Britain’s debt-laden water utilities are being encouraged by the regulator to set up new privately financed companies to deliver billions of pounds worth of critical infrastructure such as reservoirs, treatment works and pipelines, which will be paid for through customer bills.

United Utilities — the water company that came under fire this week over sewage spills at Windermere — is seeking investors for an estimated £1.75bn project to replace the ageing Haweswater Aqueduct; a 110km pipeline in north-west England that was built in the 1950s and provides about a third of the water supply in Manchester, Lancashire and Cumbria.

It is one example of a model pushed by the sector watchdog, Ofwat, known as “direct procurement for customers” (DPC). The regulator argues that the model — which involves regulated water companies creating off-balance sheet special purpose vehicles backed by private investors — will encourage competition to deliver much-needed water infrastructure across the country. Some £14bn of projects are earmarked to use the model over the next decade.

Funds backing the SPVs receive returns in exchange for financing, designing, building, operating and maintaining infrastructure on contracts lasting 20 to 35 years or more. The costs will be paid for by customers through their bills — either during or after construction, depending on the scheme — with the project returning to the water company when the private finance initiative (PFI) expires.

Although Ofwat argues that the creation of separately privately financed vehicles will lower costs, the additional charges involved in DPC schemes are likely to concern consumers who are already expecting steep increases to bills over the next five years.

Water companies are already the subject of political scrutiny and public anger after a series of service and pollution failures. The woes of Thames Water, the UK’s biggest water provider, has also put the utilities’ finances under the microscope. Water companies are under fire for paying out £78bn in dividends while racking up £64bn in debt in the 32 years between privatisation from 1991 to March 2023, according to research by the Financial Times.

Dieter Helm, professor of economic policy at Oxford university, said that although there were merits in the use of DPC schemes to improve infrastructure, their use was in part a result of “Ofwat’s failure to stop the balance sheets of the utilities being misused for financial engineering”.

“Now they need more private balance sheets from DPC to fill the gaps,” he added.

“The longer-term risk is that the DPCs will fragment the system further as, unlike the usual contracts the water companies enter into, DPC means that the utilities no longer retain control of the asset or are responsible for maintenance,” Helm said.

Ofwat said, “The DPC model is not just about financing. It improves competitive processes for complex infrastructure projects, promotes innovation by bringing in fresh ideas and widens the pool of potential investors, all of which provide better value for customers. As regards control of assets, it is a licence requirement for a company to have sufficient control of its assets and the DPC model does not change this.”

The impact on customer bills for United Utilities’ Haweswater scheme, for instance, is not yet known, according to the company, which this week said its annual profit after tax fell by 38 per cent to £126.9mn. The utility is expecting to pick the winning consortium early next year and for work to start soon after. The investors will set up the SPV that will design, build and maintain the pipeline on a 33-year contract.

Southern Water is also consulting on plans for a £459mn water recycling project that would be delivered under the DPC scheme. The company has already asked for the steepest bill increase in the country: a rise of 74 per cent that would see bills rise to about £727 a year by 2029-30 before inflation.

If approved, construction on the Hampshire Water Transfer and Water Recycling Project is expected to start in 2028 with the new system operational by 2034.

Rob Stewart, director of capital delivery at Southern Water, said the project will “help protect Hampshire’s rare and sensitive chalk streams and keep taps and rivers flowing for many generations to come”.

Welsh Water was also using the DPC to build a new treatment works that will replace three that were built in the 1900s and were “reaching the end of their operational lives and becoming increasingly difficult to maintain”, the company said. It is at the early planning stage, with proposals to be put to the public later this year.

Ofwat has refined the DPC model following the implementation of PFI deals such as the Thames Tideway Tunnel, London’s new “super sewer” that is expected to be operational next year. Thames Water customers pay for the tunnel through a surcharge on their bills — currently £26 per household per year — even though it is owned by a discrete company set up by the utility and the government.

The watchdog argues that consumers benefit from DPC projects because the regional water monopolies — all of which are privatised in England and Wales — will have to compete for their large infrastructure programmes.

“We see this offers a significant opportunity for investors and supply chain to participate in a forward capital programme,” Ofwat said in a note to investors in 2022. “The water sector has a strong track record for long term stable returns and a revenue stream underpinned by regulated revenues payable by customers and therefore is an attractive proposition to investors.”

As well as DPC schemes, Ofwat is also encouraging companies to launch projects based on the model used by the Thames Tideway Tunnel. The “specified infrastructure provider model” differs from DPCs in that the SPV used would have their own licence and be regulated directly by Ofwat.

The model was for projects with size, risk and complexity so large that it could threaten the financial survival of the existing debt-laden water company, Ofwat said. It is being considered by Thames Water for the new Abingdon reservoir, for example.

Other innovative models to deliver new infrastructure are already under way. They include a project by Southern Water and Portsmouth Water to deliver a new £340mn reservoir in Hampshire, the first in 29 years. Costs will be recovered through Southern Water customers’ drinking-water bills from 2029-30 initially at about £17 per property per year, Southern Water said.

There is still scepticism over whether the private finance models will ultimately help fix the UK’s water problems, or whether they are simply storing up problems for the future.

Ofwat has “allowed water companies to create these overcomplicated, debt-laden financial structures already and now they are going to add to that mess by setting up even more companies with completely clean balance sheets that will soon be laden with debt”, said Feargal Sharkey, a water campaigner. “Ultimately it’s always customers who pay the costs.”

Letters in response to this report:
Ofwat playing Enron card? / From Martin Large, Stroud Common Wealth, Stroud, Gloucestershire, UK

Water watchdog financing role can only end in tears / From Bill Kingdom, Oxford, UK