The ex-Dirty Man of Europe?

This is piece that we've put in our regular client bulletin "The Source" - the full bulletin can be found at here Water Bulletin 2016 Issue 2.  The piece just offers some immediate thoughts on what a Brexit might mean for the water industry in UK.

“History never looks like history when you are living through it. It always looks confusing and messy, and it always feels uncomfortable." John W. Gardner

If the balance of opinion expressed pre the recent EU referendum is remotely a guide then the inner sanctums of water company Board Rooms might be home to some feelings of discomfort right now.

Back in April, The Water Report reported on how water company executives and senior managers were viewing the prospect of a “Brexit”. The views expressed then are worth recalling:

• ?  67% thought overall Brexit would be very or slightly negative for the UK water/energy industries; 19% felt there would be no effect; 14% saw it as being slightly positive;
• ?  19% felt in the event of a Brexit they could confidently take business decisions immediately; 57% said only once the terms of Brexit were understood. For a remaining 24% sufficient clarity and confidence would require even longer.

That the balance of water industry opinion is likely to be negative about what is now the reality of Brexit perhaps comes as little surprise. Rarely do events of such historical importance touch our daily and professional lives. But there can be no doubt. History is unfolding and its messiness is already clear for all of us to see.

For two decades and more, Europe and the EU have been a big part of shaping the water industry and services we have today. In many ways we have the water industry we have today in England & Wales because of Europe. Back in the 1980s, wastewater services in particular were suffering the legacy of underfunding by the public purse and raw sewage was routinely discharged into our seas. This in part contributed to the infamous labelling of the UK as the environmental “dirty man of Europe”.

Privatisation of the public water and sewerage authorities chimed with Government policy of the day, but it also provided the expediency of a route to the significant capital that would be needed to deal with the legacy of sewage pollution in our seas, beaches and rivers.

Without the driver of EU standards on wastewater discharges (and also drinking water) it is difficult to know what kind of water industry we would have now. So where now for the water industry?

There appears to be four key areas where the ramifications of a Brexit are likely to be felt......

#1: PR19

Most immediately where does this leave PR19? Or more particularly, would it be remotely sensible to expect that PR19 can insulate itself from these wider shifts in the political and economic landscapes? The sensible answer has to be of course not. The island of the Britons may have re-asserted itself, but no sector will be immune to the cascade of shockwaves to come.

Whether it be the impact of the short to medium term recession predicted by nearly all and how that could arrest progress on bill affordability and all the consequences that flow from that (like bad debt for example). Whether it be about which parts of a competition law framework – a framework heavily influenced by EU legislation - are kept or consigned to the history book. All of this uncertainty matters hugely at the very time the water sector is finding itself opened up more and more to market reform and market forces. There is then a more basic "whether" about the simple business of Government (once a semblance of functioning Government is restored) and the inevitable change of focus that will follow. As the wheels of Whitehall lock themselves up in the name of Brexit, the industry (and its regulators) may simply find that the water industry finds itself patiently waiting on the “to- do” list. This might be the fate, for example, that awaits the review of household retail competition that Ofwat is currently looking to complete this Summer.

But perhaps the most startling unknown right now is that the two year window to complete a Brexit is slap bang in the midst of the PR19 timetable Ofwat has committed to (assuming an Article 50 trigger by this year end).

#2: Financing

The European Investment Bank – the “EU bank” has become an important source of finance for the water industry. And it’s a comparatively cheap source of capital. Set up in 1958 to further EU policy objectives, the EIB is owned by the member states (16% is owned by the UK) and its triple AAA credit ratings allow it is to secure investment monies for infrastructure projects at very low rates. In 2015 alone €1.6 billion was invested in the water sector, mostly on the wastewater side. More widely, about ￡12.6 billion of investment in water and wastewater infrastructure has come to the sector via the EIB.

The significance of EIB lending becomes even more apparent at company level. In 2016, the largest ever loan of ￡700 million was confirmed for the Thames Tideway project. A further ￡500 million loan to United Utilities as part of their 3.5 billion investment programme for 2015-20 (which includes the West Cumbria to Thirlmere water pipeline, further work to improve bathing waters in the North West and significant upgrades at the Davyhulme sewage works). In 2015, Severn Trent secured a ￡530 million loan to part finance its 2015-20 programme. The list just goes on – ￡230 million for Welsh Water, ￡100 million for Southern Water to name two more.

The simple point raised by Brexit is this: if this low cost EIB money has been available in furtherance of EU policy objectives, where does future lending come from once the UK exits and what happens to the existing loans? Common sense never mind any contractual terms would hopefully suggest very little is the answer on the latter. Just an example of the numerous devils in the detail that will soon sit on the desks of the exit negotiation teams.

The other elephant in the Brexit room of course is the implication for overall water bills. Reduced access to triple AAA bond money will have surely have inevitable repercussions in the form of a higher industry cost of capital and consequently customer bills. How much and when is simply anyone’s guess right now.

#3: Regulations and Standards

The EU policy objectives mentioned above are codified in the reams and reams of EU regulations and standards that have guided, and at times dominated, every water price review since 1994 in England & Wales.

It would be fair to say that views about the stipulations from the ever increasing standards imposed on the sector for the last 25 years are mixed. Absent or at best incomplete evidence about the benefits has often been compounded by inflexible approaches to implementation of EU standards.

Fears are still routinely expressed about the Water Framework Directive (WFD) as just the latest mechanism for ever more draconian environmental standards. All of which rather overlooks the fact that the WFD itself was a UK creation. The origins of the WFD are to be found in the UK’s 1998 presidency of the Council, and with its core focus on full cost recovery, integrated planning and the assessment of costs and benefits (via disproportionate costs) these should all be seen as UK legacies for EU water policy.

Will the EU rulebook on water quality standards be torn up? The chances of that seem highly remote and in any event largely irrelevant. Money has been spent and assets sunk in the name of the myriad of EU Directives on water and wastewater. What matters is things going forward. Will the UK under Brexit choose to shadow EU regulations and standards? Will it choose to lower standards? Or will different paths and outcomes be promoted? Only the questions can be identified as this stage.

#4: Planning

2015 saw the publication of the second round of river basin management plans (RBMPs) – one of the legacies of the WFD. The third round of plans are due in 2021 and would identify needs and programmes of measures for the 2021-2027 period. The 2027 date is of particular note as that has been viewed by some as the most likely and practical date by which all EU member states would be expected to achieve the lofty ambition of good status for all water bodies.

But that now sits in the post Brexit future and it becomes anyone’s guess if the WFD challenge of achieving good status in all water bodies is now to be consigned to the UK’s past. As of 2014 only 21% of surface water bodies in England were classified as being of good status. The Environment Agency has previously mentioned achieving 60% by 2021 and the only commitment beyond that is for ‘as many as possible by 2027’. All of a sudden even such loose objectives can no longer be relied upon.

Summing up

A week is a long time in politics we are told. In the internet age a week has become days even hours. The UK as it stands has changed course and all it took was 15 hours of voting in one referendum. A dramatically uncertain course and one thing we can be sure of is this: those uncertainties bear heavily and immediately on the water sector in the UK.

In the 1980s UK policy makers faced the vexed question of how and when to address the blighted seas and rivers of the “Dirty Man of Europe”. Who would have thought it possible that 30 or so years later the same questions of how and when would once again loom large for an ex- “Dirty Man of Europe”?

That in itself may bring the opportunities that change always offers. Certainly the environmental delivery focus of the industry in the 25 years since privatisation may witness a different lens going forward once new and different choices are able to be made. This living of history will bring its challenges and no doubt its discomforts. But what it will look like when our future eyes are cast back to this history, will be whatever history the water sector and its current custodians choose to make.

Postscript 14/07/2016

Little bit of news to follow up this article. Andrea Leadsom - a prominent Leave campaigner and ex-Tory Leadership candidate today appointed as the new Secretary of State for Environment (DEFRA) in Theresa May's Government.  Wait see as to what directions that will shape for the water sector in its post-EU future.