In this video, we will examine the sale price for the England and Wales prioritized water industry when it was fully divested from the UK state in 1989. The 10 regional water authorities of England and Wales was sold for 5.24 billion pounds sterling in 1989 prices. Well that's about 11.74 billion pounds in 2015 prices. Llandudno, Wales' population was around 49 million people in 1989 or about 22 million households. So the sale price equates to about 240 pounds per household in 1989 prices. First, let's look at the sale price from the view point of an investor. This could be an individual investor in the UK say buying a small amount of shares, or corporate investors from the UK or overseas buying larger numbers of shares. Both will try to estimate what the shares will return. The most public moment where this issue would have become clear was the sector's London Stock Exchange floatation. Sadly, I wasn't there, I was 15 as I've said. I did see TV adverts about water privatization, but my family didn't buy any water shares. Photos of the water industry floatation itself are hard to come by. If you were there, please share your experiences on the discussion forums. But I imagine the scene was similar to this Financial Times newspaper photo of the London Stock Exchange in 1984. This is a photo of dealing in sheers, not the water industry. But following the flotation of the privatized telecoms company in the UK, British Telecom or BT. That scene was described as pandemonium in a UK Financial Times Newspaper report. And I imagine things were quite similar for the water floatation. On 12th December 1989, 100% of the equity for each of the 10 main water companies was offered for sale fully under written by the UK government. The general public could buy shares and indeed 44% of shares were sold to the general public. Special shares packages were offered to UK institutions and overseas investors. And 3% of shares were retained for water company employees and for water company bonuses. The UK government retained a special so-called golden share in each water company, valid until December 1994. The government was concerned about the operational and political risks from immediate overseas takeovers. This golden share arrangement aimed to prevent that for five years. After that time the Golden share was redeemed and foreign taken over did take place. In setting the price the UK Goverment tought the water industries was a risker proposition than it's earlier privatization say British gas. There were uncertainties about the amounts of capital investiment that were doiung to be needed to meet new drinking water quality and an environmental quality standards. The new water regulation setup was untested. So in setting a sale price for the water sector, ministers in the Department of the Environment and the Welsh Office made a judgment call. According to a paper by Dieter Helm, they also considered a real rate of return of 7% to be reasonable. Give him the levels of risk to invest as in broad economic climate. This settlement would allow water companies to charge average water prices above the inflation for the subsequent 10 years. Government administer has also made a judgement call that a test of whether they had set a reasonable selling price for the water industry. Would be if the shares for all the water companies commanded a premium in the range of 7% to 10% over the initial offering price, after the first day of trading. The price of the initial offering was set at 2.40 per share in 1989 prices. At the close of trading on the day that shares were offered, that was 12th of December 1989. The average share price closed at 2 pounds 80 per share. That's an average premium of 8.7%, so government ministers were probably happy. Another measure of whether the sales price was too low was whether the share offer had been heavily over subscribed. This was one measure of whether there was more demand for shares than there was of supply. If the over subscription rate was too high, then it's possible demand could have permitted a higher sale price, which would have raised more capital. For the England and Wales water privatization, this share offer was almost three times over subscribed. This does not seem unacceptably high. Initial public offerings can often be much more over subscribed than this. Water shares continued to perform well into 1990. They outperform the FTSE All Share Index. By January 1990 the average premium over the initial offering for all the water company shares was about 20%. Although this was above the government's initial target, given all the risk and uncertainties here this seems quite close to the sale price. There is some considerations about the sale price that we need to discuss briefly. They do not affect the issue of whether the sale price of the industry represented good value to investors. Because that issue was addressed by the investor's behavior. They made judgments about the future value of the revenue stream from the industry discounted over time, which would accrue to them as the new owners. However, at these some additional considerations may leave the water privatization open to criticism as to wether the process itself was a fair sensible way to transfer ownership from the public to private shareholders. This could affect legitimacy of the sector in the eyes of the public. I'll again draw here upon the 2006 joined Defra Ofwat document about being in the Wales water industries history. And on official date from bodies like the UK National Audit Office which scrutinizes the value for money of public spending. So let's look more at the 5.24 billion pounds sale price. There were cost government, passed on to tax payers to make the sale. For instance, there was some restructuring to the administrative facilitate the sale. This cost wast 240 million pounds in 1989 prices. The privatization sale was administratively complicated. The sale administration cost a further 131 million pounds. The UK government also did something that is typically written about as cancelling or writing off all the long term debt owned by the England and Wales Water and Sewage companies. That was an additional 4.9 billion pounds in 1989 prices, or about 225 pounds per household. But this was in effect an internal government transaction that did not affect the aggregate balance sheet of the state or taxpayers. However, it did mean that the new private water companies did not have to assume the debt, making them more attractive to investors. But of course, these investors also knew that the privatized water sector was going to be required very soon to invest heavily to rehabilitate the existing networks and to meet new and more demanding EU water, wastewater, and watercourse quality standards. Private investors still would have to factor in these forthcoming expenditures when they consider what they were willing to pay for the shares. There was also uncertainty about exactly what would have to be done and how. The EU compliance cost of the time were variously estimated to be between 24 to 28 billion pounds. All that's around 1,100 to 1,270 pounds per household in 1989 prices. In fact more EU directives followed later like the Water Framework Directive and the Environmental Quality Standards Directed. These also had uncertainties in their estimated costs of compliance. And these costs were estimated to be around 10 billion pounds and 27 billion pounds respectively. But back in 1989, the UK government did contribute 1.5 billion pounds or around 70 pounds per household, towards the original 24 to 28 billion investment requirement. This was a so-called green dowry for the sale. Capital tax allowances of 7.7 billion pounds again in 1989, prices were also made, or that's 350 pounds per household. A capital tax allowance here is money a business can deduct from it's income or corporate tax liabilities or depreciation considerations. Overall the DEFRA history document describes these various sale arrangements. And I quote here, as having the effect of eliminating any process to the tax payer from privatization. This was a point of contention picked up politically in 1997. The then newly elected Labour government in the UK retrospectively levied a so called wind fall tax. This was on industries privatized under the previous conservative government. It was based on the labor party's political view that these industries had been sold off too cheaply. And it was a kind of political response to public ill feeling and media stories about things like excessive profits and executive salary fat cats and the end of the world's privatization as we'll see in our later videos. The windfall tax across all the privatized utilities was about 5 billion pounds. Around 1.7 billion of that was levied on the privatized water industry, or that's about 1.24 billion in 1989 prices, roughly equivalent to the green dowry. We have to remember though that there's no counterfactual in this story. We do not know what may have happened without privatization here. Would England and Wales citizens have reliable 24/7 high quality pipe water services, both now and for the foreseeable future or a trajectory of continued deterioration? In 1989, we can remember, the public water utility assets were crumbling and failing their quality standards. Those assets would not have been able to meet higher standards in future. Investment would have been needed to improve them to meet higher standards, even if privatization had not happened. This would have meant cost of water customers, directly through higher water prices or through general taxation otherwise to comply with these higher standards. As we've seen in our prerequisites video, this investment was not happening. There's a parallel here with many developing countries water systems. In such countries, existing infrastructure is often worth little in terms of its ability to deliver future service. In England and Wales, households were already bearing costs of various kinds, as we've seen. Customers were suffering the results of significant sewer collapses, service interruptions, low water supply pressure, poor water quality, and a polluted environment. These costs or these negative externatlities of the public water industry are simply not being monetized. One aspect of the counterfactual that we can comment on to a degree is the dynamic baseline of conditions in the wider economy. The graph on top of this slides shows the UK Retail Prices Index or RPI. RPI is one of two main measures of inflation that has been used by the UK Office National Statistic. After the end of the most water privatization, UK RPI peaked around 10% then fell to around 2.5 to 4% after 1992. The guideline average real rate of return set by government ministers back in 1989 was 7% for all of water companies. That 7% return net of inflation for the 10 year period from privatization in 1989 up to the first inveserge resetting of water prices in 1999. The bottom graph shows average nominal rates of return for the privatized England and Wales water industry from 1991 onwards. These nominal rates of return include inflation. These data are from the sector's economic regulator of water. We see a 12% nominal rate of return in the early 1990s, falling to around 5 to 6% in 2000 onwards. These nominal rates of return seem reasonable when adjusted for RPI inflation. And this is particularly, so given the risks and uncertainties of future investment requirements to meet higher standards and so forth. To summarize, we've seen that the sale price set for the England and Wales water privatization was tested by investor behaviour. So we know that this was a price investors were prepared to pay. It's difficult to know what would have happened to the industry if it had remained in the public sector. We will never know the counter factual here. For instant, what might have happened to service and environmental quality standards if the industry had not been privatized. Would customers and the environment still be baring cost of poor network and service condition? Or would it have been possible to raise the capital some other ways that needed to rehabilitate water networks, and to meet new higher European standards. What do you think? In this session's discussion forums, we'd like to hear your opinion on the following three questions. First, would customers have been better off if the England and Wales water utility sector had remained in public ownership? Second, do you think taxpayers received a fair price for the England and Wales water industry in the initial offering? And third, can you think of a better way that the initial public offering could have been designed to get a higher price? In the next three videos, we'll look at some outcomes of the England and Wales water privatization. Thanks for watching this video.
