The water wheel
Who could bet on what is next for the UK water sector? One minute it is all doom and gloom with Thames on the brink and Southern restructuring. The next minute the sector is adding another tool to the private project procurement toolkit – and a new tool in project procurement business is a rare occurrence. Once the wheel was invented, the wheel was invented.
Yep, the first DPC has been signed. It has taken a few years, but the concept is up and running with a bang, a £3bn scheme no less – United Utilities' Haweswater Aqueduct Resilience Programme (HARP) project.
Why is DPC a new? Because the concessionaire, in this case led by Strabag, will be paid by water customers via United Utilities in an allowed revenue direction agreement finalised with the water sector regulator Ofwat. The money from the customers will pass through United Utilities to the concessionaire. DPC is direct procurement for customers.
There are probably similar structures around the world, but this one involves a concessionaire, the competitively appointed provider, an appointee, a private utility and the regulator, and the customers. There is a long-term concession, but the utility will keep close control over the operations and maintenance given the importance of the asset to day-to-day operations.
HARP follows on from the £4bn Thames Tideway Tunnel procurement model. Given Thames' stretched finances and the size of the Tideway project, this scheme was taken out of Thames' balance sheet and given its own regulated asset base corporate structure. Customers pay for the asset via their Thames water bills but not, in contrast to HARP, through Thames. The Tideway asset owner has its own debt and equity which was competitively tendered separately from the construction contracts.
Ofwat has published a whole list of DPCs to be procured over the next decade. A few very large schemes could be procured under the specified infrastructure provider model, ie the Thames Tideway model.
There is another variant in the sector – the £340m Havant Thicket reservoir project which was financed two years ago. This scheme's funding is a corporate financing banked on Portsmouth Water but given the company's small size, the proceeds will nearly all go towards building the reservoir. The project is governed by an 80-year bulk supply agreement with Southern Water, which will buy water from the reservoir. Southern Water's customers pay for the construction and operation of the reservoir. The bulk supply agreement fees include a capacity charge, which represents the cost of the reservoir, and a volumetric charge, which reflects the incremental operating costs of providing water to Southern Water.
From a financing perspective all of these deals rely on the utility remaining in business, albeit less so for Thames Tideway. But if the appointee, ie the utility, does hit the skids there are protections in place under these models.
Hence the question, who did the deal given the problems of the UK water sector in the financing markets? Not MUFG and Barclays. Our sister product LPC ran a story, as the HARP deal was being announced, that MUFG sold £150m of Thames Water inflation-linked liabilities, following a similar exit from Barclays earlier in the month as banks fear the embattled utility could collapse and fall into special administration. MUFG, like Barclays which dumped £236m of inflation-linked debt, has baulked at the political risk around an entity that could be nationalised by the government, sources said. By way of illustration, investors in Southern Water's holdco will see their level reduced to £415m from £865m.
Still, life goes on. Anglian Water's midco, Osprey, found a rousing reception in the sterling market last week, issuing a £450m six-year senior secured bond that showed investors' renewed confidence in the riskier entities within UK water companies' capital structures.
Initial price thoughts of 270bp–275bp over Gilts reflected that uncertainty. One investor who said, "love it" when asked about the transaction, described those pricing levels as "generous", especially in the context of already attractive secondary levels. Pinpointing fair value, though, wasn't straightforward. The banker said there was an "element of price discovery", adding that trading in the secondary paper had been in the mid-200s. "This stuff hasn't traded inside 250bp for a long time," he said.
Any fears that the book would be relatively small were dispelled as demand reached over £1.1bn, which allowed pricing to be tightened to plus 255bp. The Osprey bond is expected to be rated BBB– by Fitch. Anglian is owned by IFM, CPPIB, GLIL, ADIA and Igneo.
HARP is a much longer piece of debt – 10 years for the banks and 30 years for the institutional investors. To get it to investment grade the deal has a National Wealth Fund credit guarantee. But pricing is said to be more project linked to specified revenues at 200bp and above, with the added spice of corporate water risk. Still, construction is the main risk.
