UK water utilities have gone from ‘hero to zero’ over the last few decades. Deregulation and chronic underinvestment have exacerbated the water pollution problem in the UK, severely damaging the reputation of the industry.
Several water companies have also been heavily criticised for prioritising shareholder dividends over reinvestment. Since privatisation in 1989, Britain’s water companies have paid out £78bn in dividends, nearly half of the £190bn invested in water infrastructure. From 2020 to 2023, water companies underspent 27% of their forecast allowance on water and wastewater enhancement activities.
So, why don’t water utilities invest more in infrastructure improvement?
Short-sighted regulation
UK water utilities have struggled with under-investment since the sector was privatised. One primary reason is that the UK’s regulatory model for water is not fit for purpose. It was not designed to address the sustainability challenges the world is currently facing, such as urbanisation, increasing water shortages and more frequent extreme weather conditions.
The regulator, Ofwat, uses the Regulatory Capital Value (RCV) model to balance affordability for consumers with the need for investment and determine the allowable return on investments for water companies.
However, this model often results in a focus on short-term cost management. The current system requires regulators to be sceptical of long-term new investment proposals, whose benefits are often difficult to prove. Consequently, priorities are given to cheaper, short-term solutions.
The well-intended but poorly designed regulation leads water companies to increase debt and prioritise excessive dividend returns to shareholders.
This has diverted necessary funds away from upgrading ageing infrastructure, leading to frequent sewage spills and environmental violations. Compared to their US peers, many UK water companies operate with much higher debt-to-equity ratios and dividend pay out ratios.
The US: A different paradigm
There is an increasingly widespread view that the privatisation of the UK water utility industry has not worked. However, investor-owned water utilities in the US perform much better than municipality-owned utilities in terms of water quality, efficiency and compliance.
US water infrastructure faces its own challenges including ageing infrastructure, the widespread use of lead in water piping, PFAS contamination and fragmented water systems. Americans also use more water per person than almost anywhere else in the world – more than three times per capita consumption in China and 15 times more than in Denmark.
To address these challenges, US investor-owned water utilities are offered a different set of incentives compared to their UK counterparts. They are regulated by state public utility commissions that often allow for higher returns on equity. They typically receive approved returns on equity in the range of 9% to 10% (6.27% in the UK). These appealing returns help attract private investment and ensure that utilities have the necessary capital to maintain and upgrade infrastructure while providing reliable services.
Many states also provide mechanisms which allow utilities to recover the costs of infrastructure investments more quickly.
Case in point: American Water Works
Due to the stark differences in market dynamics and regulatory environments between the UK and the US, our view on the environmental impact of water utilities in these countries diverges significantly.
In the US, investor-owned water utilities generally have a positive impact by accelerating capital investment in water infrastructure which in turn improves drinking water quality.
American Water Works (AWK) exemplifies the benefits of the US regulatory environment. It is the largest and most geographically diverse water and wastewater utility company in the US. The company has proactively improved its pipe renewal rate, reducing the replacement cycle from 250 years in 2009 to approximately 125 years by 2028. Its capital investment grew at a 10% compound annual growth rate from 2013 to 2022, compared to just 3.5% for the UK water industry during the same period.
AWK employs a range of advanced tools to enhance water efficiency, one of the key results being a reduction in, the number of main breaks per mile – decreasing by 30% from 2014 to 2022. Through leveraging overhead costs and ongoing productivity improvement, it has managed to maintain water bills as a percentage of median household income relatively stable over the years.
AWK’s consistent investment in infrastructure, driven by favourable regulatory conditions and financial flexibility, solidifies its leadership in the sector. Its strong commitment to sustainability is evident in its superior compliance with drinking water and wastewater standards, as well as its numerous water quality accolades.
Investing for impact
The comparison between UK and US water utilities highlights a significant divergence in their ability to generate positive environmental impact. While UK water companies struggle under a regulatory framework that limits long-term investment, US investor-owned utilities thrive in a supportive regulatory environment that incentivises infrastructure improvements. By investing in companies like AWK, investors can support and benefit from the proactive and responsible management of water resources, ensuring long-term sustainability and resilience in the face of growing global water challenges
