
  • some types of financial engineering are pretty toxic 

Which brings us to the elephant in the room: TW has suckered in a range of serious international financial players.  OK - so, caveat emptor and leave them holding the keys?  That may be possible in strictly legal / contractual terms: and HMG probably has reserve powers to direct the continued operation of the assets.  But here's the thing: like any financial player, those big Canadian pension funds and Far East investors really, really hate being left holding the keys.  In those circumstances, they have literally no idea what to do next: we know this, because it's happened many times around the world. 

So what happens now.  In coalface terms, there are asset-oriented specialists like Macquarie and Cargill who know all about restructuring and bailout.  They'd make fortunes from the gig: but they know what to do.  Is that how HMG will play it?  It won't look good.

More widely however, what does this do for the future attractiveness of UK plc for inward investment?  We've long been the envy of the world for how easily we've attracted cheap foreign dosh, and a large part of the economy is now based on it.  Kick away TW, and what do all these people do with their next chunk of money?  Equally great and easily-executed opportunities elsewhere don't grow on trees - but there are plenty enough, not least with government-backed Net Zero projects sweeping the globe.

In short, the worst-case scenario is, in sequence: (a) a serious investment strike by otherwise UK-directed money; (b) downgrading of UK plc's credit rating, with all its inflationary and currency implications; (c) drying-up of deal flow for the City.

This could be Very Ugly Indeed.  All the more reason why HMG will step in smartly.  But what if TW is just the tip of the iceberg?  Where's, *ahem* Gordon Brown when we need him to Save The World?


[1] Nobody with any brains, that is - though amazingly, some companies still do.

[2] Everyone in Enron was substantially paid in company paper - so the idea of letting the share price slip was anathema.

[3] Sold to a rapacious Centrica, as recounted here before.  They then got carried away and foolishly bought 20% of the nuclear portfolio when EDF bought the rest.  Has been doing them quite nicely just recently though, of course.


Anonymous said...

"More widely however, what does this do for the future attractiveness of UK plc for inward investment?"

So what are we proposing here? That we make the holders of the large stock of Thames Water debt whole (using tax payer cash)? I would be very against that. These investors are big boys and they need to take it on the chin. They have bought a turd (almost literally) and now need to deal with it.

Anonymous said...

Some interesting commentary here from a banker who does these securitisations.
Free to read -> https://www.ft.com/content/6c0b1144-89d1-434e-960c-ac298ceee781

Nick Drew said...

FT article is important reading to understand the optimistic case

Worst case doesn't happen overnight, just as post-Brexit decline hasn't. (Where's the much-heralded collapse in Sterling then, eh? Which isn't the same as USD strengthening.)

The Eu-wallahs have been trying as hard as they know to wean themselves off the City and thereby encourage the RoW to follow them to, errr, Paris, or Madrid, or Frankfurt, or ... where was it again? They've had limited success in a small handful of areas, but mostly failure.

The City still transacts most of the European big-asset transactions, including those with no primary / principal UK involvement (I'm working on one right now: French & US concerns in RoI): the reason, as ever, is critical mass of high-quality, ultra-responsive, broad-spectrum services (though *ahem* I say it myself)

HOWEVER - some declines are slow and pernicious, until some kind of tipping-point is reached

Something that could happen rather more quickly, though, is the next round of UK-based deals all happening at 50 bp more than before ... then + 100 bp ... then all-round downgrading of ratings. You don't like how interest rates are now ..?

Caeser Hēméra said...

@ND this ties into your recent post on regulation and a rather different watery business.

Why haven't the regulators been on the ball? Why haven't they been enforcing improvements and updates to infrastructure? Why haven't they been ensuring that assets can't be stripped in this way?

As a nation, why have we not got some protections against Interested Parties canvassing government and ensuring regulatory capture? It's not just going to be Tory politicians making hay, however they are the ones left holding the bag, and the media (and opposition parties) will have a field day if they can find links (whilst studiously ignoring any of their own) they can make headlines with. Sunak might want to check his wife's portfolio before the Sun chucks out "Rishi Washy Doshy Away!" or the like.

We're getting to the point of baseline competency in keeping the nation existing tomorrow.

Really hoping that when it comes to screwing up the nation (and I don't mean Brexit), Starmer's ascendancy to Number 10 isn't a 'hold my beer' moment.

Nick Drew said...

CH - yup, indeed. 4 reasons I know of, in no particular order:

- 'regulatory capture': though this is (in my experience) more of a problem in sectors with very few players. When there are lots of players, the regulator rather easily gets to play the splendid game of - these other guys seem to be able to do it, so you can, too. (Ain't competition wonderful)

There is a related 'revolving doors' problem, of course

- institutional stupidity: they can't pay as much, so they can't easily get ahead of the game, or even keep abreast of it. That, plus (often) a very limiting civil-service mindset

- lack of resources. Obviously some of our libertarian friends dispute this roundly, but FFS, look at the EA (to take an extreme example). They've been whittled away over the years, and are in pathetic shape. It always ends up the same way: "risk-based assessments" (meaning, if we can pretend the risk is slim, we won't bother at all), and "mark-yer-own-homework" - which the players they are supervising accept with glee.

- political interference. Not so prevalent in my (energy) sector than in some - see below - but getting worse: the rules for new nukes are being bent at direct political behest (in favour of the nukes, natch), to a degree we may all come to regret ...

All that said: my old friends at Ofgem are by no means immune to any of the above (and seriously dropped a bollock on entry requirements / capitalisation for energy supply licence-holders) - BUT they are SO much better than continental energy regulators - head and shoulders - it seems churlish to criticize. Well, churlish not to state what I've just said above: credit where it's due.

(Can't speak for other sectors - anyone have informed views? The City regulators are quite switched on, too - but political interference is rife there on the biggest issues: why is Goodwin still at liberty? etc etc)

Anonymous said...

Just a side issue on water. It's one of those bills that Joe Public likes not to pay.

Unlike power/gas it can't be turned it off (criminal) so people wait until the bailiffs turn up. Then they wait for HMG to bale them out with all the cash that's floating around at the moment.

And didn't the vampire kangaroo not have their clutches into TW and caused most of the cash stripping issues? Why would they go back for round 2

jim said...

TW OpCo will still pump water and still lose on leaks. HoldCo must live off the fat - but the music has stopped pro tem - no more fat and the OpCo needs cash - but hasn't got enough. Situation bad because everyone is too big to fail, so a haircut all round.

The money has to come from somewhere - the customers, the shareholders and HMG. Just like taxation the game is to pluck the goose without it hissing too much. I suppose this means the USS and others are going to have to accept a little less and TW customers pay a bit more and HMG pass £ under the table until enough water has flowed under the bridge. Otherwise a sudden disruption is just too much of a mess.

However this all means anyone else investing in UK plc will be looking at the books a bit more carefully. Even today Ofgem is muttering about financial stability, fingers getting too warm maybe.

Way way back in the day the consulting firm I worked for went to see the brass at a certain northern water company. Our chaps were very impressed - 'what a bunch of operators'. The water guys knew their financial business and were set to make out like bandits. Macquarie was willing to help them out. Mrs T had paid off the debts 'cos the Treasury was frit about the investments needed and had no intention of delivering clean water and not dumping poo in the sea. Just wanted shot of it.

Not much has changed, ongoing leaks and ongoing poo is what we will get - and bigger bills. Forty odd years of good cashflow was a good game though.

Sobers said...

"Unlike power/gas it can't be turned it off"

The electric and gas companies can't turn you off either, in practical terms. They may technically have the legal power eventually disconnect in certain circumstances, but in practice they just install a pre-payment meter. Its one of the reasons why they are desperate to get people to pay via direct debit and build up credit (the other being free working capital).

Sobers said...

"In short, the worst-case scenario is, in sequence: (a) a serious investment strike by otherwise UK-directed money; (b) downgrading of UK plc's credit rating, with all its inflationary and currency implications; (c) drying-up of deal flow for the City.

This could be Very Ugly Indeed. All the more reason why HMG will step in smartly. "

Thats great. The UK taxpayer gets to bail out various non-UK pension funds and sovereign wealth funds. No moral hazard here at all.......

I say if you buy an asset, you own it, and you own the risk it all goes t*ts up. Shareholders lose everything, sell the assets to someone else, and pay the debtors a few pence in the pound. Just like the receiver would if it was a used car lot going bust.

Anomalous Cowshed said...

I say if you buy an asset, you own it, and you own the risk it all goes t*ts up

Fairy Nuff.

But, since there's a regulator, then how much control - ownership - of your asset do you really have?

Sobers said...

"But, since there's a regulator, then how much control - ownership - of your asset do you really have?"

Obviously enough to run it into the ground.

Anomalous Cowshed said...

Whilst I'm at it;


The initial construction cost back the '90s, is given as half a billion or so in 2021 money. Can't find a cost for the late-2000s extension.

The current Thames Tideway project is around the 4Bln quid mark.

There seems to have been the usual whining around bills going up, certainly for TT, most likely for the Mains project as well.

And then there's AMP8 (https://www.newcivilengineer.com/latest/many-contracts-yet-to-to-be-let-in-amp8-water-investment-bonanza-27-03-2023/).

Thing is, UK live births were wandering around 650,000 a year a few years back. Net immigration ballooned up to half that around the same time.

So total population growth was 1.5x what it was.

So Regulator says, over the next five years, upgrade/build out your infrastructure on the assumptions laid out, and the expected capacity, and the expected life.

If demand surges by 50%, well within the Regulator's planning period, then the expected capacity gets used up much quicker, shortening the life and the investment cycle.

If in 2000, you were expecting an asset life of 30 years, then post A8, that life goes down to 20 years - or right about now.

And, of course, you've still got to deal with the Planning System. And there does seem to be a distressing tendency to rely upon the ten year Census cycle for planning.

dearieme said...

Water is nationalised in Scotland I believe. May we assume their performance to be infinitely better?

(Question inviting the answer "no".)

Is it as good as the ferries? (Oh cruel jibe.)

Nick Drew said...

@ "didn't the vampire kangaroo not have their clutches into TW and caused most of the cash stripping issues? Why would they go back for round 2"

for fees, anon! - fat fees! ... and some kind of cleverly engineered "upside sharing" for themselves

(that's the formula under which Drax was dug out of its hole in 2003 - not Macquarie, but another group of specialist restructurers: they made a fortune from it)

yes, they owned TW previously, so they know all about it

Anomalous Cowshed said...


Anomalous Cowshed said...

As far as UK plc goes, or FDI;


"Americans, Chinese, and Europeans have curtailed their lending and investing abroad—while also selling commensurately fewer financial claims to foreigners. In 2021, the gross value of cross-border financial transactions involving the U.S., China, and the euro area was worth about $7.9 trillion. In 2022, that figure was just $2.8 trillion."

The fate of TW might not turn out to be a cause, just another symptom. Although the investors are Aussies and Canucks plus Euros.

Anonymous said...

Sobers - those barstewards at the electric companies sent me a nice letter the other day "we like to review DDs to ensure they're congruent with electric usage" - I paraphrase - "and your DD doesn't need to change".

That's cos I currently have £1k credit with the thieves!

OT but ND might have a few clues - what's a decent energy blog these days? Oil Drum and Eauan Mearns seem dormant*, Tim Morgan likewise - where can I get decent info.

I'm pretty convinced that our economies run on energy, that our Russia sanctions/gas pipeline sabotage is a YUGE own-goal for entire UK/EU, and that coal-burning China is making a killing using that coal energy to build panels and turbines to sell to us... but I need figures and science.

Where do I get them these days?

* whatever happened to KiteGen which was going to save us?

Anonymous said...

PS - if you want to see a sad but non-strategic PE story, just look at what the barstewards are doing to Morrisons. I feel bad about it because I was a fan right from the days when they only had 3 supermarkets, all in Bradford. We students loved them because in pre-ATM days they had an instore window where you could cash a £50 cheque, saving you a bank trip. They also did the most fantastic granary bread, never found any as good since.

Sir Ken Morrison is probably doing around 15,000 rpm in his grave at present. I bet it didn't owe £7.5bn when he retired.


"The debt-laden supermarket chain, which is battling to save costs after a takeover in October 2021 by the American private equity group Clayton Dubilier & Rice..."

Anonymous said...

'Leverging', what larks!
What about the farking investment?
I bet some nerd is working on charging for and securitising the air we breath. Oh yes, Carbon Footprint!
Hoist the black flag.

Anonymous said...

Thank you ND. Our energy "policy" if it can be dignified with such a name, seems to be

a) coal is evil. I can no longer sell any of the dozen bags of coal I still possess (I gave some away to a girl living in the centre of a very Labour city), we can't dig Welsh steam coal to power our heritage railways so they are paying I think £370 a ton to somewhere like Kazakhstan for it but...

b) we are happy for China to burn record amounts of coal (2022 was a world record for coal burning) to make our solar panels and build functional thorium salt reactors, in the desert, no water needed. How long since we shut down Winfrith Heath?

c) buying cheap oil/gas/diesel from Russia is bad; we must buy our Russian oil after it's been refined in India at a price...

d) we can't build nuclear any more, not enough engineers* so we contract to buy French designs that don't work and have dodgy components thanks to Le Creusot fiddling the figures since 1960s

* Blair announced no new nuclear in 1998 and we lost a generation of civil nuclear students

Jan said...

@anonymous 7.47

I just received a letter fom my energy company to say they are now going to send me a monthly bill instead of quarterly! This is because I don't do DD or smart meter and prefer to pay as I go rather than let them amass cash at my expense!! I always paid my bills in full and on time but hey they don't like me.

I wonder who will give in first? I suppose it will be me unless there are many like-minded souls on their books who decide to band together.

Anonymous said...


As you would be considered a financial risk, the utilities are taking steps to ensure you don't have a debt burden. But in reality you are an ideal client as you are paying way over the odds for power. DD is way cheaper.

They really, really like you.

Back to TW. Now see the Regulator is siding with the water co's by acknowledging we are going to get stiffed to pay the interest charges on their debt burden. (and it's not his fault, he says).

If only water co's had the same dislike of debt burdens as the energy co's.

rwendland said...

> That's cos I currently have £1k credit with the thieves [electric companies]! - Anon @ 7:47 pm

Octopus Energy lets you change the DD amount very easily (and often) to what you wish on their flashy website interface, and has a snazzy modelling tool (graph) that shows the future debt/credit balance they forecast. So it's easy to adjust the DD payment to what you think is a fair balance every few months - I do that. So you no longer have to put up with the annoying huge credits in companies favour. They have never hassled me about doing this, though I guess they would at some debt level.

@Jan: if the huge credit build up is your main objection to DD, maybe this would do for you and give you cheaper prices?

Anonymous said...

OT, but I'm going back to Feb/March 2022 to see what the great and the good thought about Ukraine.

I was struck by CU in March:

"the economic damage will be great, whilst China and the East will benefit once more. In the grand strategy terms, this was is a total disaster for the US and Europe. For now we think it unites us, but there is no easy end and every day of fighting it strengthens an economically stronger competitor in China."

I agree with that, but the short-term gains for the US are immense - Germany totally decoupled from Russia and her energy, the entire EU closer to being a US colony than any time since 1945, yuge short-term profits for US energy and arms companies.

ND focused more on Russian military incompetence, pointing out the contempt China must have for their military. I'm not sure that's important in short/medium term, China know that if Russia go down, they are next - I'd imagine there's as much concern as contempt.

"The huge sanctions placed on Russia are going to bite much more quickly than Putin imagined."

I must confess I was hoping to find "Russia will be broke in six months", but this is probably where Russia has performed best. I'm pretty sure UK living standards have dropped a LOT more than Russian ones have in the last 16 months, and thanks to Boris and Rishi's effectively open borders plus rising interest rates, there's a lot of real hardship and anger out there - it's not just the Guardian.

This is where we find that exporting all our manufacturing to China wasn't a great plan. People seem to have already forgotten that Brits and Europeans were stood on Chinese runways outbidding each other for mask cargoes back in 2021.


Nick Drew said...

Sorry, anon, if you can't find a huge blunder in our first-draft-of-history writings of 15 months ago. (We never said Putin was about to run out of ammunition, either)

BTW, I expect you'll like this:

The FT reckons that (as confidently guessed here a long while back) Xi has, as he was always going to, marked Putin's card when it came to his childish musings about nukes. And he's smacked him on the head for being such a stupid boy.

a number of folks ostensibly worked themselves up into a lather about waking up to a blinding flash one morning (and not only BTL hereabouts: I know a number of US academics who seemed to be** wetting themselves). Nope. Putin has eaten so much shit without his trigger-finger being exercised, he'll be leaving it well alone. Crimea might be different: but Crimea is so far out of UKR infantry reach, it's not really an issue.
I say "ostensibly" and "seemed to be" because I really wonder whether they actually lost a moment's sleep between the lot of them. "They are terrors for children, Master Secretary"

Anonymous said...

It never was about a tactical decision by Putin to use nukes, Nick.

It is a "Whoops, Apocalypse !" situation we're talking about here.

Until Ukraine the Cold War was a distant (unmissed) memory.

Nato now extends to some hothead nations up to Russia's border and if you have an arsenal of nukes based on a policy of MAD then the possibility that they will be used in a crisis of existential nature has to be real otherwise why bother with them ?

Has Xi neutralised Russia ?

Wildgoose said...

I seem to recall that Liz Truss (remember her?) made some belligerent comments about her willingness to use nukes only to have a mild response from Putin of "Remember we have nuclear weapons as well" - which of course was promptly blown out of all proportion by our yellow journalists claiming that Putin was threatening to nuke us.

I can't be bothered to read the FT article. I am sure it is just yet more lies and distortions that rely on gullible people with short memories.

Anonymous said...

"Just like Mugabe, he's betrayed and hollowed out a nation he proclaims to love"


If I can read a graph that's a real qudrupling-plus of GDP.

But perhaps it's all been swallowed up by the oligarchs, as in US/UK, and wages haven't risen?


The average nominal salary in Russia was measured at approximately 57.2 thousand Russian rubles per month in 2021, marking an increase of 5.9 thousand Russian rubles compared to the previous year. After the currency redenomination and the financial default in 1998, the average wage levels in the country have grown exponentially.

Hmm. Putin got to the top in 1999.

Anonymous said...

I think if you want to see a country that's been betrayed and hollowed out, just open your bedroom curtains tomorrow morning.

Anonymous said...


I see quite the reverse with Putin. His was a an equal and opposite reaction to all of that corruption which happened under the West's dancing bear Yeltsin. A (perverted) recapture of Russia by the KGB class.

History is littered with rulers who had more wealth than they could possibly have benefited from, failing to utilise it for personal satisfaction (using it only as a public score card) and lost it all in the quest for power or some patriotic duty (Putin) whilst seeing their offspring murdered in bunkers and cellars.

There must surely be a flash point. A *whoops !* situation

Alas there doesn't need to be for the impact on the West to have already been *existential* economically and culturally.

It's not about being a bottle job (I couldn't give a fig about nuclear war and am certainly not wetting myself ) but this was all so bloody unnecessary and is yet another example of Anglo American interference gone awry.

Anonymous said...

CH - let's hope you're right on the wind direction. Yet another refugee crisis is the last thing we need.

The effects of the Kakhovka dam breach is yet to be felt.

Old Git Carlisle said...

I heard on Radio today the lenders to some of water companies were the shareholders . Paid no dividend but made up on interest from loans. Sounds a bit dodgy to me.

Al said...

@ND could they do a furniture out of town type flatpack, wipe out the debt then then hand it back to the pension funds on condition that they put in the investment needed to upgrade the infrastructure.
Essentially attach the moral hazard to Macquaries behaviour - limiting their ability to hollow out in a similar way again?
Outcome - investment keeps coming in but there is a marked reluctance to lever up public utilities?

Nick Drew said...


Everything hinges on (a) adroit regulation at the time of privatisation; (b) shrewd, tough-minded regulators - the person at the top - who needs to know the game and be singled-mindedly onside for the Greater Good

I could tell you many stories about the battles against the rogues conducted successfully by the first handful** of UK electricity + gas regulators (initially separate, then fused into Ofgem). They had brains, personal missions to make things work properly, political top-cover, and were (more or less) immune from the twin evils (identified in one of my comments above) of regulatory capture and political interference. Their personal brainpower, drive and nous compensated for lack of resources and that component of institutional stupidity that comes from having lesz-than-stellar staff
** Littlechild and his superb sidekick (a women whose name annoyingly escapes me); McKinnon; Spottiswoode; McCarthy. McKinnon, in particular, was wonderfully pugnacious and tenacious

Anonymous said...

Paid no dividend but made up on interest from loans. Sounds a bit dodgy to me.

Sounds like PIK Notes. Not dodgy but lucrative part of a PE investment. 8% over RPI is not unknown.

Al said...

Thanks @ND,
In the current situation could the regulator put TW in to administration, wipe out the debt and then hand it back to the various pension funds that own it?

That way the pension funds don’t lose out, TW is back on a sound financial footing, with the main loser being the banks(?) that allowed TW to become leveraged up.

In future FDI should still be available, but taking on excessive debt might be more of a challenge.

Would this work or is it the pension funds themselves that have made the loans?



Caeser Hēméra said...

@anon - of course if a man with a penny finds a 5p piece, and a millionaire a £50 note, then the lucky man with a penny has increased his wealth many times over than that poor millionaire.

If the West is such a terrible place, and Russia so much better, I'm somewhat surprised that Russians will send their families over there just as soon as they've gained enough wealth to do so.

Most confusing.

Their unemployments stats are pretty good too, over the last couple of years.

And, let us not forget, they'll have a bright future competing in the next few Paralympics.

Wildgoose said...

Returning to the subject of Thames Water, this Unherd article from last week had some very valid points.


Not least that (although not spelled out explicitly) that England is being badly served by the UK. English Independence and an English Government committed to England would do us a world of good.