Drinking water companies have to change their financial conduct owing to climate change
During the last few Dutch summers, the water level sank below acceptable standards due to periods of drought. Water pressure had to be lowered in several regions. How will drinking water companies adapt to climate change? In an opinion article from Het Financieele Dagblad, Professor of Empirical Economics at Erasmus School of Economics Elbert Dijkgraaf argues that regulations concerning profit levels require adjustments.
One thing is crystal clear: to maintain a reliable level of healthy, clean and sustainable drinking water, extra investments have to be made in production and distribution capacity. In the next ten years, investments have to increase by an astrological amount of 60% to reach the required 6.7 billion euros in spending. But how are we going to finance this?
In the current situation, the government sets a maximum profit level every few years. This profit has a set objective: it will be used to finance the cost of debt and equity. This is measured by the weighted average cost of capital (wacc): the excess return on an investment. However, the wacc has decreased significantly due to a declining market interest rate. In the period 2011-2019, the wacc was on average 4.8%. Next year, estimations of the wacc are around 2.2%. Because of this development, equity of drinking water companies is too low to cover the cost of investment. According to Dijkgraaf, equity levels are still too low if drinking water companies were to be able to realise the maximal authorised profit levels.
Dijkgraaf points to two solutions: to inject capital via the shareholders, or to change the system in order to allow higher profit rates. The first solution would be a peculiar one, since the shareholders of drinking water companies are provinces and municipalities. This means that a capital injection would effectively be financed by citizens, since all that capital is tax money. The second option is more logical, according to Dijkgraaf. The current system has been set up in order to protect citizens. This is explicable, because drinking water companies operate in a closed and heavily regulated market and are monopolist. Profit regulation was deemed necessary to prevent owners of these companies to enrich themselves at the expense of the consumer. The simple fact that profits would be made, is not problematic, since it can be used for good initiatives. The solution to prevent enrichment is to put a cap on profit payments and solvability.