Thames Water’s assets are looking worse and worse. Bondholders must pay | Nils Pratley

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What does Thames Water’s latest disgrace – top billing in a multi-year, multi-company sewage scandal, as finally detailed by the regulator, Ofwat, on Tuesday – mean for its great refinancing challenge? At one level, you could say it makes little difference. A £104m penalty is close to the maximum under Ofwat’s powers, but is a rounding error in the context of borrowings of £15.2bn in the regulated entity. Since the board has known what was coming for months, one assumes the sum was included in last month’s calculation that there is enough cash to keeping going until next May. In any case, a separate potential criminal investigation by the Environment Agency for the same sewage failings is probably the bigger financial threat. But, viewed a different way, the detail of the report underlines the scale of pure operational improvements required at Thames. An astonishing 67% of its wastewater treatment works with “flow to full treatment” permits were found to have “capacity and operational issues”. At the other miscreants, Yorkshire Water and Northumbrian Water, the figures were 16% and 3% respectively. Thames was not the worst of the dirty trio for breaches related to storm overflows, meaning the emergency relief points that stop the sewage network being overwhelmed during usually heavy downpours. Its 16% non-compliance level was better than Yorkshire’s appalling 45%. But there is a reason why Thames was fined (subject to appeal and consultation) a sum equivalent to 9% of turnover in its wastewater division, versus 7% for Yorkshire and 5% for Northumbrian: it was the worst offender in aggregate, albeit the rest of the industry is still to have its turn in spotlight. It is yet another reminder that the direct source of Thames’s woes is not the financial engineering and dividend-extraction over the years, appalling though that has been. It is old-fashioned operational failings. Thames has failed to keep pace with the effects of population growth and the climate crisis, and is running a water and sewage network that the company itself describes as the oldest set of assets in the industry. The tally of water treatment works deemed “potentially non-compliant” is an astonishing 157, according to Ofwat’s document. The refinancing script still fondly imagines that new investors can be found to replace the current owners who declared the company “uninvestable”. In reality, the task of raising £3bn-plus looks virtually impossible without some form of debt write-down to clear the financial decks. Given the state of the assets, which sounds worse with every glimpse we get, any new investors would surely want to maximise the hit for bondholders before putting in fresh capital. At the moment, though, there is no sign of bondholders volunteering to shoulder losses of, say, £5bn-odd. If that remains the case, a spell in special administration – essentially temporary nationalisation – looks the most viable alternative as a way to impose the necessary losses on bondholders. The advantage of an administration process is that a government-appointed outsider would determine a capital structure to allow financial headroom for catch-up spending. If the path could simultaneously be set for a return to the stock market eventually, so much the better. One of the restructuring outcomes has to be chosen within a matter of months because the financial farce cannot run indefinitely. In the meantime, be scandalised that it took so long for the regulators to catch up with the scale of the sewage spills. The breakthrough happened only when water companies were forced to install monitors to measure flows, which started to happen from about 2015, while the appalling evidence only emerged in 2021. It is very hard to believe the water industry did not know there was an enormous problem before then.