Water, water: Once, we barely gave it a thought. Now, with charges rising further, it is our most hated industry. Helen Kay on what went wrong

LAST Thursday Ian Byatt, the water industry regulator, announced new price controls for the 31 water companies in England and Wales.

Over the next decade customers will see their bills rise by an average pounds 2 a year more than inflation, so that in the year 2005 they should be paying pounds 23 more in real terms for their water than they are now.

As he spoke, the shares of most of the 10 water and sewerage companies went through the roof. Traders and analysts in the City of London were delighted. Not only would the water companies be allowed to go on putting up prices, but Mr Byatt was even letting them off some of the expensive capital expenditure on construction and repair work he had previously demanded they carry out.

'We are still forecasting average dividend growth of 4 per cent in real terms over the five- year period until 2000,' said Nigel Hawkins, utilities analyst at Hoare Govett, the stockbrokers. No one was in any doubt: it was time to buy water shares.

Those speaking for water users, meanwhile, were giving a different reaction. The National Consumer Council said: 'We're pleased that things aren't going to be as bad as they would otherwise have been. But many consumers are still going to see their bills rise by more than inflation, on top of steep increases in earlier years.'

The Consumers Association said: 'The companies' easiest option has always been to dip into consumers' pockets. That licence has now been curtailed.'

In the press, across the spectrum from the Guardian to the Daily Telegraph, the editorials gave Mr Byatt, as the latter newspaper put it, 'one-and-a- half cheers' for his efforts.

Out among the bill-paying public, it was soon clear, the new arrangements were not going to wash away overnight the bitter taste left by five years of steeply rising charges, steeply rising water company profits and steeply rising salaries for the company bosses. And the spectacle of water shares soaring only makes matters worse.

JUST a decade ago, we hardly thought about water, still less argued about it. Reservoirs, filtration plants, sewers and Victorian pumping stations were part of the national furniture, not the national conversation. So long as we could fill the kettle and flush the lavatory, we were happy to think about other things.

Now water is the stuff of headlines, and even scandal. The Sun recently devoted two indignant pages to the earnings and homes of the newly rich water bosses. When Mr Byatt announced his new regime of charges, he led the television bulletins and appeared on newspaper front pages.

This change is the result, more than anything else, of privatisation. Now that the public no longer owns the water system, it has become agitated about it.

In fact, the 21 water-only companies - those which supply water but not operate sewerage facilities - had long been in private hands. It was the 10 water and sewerage authorities, which are much bigger and which cover three-quarters of England and Wales, which passed from the public sector to the private in 1989.

Why did this happen? One key protagonist was Sir Roy Watts, the late chairman of Thames Water. In 1983, after 30 years at British Airways, Watts was brought in with a brief to run the then Thames Water Authority on private-sector lines (staff at TWA - as it was known internally - joked that he thought he had taken over an airline).

Watts pared costs to the point where he was able to raise prices by only 3 per cent, but then, by his account, the Government moved the goalposts and demanded a 10 per cent increase (the surplus going straight into the Treasury till). Instead of knuckling under, Watts chose to fight. 'We had a banner on the Thames which said, 'No Minister',' he once recalled proudly.

He lost that battle, but he was determined it should not happen again. After his British Airways experience he was already a keen advocate of privatisation, and the Government's price shenanigans convinced him that water would be better off free of Treasury control.

He found a soul mate in Nicholas Ridley, then Environment Secretary and the man responsible for drafting the Conservative government's original privatisation plans.

Ridley had not always favoured selling off water. In 1979, he noted in his memoirs, he could see 'no gain from putting a monopoly into private hands' and did not recommend privatising the utilities. By 1987, after the experience of British Telecom, British Gas and others, and with the active encouragement of Watts, he had changed his own mind and Margaret Thatcher's with it. Water was to be the next stage in rolling back the state.

But consumer polls showed that the public did not see the water industry in the same light as BT or British Gas. It was not a business, more a service, and water itself was not a commodity, it was God-given. Labour, too, opposed the plan, warning against private monopolies.

Margaret Thatcher would have no truck with such qualms. Some people thought water came from the heavens and should be free, she thundered, but 'clean water doesn't come cheap. The pipes, the pumping stations and the purification plants all cost huge sums to instal and maintain'.

And she had another, powerful, string to her bow. Not since its golden era in the 19th century, when the two Josephs - Bazalgette in London and Chamberlain in Birmingham - laid the foundations of the national water system, had there been any serious investment underground. The sewer network was falling to pieces.

By the late 1980s, it was estimated to need about pounds 12.8bn in cash. Such a sum could simply not be found in the public coffers, and if the water authorities borrowed it on the money markets that would have played havoc with the Public Sector Borrowing Requirement - something the Government would not contemplate. Private water companies, by contrast, would be free to raise the cash either through the issue of new shares or through borrowing. Mrs Thatcher asserted that there was no alternative to privatisation.

She had her way, and in September 1989 the functions and assets of the water authorities were transferred to the newly created water companies.

But if the family silver was tarnished, it had still gone for a knock-down sum. In its eagerness to woo 'Sid', the small investor-in-the-street who had bought British Gas shares when the gas giant was privatised in 1986, the Government wrote off water authority debts of pounds 4.9bn and provided a pounds 1.7bn cash injection.

When water came to market, the price was pounds 5.2bn. The Government, in other words, actually received a little less from the sale than it had spent tidying up the books to make water attractive to buyers.

It was not the first time this had happened, and it might have been quickly forgotten if things had gone smoothly in succeeding years. They did not.

THE DAMNING evidence on the events of the past five years is catalogued in a report from the National Consumer Council published this month.

The companies have enjoyed a remarkable boom. 'Between February 1990 and February 1994,' the NCC says, 'the share value of the 10 water and sewerage companies had risen by 99 per cent.' Originally valued at pounds 5.2bn the companies are in fact now collectively worth pounds 13bn - even more than the NCC figure for last February. Shareholders have reaped rich rewards - dividends have risen by about 6 per cent annually in real terms.

Remember, this happened in a recession. While the value of the water companies was rising 99 per cent, the NCC points out, the FT-SE All-Share Index rose by a more modest 39 per cent. Water was not just floating upwards with the market.

How was this achieved?

There is little sign that it has come from cutting costs, although efficiency was often cited as a justification for privatisation. Average staff numbers across the companies dropped by 2.6 per cent between 1990 and 1993, but this fall was largely due to a 21 per cent cut in manpower at one company, North West Water. Six of the 10 companies actually increased their workforces. In fact, most of the industry's efficiency gains were made during the 1980s, before privatisation, when manpower was reduced by more than a fifth.

The companies cannot be accused of shirking their responsibility to invest. In fact, they have so far spent about pounds 13bn. And with the building and construction industry in the dumps, they have been able to reduce the cost of the original programme of sewer renewal and replacement. This gain has been balanced, however, by new obligations - mainly quality and environmental requirements determined by the European Commission - which have added to their overall burden of costs.

Nor can the industry be accused of living on borrowed money. Although it was one of the principal planks of the privatisation platform that the companies needed the freedom to raise cash through share issues and loans, they have been reluctant to do so. As a result their 'gearing' - the relationship between debt and assets which is often taken as a measure of a company's strength - is enviably low.

No, it is not borrowing that has made the water companies so rich, and nor is it penny- pinching. It is higher charges to water consumers - much higher.

Since privatisation, the NCC points out, water bills have risen by an average of 67 per cent. 'By 1993-94,' the NCC said, 'domestic customers had paid the 10 companies an extra pounds 2.68bn more than they would have if charges had kept in line with inflation.'

This torrent of cash has been spent in a variety of ways. It has funded dividends. It has paid for the new sewers - the NCC estimates that consumers paid for about 69 per cent of all capital investment in 1992-93, when overall borrowing accounted for just 24 per cent.

Most notoriously, it has met the cost of vastly higher salaries for the water industry managers. For example, Nicholas Hood, chairman of Wessex Water, has seen his pay more than triple from pounds 55,000 to pounds 164,000, while water bills have risen 62 per cent. Keith Court, chairman of South West Water, has done almost as well, with a salary up 120 per cent, to pounds 108,000, while bills have jumped 138 per cent.

Water, as Nicholas Ridley saw more than a decade ago, is a monopoly business. A customer who does not like the service he is getting, or the price he is paying, cannot simply transfer to another supplier. If you live in the Wessex Water area, then Wessex Water is what you make your tea with, and Wessex Water bills are what you pay, like it or not. This captive quality has served to exacerbate public outrage.

The water companies defend their record by pointing to improvements in service and quality. These include renewing or replacing 15,000kms of water mains and 93,000kms of lead communication pipes between the mains and customers' premises. The quality of drinking water has also improved every year, with almost 99 per cent of the 3.5 million samples that are tested meeting all health and aesthetic demands.

Today, claims the Water Companies Association, 96 per cent of the population is connected to sewers - the highest level in Europe - and 95 per cent of sewage works meet the rules laid down by the National Rivers Authority.

This is not enough, however, to mollify consumers, and when the Water Companies Association boasts that customers are 'offered far more flexibility in how they pay their bills' it merely adds insult to injury. Shareholders too have grounds for complaint. By 1993, says the NCC, the 10 water companies had collectively invested about pounds 1.2bn on activities outside their core water business, with conspicuous lack of success.

By 1992-93, the non-core businesses had contributed just pounds 35m to operating profits, while about pounds 727m had been written off as a result of various mishaps. Even by the turn of the century, diversification will generate only about pounds 180m. Such failures do not help when it comes to justifying high executive salaries.

It is a sorry picture. Yet it would be wrong to see the water companies as out of control, for they must answer to the industry regulator, Ian Byatt.

In principle Mr Byatt has the task of simulating competition, in other words of working out what things would be like if there was a water market and setting corresponding constraints for the companies. This protects the consumer, the theory goes.

The first round of constraints on the water companies was as generous as has come to be expected with privatisations - part of the 'sweetening' procedure to attract investors and get things off to a good start.

Last week, Mr Byatt refused to comment on whether customers had received a raw deal as a result. And despite the stock market delight that greeted his new regime of regulations, he insisted that he was offering 'a better deal for customers'. No, he would not criticise the extraordinary pay rises awarded to water company bosses. All he would say was: 'The new price limits give managers an incentive to cut operating expenditure. How they do so is a matter for them.' If they cut their own pay, there will be universal surprise.

How good is the new deal? As the consumer bodies said, it was an improvement, but it could hardly fail to be, and prices will still be going up.

In fact, some customers will have more than others to grumble about. Although the average water and sewerage bill, currently pounds 200, will be about pounds 216 a year by the turn of the century, customers of South West Water, which is spending pounds 900m to clean up its long coastline to meet EU standards, are already paying pounds 302.

By curbing South West's ability to raise prices Mr Byatt has clearly responded to the groundswell of complaint. However, customers there will still pay pounds 312 by the year 2000. Customers at Southern Water also have grounds for concern. They will see their bills rise from pounds 201 to pounds 242 by the end of the century. Both are well above the average.

Such regional divergences, which have spurred some of the political controversy in recent years, will gradually shrink in years ot come. At present, customers of South West Water pay 79 per cent more than those in Thames Water's region, which has the lowest bills in England and Wales. By 2000, that differential will be more like 43 per cent.

But knowing that your neighbour is little better off than you is not much consolation, if you believe - along with millions of water users - that you are still very badly off. Meanwhile, if market expectations are anything to go by, the water firms will continue to do very nicely thank you.

(Photograph omitted)