View from City Road: Byatt's cloud keeps a silver lining

A cartoon recently appeared in a periodical depicting two men positively drooling over a small puddle of water. 'Look, water, I'm rich,' read the caption. Since privatisation nearly five years ago, those lucky enough to be an executive with one of the 10 regional water companies have grown rich with their shareholders, who have seen dividends and share prices rise many-fold.

Water, once condemned as a no- hoper for private ownership, has proved one of the most lucrative stock market investments in a long time. Carefully designed executive share option and bonus schemes have enabled executives to share in the bounty.

For most companies, such good fortune would generally be regarded as well deserved and earned. Water companies do not, however, operate in a competitive environment. They are pure monopolies with a captive customer base; they have enriched themselves largely at the expense of taxpaying householders.

Given the political heat that has been generated by water charges, any review of pricing policy was bound to be harsh.

The City had certainly braced itself for much worse than was delivered yesterday by Ian Byatt, head of the industry watchdog, Ofwat; share prices rose accordingly.

Mr Byatt's price caps for the next five years were greeted with howls of outrage by opposition MPs and consumer groups. This despite the fact they are far tougher than the price caps now enjoyed by water companies and considerably worse than what the companies believed was the least they could live with.

Consumers wanted more. Read the detail of his periodic review, however, and you find that Mr Byatt has gone about as far as he reasonably could in the customers' direction without breaching his terms of reference. It is not really a question of Mr Byatt performing a balancing act between the interests of customers and investors; to have gone further would have been beyond his remit.

In arriving at the new price caps, Mr Byatt has cut capital spending programmes to the bare legal minimum. If water companies want to do anything extra, they will not be allowed to charge customers for it.

Nor is the rate of return he has assumed anything other than lean and mean in the extreme, even for a low- risk monopoly such as water. The efficiency targets are as rigorous and demanding as any in the private sector. Water companies are being asked to cut costs by about 15 per cent over the next five years.

Given that half of water companies' costs are beyond their control, the effect is multiplied in the payroll; water companies are going to have to reduce their workforces by about 30 per cent requiring very dramatic cultural and organisational changes.

Long overdue, many will say but, as with all the other privatised utilities, a better deal for the customer is to be accomplished at the expense of an extremely high cost in jobs.

Only one company, South West, has so far said the new regime is so harsh that it is appealing to the Monopolies and Mergers Commission. With the salutary lesson of British Gas - which went to the MMC and is now having to break itself up - to go by, few others will want to pursue such a strategy.

Mr Byatt, in any case, needed at least one MMC reference, if only as a way of canonising the criteria and methods he has been using. South West's price may have been set in a harsh manner to ensure he got one.

For the investor, the new price caps are hardly anything to cheer about. But for companies that can meet and beat their efficiency targets, continued real dividend growth looks easily possible.

The threat of an incoming Labour government seems the only obvious dark cloud on the horizon.