Memorandum submitted by the Water Industry
Commission for Scotland (DFWMB 24)
COMPETITION IN THE SCOTTISH WATER INDUSTRY
AND THE ENVIRONMENT
The Water Industry Commission for Scotland welcomes
Professor Martin Cave's thorough report on competition and innovation
in the water industry in England and Wales. We understand that
the Government intends to add clauses to the Floods bill, the
remainder of which the EFRA Committee is currently considering.
Competition in the water industry and environmental
issues are rarely considered as compatible. Indeed, it is often
perceived that competition could in some way be harmful to the
environment. However, this note outlines why, in our view, this
position does not stand proper scrutiny. This note addresses the
first "easy" step, the introduction of retail competition
based on the Scottish experience and the potential of a further
reaching reform of the water and sewerage industry. As Professor
Cave highlights, however, there are further benefits, which could
result from the development of markets in water resources, discharge
consents or in the treatment of water and sewerage.
SCOTTISH EXPERIENCE
Since 1 April 2008, organisations in Scotland
have been able to choose who supplies their water and sewerage
systems. These non-household organisations in Scotland are the
first, anywhere in the world, to have such genuine choice.
In the year since the water and sewerage market in
Scotland was opened up to competition, over a third of businesses
and public sector organisations are getting a better deal on their
water bills or enjoying other advantages such as bespoke water
saving advice, easier billing and new tariffs. This is only the
beginning. We anticipate that more suppliers will enter the market.
As the market flourishes, further cost savings, more tailored
services and environmental benefits should become available.
The successful introduction of retail competition
was a first step in introducing competition to the wider industry.
We are now concentrating our efforts on how the market might be
developed further. We are, for example, considering who might
be best placed to deliver activities such as metering, new connections
and trade effluent.
RETAIL COMPETITION
The introduction of successful retail competition
requires the legal separation of customer facing activities from
the network and treatment activities. This changes the balance
of incentives of the customer facing company to assist its customers
to reduce their consumption of water. At the current time the
vertically integrated water companies have a licence condition
to provide water efficiency advice to customers—but they
also have a clear financial incentive to develop further water
resources and not to reduce their revenues too far. The separation
of retail activities changes the balance of incentives in favour
of providing water efficiency advice where this is in the interests
of the customer. The introduction of competition ensures that
even the separated arm of the previous incumbent monopolist provides
water efficiency advice or risks losing a customer to a new entrant
to the market.
Similarly, a separated retail function will make
it more likely that the customer will receive a more tailored
service in waste management and surface drainage. There may be
a number of options open to a customer, including water harvesting
(if a customer has a need for non-potable water); the construction
of a sustainable drainage system (eg a small pond on an industrial
or business development) or pre-treatment of waste before it is
discharged to the sewerage system. In each case, the customer
may save money and there can be environmental benefits. These
benefits would include reduced power use in treating smaller volumes
of waste water (some of which does not really need to be treated),
less harmful discharges to the environment and less power used
in pumping sewage flows to the nearest treatment works.
Retail competition for those managing a large
estate of smaller properties (shops, pubs etc.) could also bring
important environmental benefits. In a monopoly situation, incumbent
suppliers generally adopt a "one size fits all" approach
to service provision. For instance, with a single supplier, multi-site
organisations often receive multiple paper bills for each sites
each quarter—not because that is the most efficient method
of billing that customer, but because that is the standard method
for billing all customers. Competitive suppliers bring much greater
diversity, seeking to win customers by tailoring their services
directly to need. In the example above, providing a single online
bill would save paper, postage and significantly reduce the carbon
footprint of the billing process (including the customer's carbon
footprint resulting from extra bill processing).
The introduction of retail competition may also
allow for more effective use of the existing network of pipes
and treatment works and less pressure to develop new water resources
(or waste water treatment capacity). This could happen through
the introduction of capacity trading or sharing. A customer's
connection has to be of sufficient size to deal with his peak
usage. But different customers will have peak usage at different
times of day or even at different times of the year. A water company
needs to maintain the ability to meet peak usage, but there is
the opportunity to manage the totality of customers as a portfolio
and meet all their needs with less resources than the theoretical
total of each customer's maximum demand. This could reduce the
need for abstraction in some areas and could, at least, postpone
the need for building high carbon emitting desalination plants.
The introduction of retail competition in Scotland
also provides a stronger incentive and greater freedom to innovate.
We have introduced a specific financial incentive for suppliers
to innovate—if they can demonstrate that they have reduced
the costs of wholesale supply (for example by reducing power used
or by reducing the need to increase the size of treatment works
or by reducing the need to abstract from a water stressed area),
they can have those costs subtracted from the wholesale charge
they pay to Scottish Water.
UPSTREAM COMPETITION
At the current time, it is relatively rare for
water companies to supply each other with water or to treat waste
water collected by another company. In many cases there could
be more cost effective and environmental solutions available if
such options were considered. The current regulatory framework
for price setting makes it unattractive for companies to take
advantage of a supply from a neighbouring company. There was a
case considered by the Competition Appeal Tribunal (Thames
Water v Albion Water), which considers this issue. Notwithstanding
the conclusions of the Tribunal, Thames remains reluctant to take
advantage of this source of water. Incidentally, abstracting this
water would actually have an environmental benefit because the
London water table is too high.
There could also be advantage in allowing for the
trading of abstraction and discharge rights. This would ensure
that these rights are used as effectively as possible and that
alternative options may be available to those who would otherwise
seek permission to abstract from more stressed water resources
or discharge into receiving waters with less capacity for dilution.
Competition upstream would require an improved
understanding of the industry's incidence of costs.
THE CURRENT
REGULATORY FRAMEWORK
The current regulatory framework gives the incumbent
a clear incentive to adopt a civil engineering solution. Fixed
assets are added to the company's regulatory capital value and,
once completed, earn a return over their whole life (whether or
not their full capacity is required). This mitigates against potentially
more sustainable solutions such as working with landowners to
improve the management of a water catchment area.
Similarly, the industry's understanding of its costs
could be improved markedly. At the current time, cost allocations
appear to be strongly influenced by the regulatory framework.
Initial evidence from our analysis in Scotland suggests that,
on a forward looking basis, the costs of water and waste water
treatment (including abstraction and discharge back to the environment)
represent a far greater proportion of on-going costs than is normally
reported. This has several important implications for sustainable
development. Firstly, it is likely to reduce the economic level
of leakage potentially by a significant proportion. Second, it
should (subject to the regulatory disincentive noted above) increase
the attractiveness of working with stakeholders on changing behaviour
to find longer term more sustainable (and lower carbon emitting)
solutions. Finally, it could increase the attractiveness of more
sustainable and long term regional solutions to water and waste
water improvements beyond the boundaries of the current companies.
The Commission would be happy to explain any
of these issues further or to answer any specific questions that
the Committee may have.
Water Industry Commission for Scotland
May 2009
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