Thames float faces threat of heavy fine from watchdog

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Thames Water may be in line for a massive fine from the industry regulator after missing its leakage reduction target for the fourth successive year and being blamed for the drought in the London area.

The prospect of heavy fines and other regulatory action could cast a shadow over the company's planned flotation on the stock market later this year, which is expected to value the business, Britain's biggest water company, at about £7bn.

Ofwat described Thames's inability to meet its leakage target last year as a "significant failure" and said it was unacceptable in light of the 24 per cent increase in bills customers are facing over the next five years. Higher charges helped Thames to increase its pre-tax profits by 31 per cent last year to £346.5m and raise the dividend paid to its German parent company, RWE, by 53 per cent to £216m.

The regulator has the power to fine Thames up to £140m, or 10 per cent of its £1.4bn turnover. Ofwat said it was still awaiting an assessment from an independent reporter before deciding on regulatory action.

Apart from fines, this could include enforcement action and, in the extreme, the drafting in of external managers to run parts of the company. An Ofwat spokesman said: "We have not ruled anything in or anything out at this time."

Thames's target for the past year was to cut its leakage rate from 905 million litres a day to 860 million litres. In the event, Thames only cut leaks to 894 million litres a day - a leakage rate of 30 per cent. At that level it is losing enough water each day to fill 357 Olympic-sized swimming pools. The shortfall of 34 million litres compared with one of 10 million litres in 2004-05. The leakage reduction target for this year is 805 million litres.

Ofwat said the drought in south-east England was the result of two consecutive winters of below-average rainfall. However, it added: "The company's poor leakage performance is not only inefficient, it is also contributing to water shortages that have led Thames Water to impose a hosepipe ban and seek a drought order."

Jeremy Pelczer, the chief executive of Thames, said that it was "immensely frustrating" to have missed the leakage target but he said that the company was investing £1bn to tackle leaks over the next five years and had agreed to put in an extra £150m of its own money to speed up the replacement of ageing water mains.

He said that last year, 20 per cent more mains were replaced than required by Ofwat in its latest price review while 1,000 miles of mains will have been replaced by 2009, one year ahead of schedule. Thames has the oldest network in the country, with some 3,000 of its 10,000 miles of water mains being more than 150 years old. It is also the most densely populated part of the country, making replacement work more difficult.

Mr Pelczer said the increase in the dividend payment from £141m in 2004-05 to £216m was designed to put Thames's payout on a par with other water companies and denied that it was an attempt by RWE to "wring the lemon dry" before it sells the company.

RWE has said it intends to complete the float by the end of this year. It is pursuing a "twin-track" approach which involves preparing Thames for flotation at the same time as inviting trade or private equity buyers to make offers.

Thames is committed to investing £3.1bn in the 2005-10 period. Capital investment went down last year from £570m to £554m but Thames said this was mainly due to delays in building a desalination plant in east London to meet 7 per cent of the capital's needs. The project has gone to a public inquiry after objections from London's Mayor, Ken Livingstone, on the grounds of the amount of energy it would consume.

Enough leaks to fill a few hundred swimming pools

* Enough water lost each day to fill 357 Olympic-sized swimming pools

* Capital investment of £3.1bn, including £1bn to fix leaks

* Average customer bills rising by 24 per cent, to £261, in real terms

* Dividend payment to German owner RWE up 53 per cent to £216m

* 10,000 miles of water mains - a third more than 150 years old