Where exactly is the river Pang? Maps say that this little chalk stream - the one believed to have inspired Kenneth Grahame's Wind in the Willows - bubbles from a spring in the heart of the Berkshire Downs and flows south and east to the river Thames at Pangbourne. But last week, when I went to find it, almost a third of the Pang was missing.

I went with Alastair Driver, the Environment Agency's head of conservation, and it was certainly nowhere near where his map said it should be, just outside the village of East Ilsey. Nor was it under Apple Pie Hill, grid reference SU5274979250, where the Ordnance Survey map pinpointed it.

"I bet it's there, in that ditch," said Driver as we drove through the village of Compton on the edge of the Downs. But it soon became clear that the river had migrated to lower ground.

"Pang? Dunno, never heard of it," said Paul, a contractor replacing 10km of leaking pipework for Thames Water on the other side of the road from the course of the Pang near Hampstead Norrey. "There's been no water in it for two years," said the landlord of the White Hart Inn, which once overlooked the river. "There used to be ducks in there - now look at it ..." A wooden bridge outside the pub spanned only earth.

We did find water in the Pang three miles further on, but a game of Pooh sticks assured Driver that the river was not flowing and so was technically a pond. Eventually we spied the Pang trickling gently over a gravel bed - at least nine miles from where we had started. The first butterflies of the year flapped past blossom, a deer crossed the lane and Driver was ecstatic at the arrival of spring and the finding of the river.

But more generally, Driver is far from happy about the way things are going: he thinks that a wildlife disaster is now practically inevitable in south-eastern England this year because it has rained so little these past 16 months. "Unless we get freakishly heavy rain you can assume that we are in for the toughest year since 1976," he told me later.

For most of Britain, emergency drought measures and government exhortations to save water seem irrelevant. Last week, even as seven south-eastern water companies imposed hosepipe bans and three asked for more draconian drought orders, reservoirs in Wales and the west country were releasing water to prevent flooding. Heavy rains and snow left rivers full in the north, and levels in underground aquifers across much of Britain were well above average.

But south and east of a line roughly from Norfolk to Hampshire, Britain is increasingly like a desert. It's one of the driest areas of Europe, and rainfall is declining. Meanwhile the water-guzzling population is going ever up and the summers are getting ever warmer. Because of the geology, the 11 million people who live there mostly get their water from boreholes which tap into chalk aquifers, but because there have been two consecutive dry winters, water levels are now seriously depleted - as can be seen in the Pang. And because almost all the rain that falls between April to October is taken up by trees and plants or by evaporation, there is no chance that they are going to replenish at all before next winter.

But just how bad is the situation? The Environment Agency said this week that its monitoring borehole in the Chiltern hills was showing lower water levels even than in 1976, the time of the worst drought in living memory. Thames Water, the country's biggest water company, says that things are now "very serious".

But then it would say that, you might argue - or how would it get us to reduce our consumption? So I asked one government water man to be brutally honest, off the record. "It's not an emergency - yet," he said. "But if it's a dry summer, and anything goes wrong at the end of August or in September - such as a major water main burst - then you could have difficulties." What does that mean - water rationing?

"Yes ... but the real nightmare is what happens if next winter is dry, too. What happens if the aquifers do not get replenished as they should from October through to March? "

Elliot Morley, the water minister, has been playing down the drought. "The water supply in the south-east is not in crisis," he reassured MPs last week. But Mike Hegarty, for one, is not so sanguine. The operations director of Sutton and East Surrey Water, which supplies 650,000 people south of London, is on the front line of drought defence.

This week, Hegarty's company's only reservoir, which provides 15% of the company's water, was full. But most of its water comes from underground and its test borehole, showing the state of its underground water supplies - in use for the past 45 years - was registering its lowest levels ever. Hegarty can't drill deeper for water because of pollution problems, and he can't dig elsewhere for water because there's nowhere left to dig.

"We have had almost 30% less rain in the past 18 months than the region normally receives. This is a 100-year event," he says. "We're now in uncharted territory. We do not really know how the boreholes will react. We actually have less water available per person in a year than the Sudan, or Egypt."

The difference, of course, between this region and Egypt, is that East Surrey is Britain's seventh wealthiest region and the most water-profligate in Britain. It has 50 golf courses, each using up to 7m litres of water a season, as well as 2,000 private swimming pools, countless dishwashers and Gatwick airport.

On top of that, every man, woman and child in East Surrey uses nearly 170 litres a day, 40 more than the average. People just do not understand the seriousness of the situation, says Hegarty. Despite a hosepipe ban, letters to every household and ads in the cinemas, demand has still not been quenched, he says.

Now the company wants a drought order to allow it to ban car-washes, park and playing field watering, the filling of swimming pools, the playing of fountains and the cleaning of boats, among other things. A group of window cleaners, some golf courses and the swimming pool maintenance workers have objected, but many of the region's 17,000 businesses are probably unaware how hard they may be hit. If the order is approved by Morley, Hegarty expects to cut demand at peak times in the summer by 25%.

And if suburbia refuses to save water? He shrugs. "It's generally accepted that the resource is fully developed in the south east. [He means by this that there's no water available.] It's not as if we can borrow it. We're getting a bit from Thames, but everyone is in the same situation."

In fact, few people in south-east England have much sympathy for the water companies. Although rivers are evidently healthier and bathing waters cleaner than a decade ago, water charges have risen nearly 25% in the past two years, and will go up again soon. Meanwhile the companies leak 15-35% of what they supply, and their profits are in many cases spectacular.

Thames Water, for example, is losing 227m litres of water more per day from its pipes than it did in 2001. This is more than all of Leeds, with 800,000 people, uses each day. "We would like what they leak," says Hegarty.

Thames Water says that it can't win. "Until recently, all the regulatory pressure was to improve the water quality and sewerage. That took the lion's share of the investment," says its spokesman, Nick Tennant. He says the company now intends to replace 1,000 miles, or 5%, of its ancient pipes by 2010.

Then there are the 565,000 new houses the government intends to build in the south-east. "Where will the water come from to supply the additional housing demand?" asks Nick Herbert, MP for Arundel and South Downs, whose own patch is to take 58,000 new homes.

"Even after the pipes have been fixed and with much greater water efficiency, there's no way we can keep up with that population increase," says Thames Water.

The water companies view the future with alarm. To make money they must sell as much water as possible, which means they must have access to as much as possible. As they can no longer rely on underground water, and the Environment Agency will not let them draw any more from rivers, their best option, they believe, is to build reservoirs. New ones are already planned for Southern Water, South East Water, Portsmouth Water and Thames Water. Others propose to extend existing ones.

The government, embarrassed by its ecological illiteracy while planning for massive growth in a semi-arid region, and its refusal to insist on water minimisation standards in new homes, will probably allow most water companies to eventually build reservoirs but only when they have shown they have stopped their leaks and explored all other possibilities.

So it is that Thames Water, for one, is investigating desalination plants, a water grid, transferring water by canal, rain-cloud seeding, even towing icebergs down from the Arctic. But it's no secret that what it wants is a Very Big Reservoir.

Officially it's called the Upper Thames Major Resource Development (UTMRD). Unofficially, it's going to be a 10 square mile lake, one of the biggest in Britain - in a boggy area of Oxfordshire four miles from Abingdon. It has been quietly planned for more than 10 years and is expected to cost nearly £1bn to construct. Ecologists reckon it would be no great loss to the Thames Valley but local people are divided on the project. Some want the reservoir to be made as beautiful as possible, to attract wildlife and water sports, while others want it as ugly as possible to deter crowds of sailors and traffic. It would probably take 10 years to build and fill.

"We would just like it to come to a head," says one member of a local residents' group called Fluvius, which is talking to Thames Water about the reservoir. "I was in a pub not long ago and asked how many people here were for the reservoir. Only two were against. Basically, [it will be built on a] flat agri-desert that grows lousy crops. The main worries are whether it will affect the water table and flood our houses."

Back near the River Pang, Driver finds a small pond, half full, in a nature reserve. He bends down and shows me the egg of a great crested newt that is about to hatch. He says it will probably die as the water evaporates over the next month or two - as will much of the insect life here. "The water companies will undoubtedly apply to [extract] large amounts from rivers this summer, in which case wildlife will suffer badly. The Pang can recover because it habitually migrates according to the water table, but it could take a decade or more for most rivers to recover if too much water is taken out of them.

"This is really all about how we use our water and how efficient we are with it. It's not as if we are going to die if we don't use our dishwashers. The question really is, should we be using a dishwasher and letting a river die?"