View from City Road: Byatt's warning disturbs surface

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Ian Byatt, the director-general of Ofwat, has resorted to scare tactics. He has warned that water bills may double by the start of the next decade in order to make the public aware of the cost of water purity.

But this is the worst-case outcome. It is by no means certain that customers will have to shoulder the entire bill for higher environmental standards. Some of the cost might have to be absorbed by companies - and possibly shareholders - through increased efficiency and higher borrowings.

Yesterday's share price jump suggested that investors were taking Mr Byatt's threat to consumers seriously. It looked like they had interpreted bad news for consumers as good news for companies. In reality, however, the rise was a recovery from recent weakness, not anything more significant.

Mr Byatt's statement was the opening shot in what will be a long battle. The way the companies will fund the extra costs in the second half of this decade will not be settled for another three years.

The battle has started with the regulator, the water companies and consumers on the same side. Their common enemy is in Brussels. But it would not be surprising if, at a later stage, the regulator and the consumer found themselves on one side facing the water companies. This has happened with other utilities, notably British Gas.

Mr Byatt is unlikely to allow the water companies to pass on the entire costs of extra capital spending. He will almost certainly require them make further savings in operating costs. His decisions may result in them taking on extra borrowings and some may even have to have rights issues. Shareholders are not in the clear yet.

But none of this will take effect until 1995. Until then, the water companies are operating in a stable regime. Their dividends look set to grow by 5 per cent or more in real terms, which is more than can be said of most listed companies. The water sector looks like an island of tranquillity in a turbulent sea.

For all but the most bullish, the water companies continue to look attractive, with their shares yielding 20 per cent more than the market as a whole. But anyone seeing the rise in manufacturing output and Hanson's comments on the US economy as significant might prefer to buy recovery stocks. Investors, however, have such a fear of false dawns that few are likely to opt for the latter course yet.

(Photograph omitted)