Southern Water sewage dumps show scale of clean-up job for Australian owner

The putrid brown seawater that prevented people swimming at stretches of popular English beaches on some of the hottest days on record this summer was the result of a sharp increase in failures at Southern Water’s sewage pumping stations — and a sign of the scale of the task facing its owner, Macquarie.

A year after the Australian asset manager took over the regional water monopoly in an emergency £1bn refinancing, Southern is facing a torrent of maintenance problems.

More than half of the pollution incidents in its network — which includes popular tourist destinations Herne Bay, Whitstable and Brighton — were due to a rise in breakdowns at pumping stations, while ageing infrastructure means operational failures are happening with increased “frequency and severity” across the network, according to corporate filings seen by the Financial Times.

Southern also sparked anger among some of its 4.2mn customers across Kent, Sussex, and Hampshire when it became the first water company to impose a hose pipe ban in August. Most of its main trunk lines are more than 100 years old, causing a fifth of treated water to be lost in leakage.

Southern was not the only provider to pollute beaches and impose hose pipe bans this summer; there has been a nationwide outcry against the water and waste groups that were privatised with a £1.6bn government handout to improve their networks more than 30 years ago.

But Southern is one of the most financially stretched, making upgrades more difficult.

The £1bn of equity Macquarie injected into the business in September 2021 prevented Southern collapsing after its previous owners, a consortium led by JPMorgan, warned it risked defaulting on loans.

Just £230mn of that was used to improve Southern’s operations, according to a consultation by regulator Ofwat into the ownership transfer that finished last week. The rest has been used to reduce loans between the complex array of holding companies used by its former owners, which retain a 38 per cent stake.

Separate corporate filings seen by the FT warn that Southern’s “risk profile has deteriorated over the year” and the “company continues to be at risk of a credit rating downgrade as a result of poor operational performance”.

The company’s net debt has risen from £5bn to £6bn over the past year, which Macquarie said was due to rising inflation rather than new borrowings. Already at least one-fifth of the typical £400 per year household bill goes to paying interest rather than infrastructure improvements and services.

Meanwhile the number of pollution alerts this summer from Surfers Against Sewage, which uses real-time information from monitors on key outflow pipes to warn swimmers of health risks, suggests sewage dumps are far more common than the Environment Agency data indicates.

Martin Bradley, head of Macquarie Asset Management’s European real assets team, insisted a turnround programme was already “showing early signs of operational improvement”.

This includes a 50 per cent increase in capital investment, to £632mn in the year to March 2022, to halve pollution incidents as defined by the EA compared with last year.

Macquarie is also investing in 30,000 monitors across the network “as part of a long-term transformation that will see Southern Water become more sustainable and resilient,” said Bradley.

But it is still unclear how Macquarie can address a decades-long backlog of work at a time when the cost of living crisis is making it harder to raise bills and the risk of non-payment is increasing, especially as water companies are prevented by law from turning off supplies.

“Interest rates were exceptionally low over the past decade and that would have been an ideal time to finance large investment programmes,” said Colm Gibson, head of Berkeley Research Group’s regulatory practice. “With rates rising, it will be harder now.”

Macquarie is best known for its decade-long ownership of England’s largest water and waste group, Thames Water, which it sold in 2017. The company has been criticised for increasing Thames’s debt, taking out dividends and paying little in corporation tax — while presiding over leakage and pollution failures. Macquarie has stressed that £12bn was invested in the network over the period.

Since 2005, the Australian asset manager has bought more than £50bn of infrastructure assets in the UK, many of them former state-owned monopolies that benefit from a steady government-backed income stream. These have included Cadent Gas, the largest gas distribution network in the UK, a stake in National Grid’s gas transmission business and South East Water.

Ofwat noted in the consultation on the Southern takeover that Thames had “performed poorly across a number of metrics and concerns were raised about the business’s financial management”.

There are now fears this will be repeated at Southern.

In July Macquarie appointed two former Thames executives to Southern — Lawrence Gosden as chief executive and Bob Collington as chief operating officer. Southern’s new majority shareholder is domiciled offshore in tax-friendly Luxembourg.

Macquarie has also signalled a possible return to dividends as early as next year if Southern’s “performance is on an improving track.”

The Australian asset manager said the capital it was providing would “enable Southern Water to invest significantly to upgrade its network with £2bn to be invested over the next four years of the current regulatory period to fix the pipes, pumping stations and sewers, which are underperforming and causing harm to the local environment”.

It has also pledged to simplify Southern’s corporate structure, including the replacement of Cayman Islands-registered financing companies, which it said would take place next week.

Ofwat remains optimistic that the situation at Southern will improve. The regulator said it had made clear that “very profound changes are required and much overdue to improve and strengthen” Southern’s performance given its role as a provider of an essential public service.

But Kate Bayliss, an infrastructure finance expert at SOAS University of London, said previous history “suggests that investor returns will always be Macquarie’s priority rather than the long term social and environmental welfare of the water company operations”.