WATER UK RESPONSE
DETR CONSULTATION (EXTRACTS)
1. The DETR consultation on water competition
in England and Wales is a welcome step forward. Provided that
a sound legislative and regulatory framework is in place, competition
is a positive force which acts for the good of the industry and
2. Government has identified a number of
objectives in Section 4 of its document and we support them fully.
[These were health, environmental and social objectives.] Water
UK strongly believes that, to achieve them, Government needs to
adopt a strategic approach and develop a sound legislative framework
for competition. The way competition is introduced and develops
will have a far-reaching impact for customers, service quality
and the environment.
3. In certain circumstances, some of these
objectives may conflict with each other and we are concerned that
Government has not yet developed proposals to put the mechanisms
in place which enable the achievement of all its objectives in
a competitive environment. In particular, the Competition Act
1998 has the potential to thwart the achievement of some of the
Government's objectives if it is applied in an indiscriminate
fashion to the water industry. We believe that legislative action
is needed now to secure the Government's objectives and specify
the role that the Competition Act must be allowed to play in water.
4. First of all, we believe that Government
must decide what scope competition should have in water, for which
an appropriate framework is needed. We discuss this and related
strategic issues in Section 1 on the scope of competition.
5. We then discuss a number of broad principles
governing regulation and charging in a competitive environment
in Section 2, which are relevant whatever form competition takes.
Then, in Section 3, we comment on the proposed changes to the
abstraction licensing regime and water resource management generally.
We shall make fuller comments in July in response to two further
Government consultations on water resources.
6. We very much regret the order in which
Government is consulting: the two specific consultations on water
resources would have been more useful in anticipation and in support
of the competition consultation instead of, apparently, following
their own courses independently of competition. We attach a diagram
to this submission showing how we believe the issues are linked.
7. Finally, in Section 4, we comment on
the Government's proposals for incremental changes to the current
competitive arrangements (inset, bulk-supply, mains connection
etc). We are concerned that Government is proposing to remove
some of the controls which existing water undertakers currently
exercise to protect public health and the environment and appears
not to have yet developed proposals for the mechanisms which it
will need to put in place as a replacement. Without these replacement
mechanisms, competition will be seen as increasing risks to the
public when it need not be so.
[Section 1 omitted]
8. Competition will deliver most benefits
if it is conducted according to certain rules which all competitors
must follow. In water, the reasons for these rules are based on
considerations of health and safety but also on the need to ensure
that only those competitors succeed who are really best at serving
their customers, and not merely those who gain a short-term advantage
because they avoid some of the obligations currently placed on
9. A fundamental principle for water competition
is that all participants must be subject to licensing by the Director
General of Water Services and monitoring by the DGWS, Drinking
Water Inspectorate and Environmental Agencyand not by the
existing undertakers. All participants should (as far as practicable)
be subject to the same legislative regime as the existing undertakers.
This principle is essential whatever form of competition is introduced
for a number of reasons:
Licensing provides for an independent
check on the suitability of new entrants. Otherwise existing water
undertakers would be policing entry to the water industry by potential
competitors, which is inappropriate.
Even if a new entrant were to engage
in retail competition only, without common carriage, such a new
entrant would need to be licensed to ensure that it fulfils appropriate
environmental and social obligations like the other participants
in the market.
If common carriage is introduced
as well as retail competition, licensing is essential to safeguard
health, security of supply, and integrity of the network. The
Drinking Water Inspectorate has jurisdiction over licensed undertakers
only, and it would be unreasonable to expect the current undertakers,
as pipe owners, to face a criminal liability for failing to supply
wholesome water when the offending water has been provided by
new entrants which are not subject to DWI controls. New entrants
ought to be policed for water quality by an independent authority,
namely the DWI, as well as by the organisation responsible for
network management and the final delivery of water to customer
Moreover, licensing can require that
appropriate provisions are made to ensure that a supplier of last
resort exists for all domestic customers without stifling competition.
10. Primary legislation will be needed for
a well-functioning licensing system to be set up and to ensure
that the criminal liability for supplying unfit water is assigned
correctly. Water UK offers to work closely with DETR to settle
the details of the required legislative changes.
11. Apart from provisions for universal
licensing, the regulatory framework needs to be augmented by provisions
which make it clear that the current statutory undertakers, as
pipe owners, retain overall control of the network and inputs
to the network.
12. We believe that there is already a substantial
degree of reasonable consensus on access to networks. The water
industry has agreed and published its Principles for Network Access.
A combination of these Principles and a clear framework of legislation
and regulation could form a sound basis for a national code.
13. The industry and Water UK would wish
to take the lead in developing such a code in partnership with
relevant stakeholders. The result would be fair and balanced and
would reflect the needs of both parties to an agreement as existing
members of the industry, so far, have been the most active competitors
and new entrants in others' territories.
14. If Government felt it necessary, such
a code could then be translated into a statutory code under of
the Water Industry Act 1991. It may be necessary to legislate
to ensure that such code is exempt from the Competition Act but
further legislation would be counter-productive. Indeed, such
a code can provide a broad framework only, as many local issues
need to be resolved on a case-by-case basis. Also, and most important,
any access code, even a national one, needs to be able to evolve
Cost of Competition
15. It is important that the introduction
of competition is accompanied by efficiencies in regulation, where
possible. However, we are not over optimistic about the scope
for reducing the costs of regulation as we see little opportunity
for significant reduction of OFWAT's regulatory activities as
a result of this consultation paper. OFWAT's budget has increased
inexorably ever since it was set up and this year's increase has
been justified by the need to take on extra work arising, in part,
from the Competition Act. Also, the cost of regulatory activities
for DWI and the EA could increase significantly.
16. Nevertheless, we think OFWAT should
be challenged by central Government to put forward proposals for
17. We would like to see a proper regulatory
appraisal by Government of the costs and benefits of introducing
competition, in whatever form. We presume that this will be issued
at the time that Government responds to consultation and would
welcome confirmation of this.
18. The prime aim of competition, as set
out in section 3 of the consultation document, is to achieve greater
efficiency than might otherwise have been achieved under the existing
competitive pressures that already applyOFWAT's approach
to comparative efficiency, and capital market disciplines. In
water, regulation via comparative efficiency has already led to
substantial efficiency gains, and the scope for further improvement
may be limited.
19. In framing an assessment the impacts
on all customers should be considered. As paragraph 3.7 of the
DETR document indicates it is important not to give some customers
benefits at the expense of others. The impact on average bills
for all customers over the medium term, relative to what might
otherwise have happened, is therefore a good indicator.
20. Other important issues are whether there
are impacts on public health, environmental quality, water quality
and service standards, and on vulnerable groups.
21. We agree it is important that potential
new entrants pay a fair share of regulatory costs. As an OFWAT
letter to Managing Directors (MD154) indicates the direct costs
of new entry should not be spread across the entire customer base.
This is supported by observation of competitive markets, where
cost of entry is borne by the new entrants and recovered from
22. One mechanism that achieves this is
to ensure that the licence fees paid by existing undertakers and
new entrants are all properly cost reflective. We are not aware
of OFWAT's policy on this matter, which perhaps needs to be reviewed.
Another mechanism is to allow incumbents to charge for work to
assist new entrants.
23. The competition framework must be designed
to ensure that all customers receive financial and other benefits
from competition, not just a few at the expense of others. Water
UK welcomes Government's clear statement that it wishes to maintain
regional averaging. This objective, however, has a fundamental
impact on the way access to the pipe network is priced.
24. The continuation of regional averaging
requires both legal and regulatory support. Indeed, it is because
of this support that the consultation document, in the last sentence
of paragraph 7.20, can refer to the maintenance of averaging in
gas and electricity, and it would be misleading to suggest that
the maintenance of averaging in these sectors is not the direct
result of statutory and regulatory action.
25. The statement in paragraph 7.21 that
Government believes it important that "costs continue to
be averaged across all customers in a region" provides an
initial statement of Government policy that needs to be developed
further. We believe that the principle of average pricing should
be retained for all domestic customers and the link between policy
for business prices and that for domestic average prices needs
to be carefully assessed and controlled.
26. The Competition Act may lead to pressure
from customers, particularly in distinct sub-regions, for a de-averaged
price, using a challenge under the prohibition contained in Chapter
II of the Act. Government could help to avoid this by modifying
the application of relevant aspects of the Competition Act with
regard to the water industry.
27. Beside the maintenance of regional averaging,
a regulatory and legal framework needs to be put in place to ensure
that the burden of the social and environmental obligations currently
borne by all customers continues to be shared among them in a
fair way. Customers should contribute to these obligations independently
of who supplies them with water services. One method to achieve
this would be through the universal licensing process which we
Charging for network access
28. The principle of price averaging at
the retail end must be backed up by regionally averaged network
access charges, rather than charges reflecting the local costs
of distributing water for a specific new entrant. [Allowances
for leakage, for instance, may also need to be averaged over the
whole of a regional network.] Government needs to provide clear
guidance to the economic regulator that such charges [and leakage
allowances] should be supported but it is important not to over-constrain
companies at this very early stage of the development of competition.
29. There will be pressures onand,
perhaps, incentives forcompanies which own pipes to which
new entrants seek access to set access prices on the basis of
relevant costs. This is likely to lead to a degree of regional
de-averaging, for example between divisions within companies.
One way forward could be for existing companies (pipe owners)
to put forward access charging proposals that are appropriate
to their local circumstances and for these to be reviewed by the
regulator against principles agreed with Government.
30. Without express statutory provision,
we do not think that regional averaging will be sustainable in
water. This results from the relatively high costs of transport
between regions, and the variations in the costs of new resources
between areas. There is significantly less connectivity in the
water "grid" both between regions and within regions.
Hence transporting water is not only expensive, but often physically
impossible without further capital investment.
31. As Government notes, the costs of laying
pipes vary with geographical conditions (paragraph 7.20). This
is likely to remain a relevant fact and we do not fully understand
the first sentence of paragraph 7.20 suggesting that the unit
cost of pipe laying and maintaining could be driven towards an
industry norm. There is nothing in the Government's proposals
that would increase the incentives to drive that cost towards
an industry norm over and above incentives that already exist
under the existing regulatory regime.
32. Cost differentials within regions are
probably large. Reliable information is unlikely to be available
because the water industry has not needed to assess the differentials
until now. Experience in other network industries is that estimating
cost differentials is not a straightforward exercise; it relies
heavily on the chosen methodology and benchmarks. If Government
wants to assess the cost of regional cross-subsidies, we suggest
that an industry-wide exercise is needed to develop an appropriate
Charging for supply of last resort
33. The cost of being a supplier of last
resort must be recoverable by the organisation responsible for
it, currently the existing water undertakers. For business customers
the arrangement should be a commercial matter to be agreed between
the pipe owner and the new supplier, subject only to normal competition
34. Operational costs might only be charged
for when the particular failure arises that causes a call to the
supplier of last resort. If spare capacity must be maintained
then a capacity charge would be required, which should be charged
to customers of the new supplier, not customers in general. The
opportunity cost of water reserved for cases of need but not sold
to others must also be recovered. And the incumbent would need
to be reassured that payment would be made.
Charging for trade effluent
35. As the consultation document notes,
the water industry charges business users on the basis of an agreed
formula, the Mogden formula. There is a lot of misapprehension
about the nature of the Mogden formula which is reflected in the
questions posed in the consultation document. The Mogden formula
does not raise any significant competition issues that are not
already addressed by the economic regulator.
36. The Mogden formula is a flexible framework
and companies are entirely free to adapt the formula to their
own local circumstances by, for instance, adding cost drivers
for new substances. The balance between components is investigated
by OFWAT to ensure that charging schemes are properly cost reflective.
37. Most concerns that customers have about
trade effluent charges are essentially about rising charges, especially
at coastal sites, which are a direct result of government policy
to raise standards of treatment. It is the underlying cost pressures,
not the formula, that constitute the real problem.
38. We do not believe that changes are needed
and, therefore, do not have suggestions for making alterations.
Enforcement under the Water Industry Acts would be an unnecessary
addition to the burden of regulation and inconsistent with Government
policy on better regulation. It would also add rigidities in a
pricing mechanism which, subject to the provisions of the Competition
Act and OFWAT's regulation, must remain responsive to the industry
Cost of capital
39. The view attributed to OFWAT (at the
foot of page 10 of the consultation document) that competition
will have a minimal impact on the cost of capital is clearly incorrect.
Markets are already aware that Government wishes to extend competition
in water and that this is likely to lead to sizeable losses in
incumbent company revenues.
40. This prospect is already included in
water company share prices and is one factor, together with the
1999 price review outcome, which explains why the market value
of many companies is currently below regulatory capital value.
41. The economic regulator has a continuing
duty to finance companies' functions. This means that at the next
price review the DG should allow a more realistic cost of capital
than allowed in the 1999 review and make proper allowance for
the risks associated with competition, including stranded assets.
42. In responding to this part of the DETR
consultation we have taken other Government consultations into
consideration as far as possible, namely that by the DETR on Economic
Instruments and that by the EA on Catchment Abstraction Management
Strategies (CAMS). A diagram
at the end of this response outlines how we believe the issues
are linked. We shall comment more fully on issues relevant to
water resources in responding to these two consultations.
43. If Government decides that competition
should develop through common carriage and competition for water
resources, the need is then to devise mechanisms for water abstraction
and treatment which ensure that competition for water resources
leads to greater water efficiency and cost savings. We do not
believe that the current proposals will necessarily achieve this
result. Specific proposals may, instead, increase the cost of
abstraction licences, which will eventually be passed to customers.
44. We agree with the policy objective in
paragraph 4.4 that there must be no detriment to the environment
from changes in the abstraction licensing regime. Any changes
must be underpinned by clear legislation.
45. We are very disappointed that various
proposals in the three consultations apparently ignore the fact
that the industry needs to retain licences because of its obligation
to supply and its role as supplier of last resort. If the current
water undertakers are to retain their obligations as suppliers
of last resort, which would seem appropriate for the time being,
then they must have a guarantee that the water resources will
be available. Indeed, our understanding of the Water Resources
Act 1991 (section 15) is that it provides that the Environment
Agency must have particular regard to the effect on water undertakers
of the exercise of its statutory powers.
46. Many of the proposals also do not seem
to recognise that the water industry is far from having a monopoly
over water resources.
47. The supplier of last resort issue is
important and needs to be properly addressed. In the interests
of our customers, we must start from the presumption that, for
domestic customers, the obligation to supply of last resort rests
on the current water undertaker, as now. There is no such presumption
for industrial customers. To impose one will limit innovation
and, hence, competition.
48. Companies hold licences which they do
not use because of their need to plan for drought years in particular.
It would be inappropriate to assume that these licences are therefore
hoarded in contravention of the Competition Act. We are concerned
that Government does not appear to recognise this essential point.
49. The new legal framework which we are
asking for must make clear provisions identifying the supplier
of last resort, recognising that this role could evolve as new
entrants become large suppliers. The concept of "supplier
of last resort" will need to be defined very carefully. It
must relate to objectively measurable conditions such as "extreme
drought" and not, simply, to the fact that a competitor has
used cheaper, but unreliable or interruptible water sources. As
we said earlier, the costs to the supplier of last resort must
be realistically assessed.
50. For the time being, the network owner
must remain responsible for drought contingency plans.
Transfer of licences and bulk supply
51. We do not support giving a special role
to DG to order compulsory transfers of licences or bulk supply.
Additional powers for the Director General merely add another
layer of complexity. Management of the abstraction licence process
and water resources generally needs to be clearly defined and
left to the EA in furtherance of their own statutory water resource
duties. The Director General, the OFT and the courts can already
challenge companies for the abuse of a dominant position under
the Competition Act.
21 Not printed. Back