Will competition change the water industry?
19 November 2012
By Nicola Fomes, Consultant, PwC
Last month, Sonia Brown, Senior Director of Markets and Economics at Ofwat, delivered an interesting lecture on overcoming barriers to competition in water, as part of the Beesley Lecture series. Sonia’s lecture focused on the rationale for applying market forces to deliver goals of greater choice for customers and greater productive, dynamic and allocative efficiency within the industry.
The water sector is about to enter a period of change, including the introduction of greater competition. The UK Government published a draft Water Bill in July 2012, expanding the market reform proposals and commitments made in the Water White Paper issued in December 2011. The key initial milestone for market reform is the target date of April 2017 for opening a cross-border retail market between England and Scotland. Meanwhile, Ofwat has started the consultation process on the price limits for the next regulatory period (2015–20) including separate wholesale and retail price limits, as well as extending accounting separation to measure the costs of services provided by the water companies. The proposed reforms have led to regulatory uncertainty while the details of implementation are worked through.
While the reforms could lead to a tougher operating environment, they could also offer new opportunities for the more efficiently run water companies. The changes are the most extensive and far-reaching since privatisation in 1989, - though the core regulatory framework will remain in place for wholesale (core infrastructure) operations.
The market reforms broadly fall into three areas:
- Extending the retail market to all non-domestic water and sewerage customers in England and steps towards a cross-border market with Scotland (currently the market is only open to customers using over 5 million litres per year).
- Increased water and (potentially) wastewater trading between companies, aimed at achieving a more efficient allocation of resources between companies.
- Allowing entry to the market for upstream resources and treatment. However, the design of upstream market arrangements is likely to be complex, and significant work from government, regulators and the industry will be needed to implement them, with uncertain outcomes.
More information on the reform of the water sector is available on our website www.pwc.co.uk/water.
Sonia Brown argued that business customers want greater choice, and that companies are already reacting to the future changes to the retail market proposed in the draft Water Bill. Examples include companies in England obtaining licences in the existing market for non-domestic water and sewerage retail in Scotland; and incumbents restructuring their retail and wholesale functions to improve the emphasis on service to customers. This may be an early indication that the reforms proposed in the draft Water Bill will drive innovation.
She also highlighted dissatisfaction among individual domestic customers who appealed complaints to Ofwat. However, the White Paper effectively rules out domestic competition. So domestic water customers will remain reliant on the regulator to drive improvements in efficiency and service.
The overall structure of the incumbent companies is left unchanged by the draft Water Bill, which retains the vertically integrated ‘source to tap’ and ‘sink to sea’ model for incumbent licensing and regulation. This follows the Government’s direction, set out in the White Paper, that the investment model for the industry should be protected to ensure that incumbent companies can deliver significant future infrastructure needs efficiently. Sonia expressed a strong view that allowing exit from the retail business for incumbent companies on a voluntary basis would be beneficial and should be allowed. The industry broadly agrees.
Sonia Brown pointed out that the continued vertically integrated structure of the incumbent companies is likely to result in the need for additional safeguards to achieve a ‘level playing field’ for entrants and incumbents. Various policy levers are available, including the licence and market rules contained within the statutory market codes that will be part of the reforms. But licence changes could involve significant compliance costs or risks for incumbent companies. The industry will be keen to understand the changes Ofwat will be proposing to achieve a level playing field due to the significant impact it is likely to have on the way they operate their businesses, and manage staff conduct.
While the draft Water Bill sets out a clear Government direction on retail and upstream competition, delivering the reforms is a major challenge for the industry. The Bill leaves many areas of uncertainty, including market design, access pricing, and the detailed contents of statutory codes - so the devil will be very much be in the detail of how these are implemented. The industry will be heavily involved in developing solutions through the High Level Group and working groups tasked with implementing the reforms, which should allow companies to raise their concerns, and hopefully provide an open forum to offer practical solutions.
Sonia Brown argued that market forces are a more effective tool than regulation in resolving issues such as arriving at the best means of allocating scarce water resources, especially in the south and east of England where there are areas of overabstraction or overlicensing of water sources. There is debate within the industry whether the combination of abstraction-related incentives and use of market forces is sufficient to replace the sort of co-ordinated approach to managing water resources that has historically been undertaken by companies during droughts. Comparisons with energy, where long term security of supply is a key issue for Government, would suggest that these concerns warrant closer consideration during the implementation process.
In the latter part of the lecture, Sonia highlighted enabling reforms that will underpin future regulation, including separation of retail and wholesale price limits and the introduction of a new incentives framework for the sector. Taken as a whole, the reforms are the largest collective set of changes to occur in the England and Wales water and sewerage sector since privatisation in 1989. The water sector needs to make itself ready for the significant tasks that will be asked of it over the coming years.
Email: Nicola Fomes
Tel: +44 (0) 20721 28047