Andy Burnham came to power promising greater “public control” over the UK’s utilities, such as water and energy. His reasons for doing so were to cut what is described as the “privatisation premium” paid for public services by consumers, and to improve their quality. The plight of the stricken Thames Water exemplifies the scale of those problems.
Yet two months on, the government has failed to provide any real clarification of what it means by “public control”, beyond stating that this may not necessarily mean public ownership of these companies. One option under discussion is to build a network of regional political bodies to hold water companies to account. But such a step would not, by itself, confer the control needed to meet the prime minister’s objectives. Meanwhile, in a febrile environment for borrowers, uncertainty about “public control” is imposing real costs, both on those companies affected and the UK government.
As a result of this uncertainty, bond issues by utility companies that would have financed investment are being deferred and their costs are rising. Thames Water is in a state of suspended animation, in part because no one knows what its ultimate proposed ownership and regulatory structure will be. With public ownership not having been ruled out, its potentially significant cost is another factor adding to pressures in UK government debt markets.
In the face of these mounting costs, there is a strong case for the government to quickly clarify its intentions. What should it mean by public control of utilities, in order to secure the best possible services at a reasonable cost?
Good governance typically involves seeking an appropriate balance between incentives and expertise. For public services, this means a set of incentives well aligned with the interests of customers – namely, the general public – while having the expertise to deliver services effectively.
This underlines the perils of the privatised model. For example, Thames Water is owned by a consortium of investors, including highly leveraged hedge funds. This governance structure has no shortage of high-quality financial expertise. Unfortunately, this highly “innovative” (and leveraged) financing structure is singularly ill-suited to a low-risk public utility; investor incentives are horribly misaligned with the public good.
Full nationalisation faces the opposite problems. In this scenario, the company’s incentives would be aligned, by statute, with the public good. But without commercial discipline and expertise, there are fewer reasons to expect it to be run expertly and efficiently. Past experience – from British Rail to British Steel to British Leyland – demonstrates this risk.
For public utilities, then, “public control” should mean seeking governance structures with aims that are aligned with those of the general public. This should not be mistaken to mean that the public sector itself should necessarily play a central role in owning or operating the company. This erroneous belief is costing the UK (and the utilities) dear, and needs dismissing once and for all.
Having done so, what alternative governance structures strike a better balance than the extremes of nationalisation or privatisation? Aligning the incentives of utilities with those of the public could be done most easily and effectively by turning them into public-benefit companies with a primary, constitutional objective of delivering high-quality services, with profitability subordinate to that broader aim.
This has the advantage that it could be introduced within the current ownership and licensing regime. While not without potential legal challenge, in principle it would not require expensive compensation to shareholders who have already considered a level of regulatory risk when making their investment. The government itself could take a special or “golden share” at a nominal cost of £1, of the type used to maintain BAE Systems and Rolls-Royce (and latterly Royal Mail) in domestic ownership.
Importantly, the utility companies would go beyond “benefit” or B Corps (obliged to display high standards of social and environmental performance, transparency and accountability), and instead would have more demanding governance requirements, tailored to their needs and standards. These could be taken off the shelf – for example, Ofgem already requires energy companies to comply with certain international environmental standards – or alternatively, stakeholders could work together to develop industry-specific standards.
With this core structure, there are various ways the governance regime could be enhanced. For example, utilities could be required to have a minimum fraction of their shares publicly listed and traded, which would help transparency and market discipline. Publicly quoted utilities have tended to outperform the alternatives across all metrics.
To strengthen further public incentives, executive pay could be linked to public-benefit outcomes. This could also be achieved by requiring each utility to create an independent customer group and incorporating its views in all dimensions of the companies’ decision-making. There is good evidence across the utilities of customer involvement improving outcomes.
Lastly, this would imply a paradigm shift in the culture and architecture of regulation, currently alternating between regulatory capture and mutual distrust, which has palpably failed. Public-benefit utilities would be constitutionally obliged to want the same outcomes as public-interest regulators. Open-book accounting would be routine as regulator and regulated both prioritised the delivery of high-quality public services.
There is an urgent need for the government to clarify its intention around public control before uncertainty imposes further costs on fragile utilities and public finances alike. A public-benefit structure would, we believe, achieve a much better balance between public-good incentives and operational expertise at a much lower cost for consumers, investors and the government. It would be measured in single pounds rather than hundreds of millions. Burnham won power by daring to be different. Daring to be different – within practical bounds – should also inform his approach to public control of utilities.